naked capitalism

Reader Steve sent this tidbit from the Australian. Sovereign wealth funds not all that long ago were generally seen as sophisticated to at least competent. But so were university endowments, and in many cases, “sophisticated” turned out to be tantamount to “has a higher appetite for risk than most” which in a bull market can look very clever.

In this case, Citigroup looks to be the clear winner in a deal with Abu Dhabi’s SWF. Unless the bank’s stock rallies massively, the fund will convert preferred stock paying rich dividends into common at a conversion price of $31, on a stock now trading in the neighborhood of $4.

Moral of the story: if you have a deal with an embedded bet (in this case, that the stock would appreciate) you need to ponder whether that bet will pan out. I would have held onto the fat dividend for as long as possible (and I suspect it could have been longer than two years).

From the Australian:

The terms of the Citigroup deal looked lucrative for Abu Dhabi back in November 2007, when it raced to Citi’s rescue as the New York bank crumbled under soaring investment losses tied to the depressed US mortgage and housing markets. Abu Dhabi wrote a check for $US7.5 billion in exchange for an 11 per cent annual dividend.

The bad news for Abu Dhabi is it only demanded such dividend payments for a little more than two years — until March 15, 2010. Afterwards, Abu Dhabi would in essence exchange its original investment in four instalments for Citigroup common stock, which was then worth nearly $US31.

To pull off that exchange, Citigroup on Wednesday announced a coming public bond offer that will pay a much smaller yield of slightly more than 6 per cent. The proceeds will go to Abu Dhabi, which is required to use the cash in March for its expensive purchase of Citigroup stock.

Abu Dhabi, by agreeing ahead of time to exchange cash for stock at a price of $US31.83, figured to make money under the assumption that Citigroup’s shares would rise modestly over more than 27 months. “This investment reflects our confidence in Citi’s potential to build shareholder value,” Sheikh Ahmed Bin Zayed Al Nahyan, Abu Dhabi’s managing director, said at the time.

But now it is Citi, not Abu Dhabi, that is seeing prospects for a winning deal. If Citi’s stock price holds steady through March, the beleaguered New York bank will basically be able to raise new capital by selling stock at more than seven times its market price. The deal will also boost Citi’s Tier 1 common equity and tangible common equity by $US1.875 billion, according to Wednesday’s statement.