March 6, 2008: 4:35 AM EST
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Seeking Citi's silver lining

Grim news hits Citigroup seemingly every day, but some analysts think the stock may be excessively battered.

By Colin Barr, senior writer
Citi CEO Vikram Pandit insists that his company remains fundamentally strong - and he may have a point.

NEW YORK (Fortune) -- Maybe the Citi selloff has gotten out of hand.

Every day seems to bring a new round of bad news at the New York-based bank. Just this week, Merrill Lynch analysts predicted Citi would take $15 billion in first-quarter writedowns on mortgage-related securities - on top of the $18 billion hit Citi took in its fourth quarter. That forecast came on the same day that the head of Dubai's sovereign wealth fund warned that it will "take a lot more money" to pull Citi through the mortgage mess.

The comments sent Citi shares plunging to a nine-year low Tuesday and prompted CEO Vikram Pandit to issue his latest defense of the company's financial strength. In a letter to employees Wednesday, Pandit said Citi is willing to sell some "peripheral businesses" but doesn't need to raise new capital. "While we face a challenging economic environment in many segments of our operations," he wrote, "fundamentally we remain strong."

It's no surprise to hear Pandit saying that. But with Citi shares trading at around book value following a 55% plunge over the past year, he isn't the only one saying the negativity on Citi may be overdone. "The franchise, despite its current balance sheet woes, does have an earnings capability," wrote analyst Charles Peabody at Portales Partners in New York in a Wednesday upgrade of Citi to hold from sell. "Between now and the spring, we envision greater clarity and stability emerging around the Citigroup franchise and fundamentals. We expect those two elements to provide some stability to the shares."

Even Guy Moszkowski, the Merrill Lynch (MER, Fortune 500) analyst who on Tuesday slashed his 2008 earnings estimate at Citi to 24 cents a share from his previous target of $2.74 a share, outlines the beginnings of a bullish take on the stock. Moszkowski emphasizes that he remains "concerned about loss provision potential, the direction of long-term strategy, and weak markets for the Capital Markets businesses." But he adds that, adjusted for an expected loss this quarter and recent capital raising actions, Citi stock "now trades near pro-forma book" - a level that tends to bring value investors out to kick the tires.

While Merrill and Portales are hardly making bang-on-the-table buy calls, their arguments do shed light on why investors have been taking interest in Citi stock during its long decline. Bets that Citi will bounce back seem to rest on two assumptions: that the market is underestimating the company's long-term earnings power, and that new management under Pandit - who took over in December after Chuck Prince left under the cloud of subprime-related losses - will take decisive action and set the bank back on a winning course. Pandit already has raised $30 billion in capital and announced plans to cut thousands of jobs, but news reports say he may make deeper cuts in coming months. He has also trimmed the quarterly dividend to a more sustainable level and made some changes in management. Investors expect to hear Pandit sketch out a fuller vision of where the company is going at May 9's investor/analyst day.

Another plus is that even with Citi facing billions of dollars of additional writedowns, the bank may not need to sell stock again in the near future. Citi noted back in January that its year-end capital-raising spree allowed the company to "meaningfully exceed our capital ratio targets" as of Dec. 31. Portales' Peabody writes that having already raised abundant new capital, Citi can wait to cash in on a potential Visa IPO or sell loan portfolios if it needs more cash.

That's not a view that's widely held right now. Citi shares are down 24% for the year, in part due to fears the bank will have to resort to fire sales to raise cash. Analyst Meredith Whitney at Oppenheimer has been saying since last fall that Citi will need to raise money by selling assets as writedowns mount in the subprime lending, leveraged corporate loan and consumer businesses. She wrote back on Feb. 25 that "core fundamentals are rapidly deteriorating, liquidity has been choked, and recovery rates are in the process of dropping to historic proportions."

That doesn't sound good. But for now, Pandit seems to be following the script dictated by those who believe Citi can thrive simply by reining in the excesses of the Prince era. Bill Miller, the Legg Mason Value Trust manager whose picks outperformed the S&P 500 every year from 1992 to 2006, said in December that Citi needed a strong leader who would simplify the bank's processes - not a vast strategic overhaul. Legg Mason was buying Citi (C, Fortune 500) shares in the quarter ended Dec. 31 - when the stock traded between $29 and $45, compared with $22.15 now - and owned 42 million shares at year end.

Another value manager taking note of Citi's travails is Jim O'Shaughnessy, whose O'Shaughnessy Asset Management bought 46,557 Citi shares in the quarter ended Dec. 31, according to filings. He told Bloomberg back on Jan. 10 that he was buying Citi, but if anything his comments seem even more appropriate now. "On banks and financials," O'Shaughnessy said, "the blood clearly is in the streets."  To top of page

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