By now, you've probably heard about Citigroup's (NYSE:C) subprime exposure and the potential impact it could have on the bank's earnings going forward. However, not all is doom and gloom.
The company is set to receive a major capital infusion, which should prove to be a net positive for the company and its shareholders.
The Terms of the Deal
In case you missed it among the flurry of bad news that has beset the company over the last few months, on Monday November 26 it was reported that the Abu Dhabi Investment Authority (ADIA) will invest $7.5 billion in Citigroup. That equates to about 4.9% of the company. It is expected that Citigroup will use this money to shore up its balance sheet and to weather the lingering financial storm.
In return for its investment, the ADIA will receive equity units that will pay an annual yield of 11%. The units convert to common shares at prices ranging from $31.83 to $37.24 a share. I think the fact that Abu Dhabi, which is the one of wealthiest places in the Middle East, is investing this kind of money in Citigroup is a signal that it thinks Citigroup will survive and ultimately thrive.
Another great sign is that this investment comes without any overt board strings. The ADIA will reportedly not have any special rights of ownership or the ability to designate a member of the board. The motivation seems to be Citi's investment merit and not a desire to break up the company or to influence corporate governance issues. (For more details on the deal, see "Citi to Sell &7.5 Billion of Equity Units to the Abu Dhabi Investment Authority".)
You'll note in my first paragraph that I said that I think the investment will be a net positive. There could be some downside. While it has been reported that ADIA will not have special rights, with such a large stake in the company I think that it will almost certainly be on management's speed dial, and that ADIA's opinions on certain matters will probably count for something.
The other downside as I see it is what's to stop the ADIA from shorting the stock (like some convertible bond holders may do) in order to capture the 11% rate of return with minimal risk? (To learn more about short selling, see Short Selling Tutorial.)
Now, perhaps such action has been touched upon behind the scenes and barred, or the ADIA has no plans to do this, or it can't do it. However, if ADIA did so, I suspect it could artificially hold down the stock. And so I must at least ask the question and throw that possibility at out there.
While Citigroup has been besieged with bad news, I think the recent investment by the ADIA is a positive that should provide the company with financial flexibility. Abu Dhabi Investment Authority's apparent willingness to invest in the bank for the long-term it is a good sign that it thinks Citi has a viable future.
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