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The perfect spinoff
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December 19, 2001: 7:16 p.m. ET
Citigroup's decision to shed its Travelers Property Casualty insurance operations will bolster the banking giant's finances.
By Michael Sivy
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NEW YORK (CNN/Money) - Sandy Weill got control of Citibank in 1998 by merging his insurance company Travelers Group into it. The combination, which also includes brokerage Salomon Smith Barney, put Weill in charge of the world's largest financial-services empire. Now, like a man kicking away a ladder after he has ascended it, Weill proposes to spin off the property and casualty division of Travelers. (See full news story.)
Most market forecasters are long-term bulls on financial-services stocks, which are relatively cheap and should benefit over the next couple of years from upturns in both the economy and the stock market. And many analysts rate Citigroup as one of the most promising stocks in the sector. The proposed spinoff will only make the stock more attractive.
The goals of a strategic spinoff are to focus a company's operations, while getting rid of the slowest-growing businesses. Ideally, this should be done in a way that raises as much cash for the parent as possible, while meeting the requirements for favorable tax treatment.
Generally the parent is allowed to sell up to 20 percent of the proposed spinoff through an initial public offering and keep the proceeds. Sometimes, the tax authorities also allow a little balance-sheet reshuffling that shifts cash to the parent or debt to the newly independent firm.
Barring some surprise, Travelers looks to be a nearly perfect spinoff. The property-and-casualty operations account for less than 10 percent of Citigroup's total revenues and are the slowest growing part of the company. After the spinoff, Citigroup's business mix would consist of banking and brokerage that fit well with the Travelers life insurance and annuity operations that are being retained.
The timing of the spinoff also appears to be shrewd. The IPO, which is scheduled for early next year, should be priced favorably because P&C insurers have been able to raise rates following the Sept. 11 attacks.
If all goes as planned, Citigroup could realize more than $4 billion from the IPO. In addition, Travelers P&C is slated to pay a $1 billion special dividend to Citigroup. Then the rest of Travelers P&C would be distributed to Citigroup shareholders on a tax-free basis before the end of 2002.
Once independent, the company might even be able to improve its growth rate. As a rule, the share prices of such spinoffs often drop in price right after they are distributed. Shareholders of the parent company often don't want the spinoff and sell it shortly after they receive it, driving down its share price. After any such dip, however, spinoffs typically bounce back and go on to outperform the overall market over the following two or three years.
Citigroup looks good too. Loan defaults are always an issue for bank as large as Citibank -- it was a major lender to Enron, for instance. But problem loans usually peak at about this point in a recession and are worked down by banks in the first couple of years of a recovery. Similarly, Salomon Smith Barney stands to benefit from the next stock market advance and a pickup in mergers and acquisitions. In addition, the company will have plenty of cash to make acquisitions of its own that strengthen its franchise in financial services.
The spinoff is expected to have no negative effect on earnings in 2002 and to raise Citigroup's growth rate in subsequent years. Altogether, earnings are projected to rise at a 15 percent compound annual rate over the next five years. Like most financial services stocks, however, Citigroup is priced fairly cheaply relative to its growth rate. At a current price of $50 a share, the stock trades at less than 16 times estimated 2002 earnings.
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