Abu Dhabi Investment in Citi: Not a Panacea

This morning, the Abu Dhabi Investment Authority announced that it is investing $7.5 billion in Citigroup. It is startling that some of our largest financial institutions have exercised such poor discretion that they now need to be bailed out by foreign governments, but that seems to be the case.

When I heard the news and saw Citigroup trading up, the first thing that came to mind was the Bank of America investment in Countrywide a few months ago. That investment, which caused an extraordinary spike in Countrywide's shares wasn't exactly well disclosed at the time. Whereas Bank of America's investment conversion price to Countrywide shares was initially widely reported to be at $18 a share, it later became clear that B of A has broad discretion to change the conversion price.

Fortunately, for Citibank and for investors (long and short), there was much better disclosure of the terms (although I would note that the Wall Street Journal anyway managed to fail to properly disclose the terms). In summary, Abu Dhabi is getting bonds that must be converted and will pay interest of 11% annually. They'll convert into stock priced at $31.83 to $37.24 a share, with the conversion to occur between March 2010 and September 2011. While the stock trades lower that the lowest strike price, they can still sit and get 11% interest for the next 2 1/2 years before the conversion.

Citigroup still has a lot of problems. First, it has no CEO and it has had one for a while. Second, even with this investment Tier 1 capital will remain below target after the already announced 4th quarter writedowns. Third, they are going to face additional writedowns that I believe will be significant (I actually believe that they have been unable to sign a new CEO because their candidates would want them to make additional disclosures before accepting). Fourth, the bank has refused to put its SIV assets on its balance sheet as HSBC did yesterday; it may ultimately be required to do so - these assets may be more than $100 billion. Fifth, they may need additional capital to improve reserve for loan losses.

Let's come back to the Abu Dhabi note. I think it is a pretty nice looking note, and since I cannot get yields like this on a convertible instrument, I'd love to be able to buy in too, but I cannot (even though I have a pretty nice size account with Citi). I can see that the buyers got what looks like a pretty sweatheat deal with the stock at $30 and I am not the smartest investor. I assume that not only the buyers here are as smart as me but that the sellers are also pretty smart. They wouldn't be giving away 4.9% of the company at a bargain price like this if there weren't more problems to come. The deal with the 11% coupon and the conversion strikes beginning at $31.83 makes would be a good one for both the buyer and the seller if the stock were trading around 25, but doesn't represent a good deal for the seller with the stock at $30.

While nobody is going to ring the bell and tell you that it is time to buy, I believe that this thing is going to get a whole lot close to 25 before you want to start getting in.