(By Mani) Major changes to top management could be the start of a real change at Citigroup Inc. (NYSE:C) with Chairman Michael O'Neill calling the shots.
O'Neill has successful experience as a banker who is not afraid to cut the cord if that's best for business.
As O'Neill said on the recent conference call, "You can't teach an old dog new tricks." Investors and Wall Street analysts hope he will lead a successful turn around of Citigroup, which trails JPMorgan Chase (NYSE:JPM) and Bank of America Corp. (NYSE:BAC) in terms of assets.
Citigroup abruptly announced the resignation of CEO Vikram Pandit and COO John Havens. Pandit will also step down from the board immediately. Citi´s head of Europe, the Middle East and Africa (EMEA), Michael Corbat, has been selected by the Board as the new CEO.
Corbat has been with the company for over 29 years, having served as CEO of Citi Holdings and most recently head of EMEA. It was during his time at Citi Holdings that he might have developed a close relationship with O'Neill. News outlets have reported the mounting tension with former-CEO Pandit, and Chairman O'Neill.
"We believe Chairman O'Neill is more focused on winding down the Citi Holdings unit and is open to shrinking or breaking up Citi, which we believe will ultimately add to shareholder value by driving up return on equity (ROE)," RBC Capital Markets analyst Gerard Cassidy said in a client note.
Most investors would agree that companies that deliver a higher ROE are awarded a higher price-to-book (P/B) and price-to-tangible book valuations (P/TBV). The traditional method of achieving high returns is to grow the balance sheet in most instances, which leads to earnings growth.
Given the current growth prospects and regulatory environment, growing the balance sheet may not be feasible in the near term, and possibly further out as well given the current macro uncertainty.
However, outstanding returns can still be achieved in a slow growth, low interest rate environment if companies focus on right-sizing costs, shrinking the balance sheet, and returning excess capital to shareholders.
"We believe Citi could increase shareholder returns by shrinking the balance sheet. As Citi shrinks its balance sheet, we believe Citi's ROA and ROE could reach 1.25 percent and 12.5 percent, respectively, under Basel III rules. This would imply a valuation of close to 1.5x book value," the analyst said.
In addition, assuming a glide path from 2013 to 2016 to reach 1.25 percent return on assets (ROA) and 18 percent asset reduction, Citi would accumulate over $50 billion in excess capital from 2014 to 2015, the majority of which could be returned to shareholders. This would add further support to the stock price.
"We believe that with Michael O'Neill at the helm as chairman, a shrinking of Citi could come quicker and more efficiently than under prior leadership," Cassidy noted.
O'Neill lead Bank of Hawaii Corp., with a price to book value below 100 percent when he started, to over 350 percent when O'Neill left. During his period, Bank of Hawaii was able to increase its stock price by 224 percent without the need for growth.
O'Neill's interests were aligned with shareholders' interests from day one. Additionally, rather than take cash for an annual salary he was given stock options. O'Neill knew explicitly what is taught in every Investment 101 class, companies with higher ROEs will be awarded higher P/B valuations. He drove his company's return on equity higher and was richly rewarded with a higher stock price and valuation.
As a result, there would be a radical rethinking at Citi where future decisions would be made keeping shareholders in mind.