In a couple more days, the healing can begin for
Citigroup Inc. (
C). Investors who've been waiting to see just how tall the preferred share hurdle was now have a reason for hope. Thanks to a little help from the New York Stock Exchange's 'when issued' shares of Citigroup -
something besides the 'C' shares we're all familiar with - all the potential selling pressure that stemmed from the company's convertible preferred shares won't strike the blow the market was fearing. As such, Citigroup may once again be an attractive stock.
Perhaps a little background is in order.
As part of the financial scramble banks went through last year, Citigroup raised capital to remain solvent in the eyes of regulators. At the time, issuing preferred shares that were convertible to common shares seemed like a great idea (and it may well have been the only viable idea at the time). Now, however, the ugly side of the plan has reared its head.
As part of the fund-raising deal, those preferred shares can be converted to common shares at prices anywhere from a little to a lot less than where existing Citi shares are trading. That's not an uncommon practice; many companies raise funds by sweetening the pot in that manner.
Where Citigroup's convertible preferred shares differed from other fund-raising, however, was in the sheer size of the potential conversion. At 100% conversion, the number of issued and outstanding shares of C would move from 5.5 billion to 17.4 billion.
Current investors don't particularly care for that kind of potential dilution. It's tough to compel new buyers as well, with
that hanging over your head.
Exacerbating the problem was the large degree of arbitration activity. Owners of the preferred convertible shares effectively own their shares at a lower price than common shares were trading. and they can sell those shares as regular shares on the open market at a slightly higher price than their 'cost'. It may have only been a profit of a few cents per share, but it was also
virtually guaranteed profit.
Needless to say, this is one of the reasons Citigroup shares haven't come up for air in a while... the selling and short-selling has been strong as these arbitrage efforts have been heavy (
and would have been even stronger if the short-sellers could have found more shares to trade - good thing the float is limited to only 5.5 billion shares).
Fast forward to today.
The New York Stock Exchange, not wanting to see one of its biggest residents implode when all those converted shares hit the market, effectively gave the arbitrage players an exit vehicle
aside from short-selling regular shares. Now those traders can short the 'when issued' version to lock in a particular price, and then just cover those short trades whenever they take delivery of the common shares they're due when the convertible preferred shares are actually converted.
The time frame for all this? This week. The 'when issued' security (C.WD) started trading last week, and is expected to stop trading soon. Anybody who wanted to take advantage of the 'when issued' window of opportunity should be doing so right now.
The new shares are expected to be issued on July 30th, at which time the Citigroup-When-Issued shares basically become regular shares of Citigroup's common stock.
The important piece of the puzzle that investors need to understand is that the NYSE's move relieves a great deal of the pressure that's been holding the stock down. It won't prevent dilution, but it will pace it much better. And, this will prevent the negative effect created for current shares of C by forcing all the arbitrage activities onto the 'when issued' shares.
In other words, Citigroup's odds of rising are going to improve dramatically in just a couple of days.
Note: We issued a bullish trade alert on Citigroup shares a few moments ago, though we specifically recommended the When-Issued version (C.WD) to save a few cents up front (every bit helps.) However, we're not concerned with the arbitrage dynamic - we simply like Citigroup as one of our stock picks, and will follow it as such until further notice.
