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ValueAct builds US$1.2b stake in undervalued Citigroup

[NEW YORK] Activist fund ValueAct Capital Management has amassed a US$1.2 billion stake in Citigroup, arguing that the bank long seen as trailing its sector is positioned for success by providing the "plumbing" that multinational corporations need to operate.

Jeff Ubben's San Francisco-based hedge fund, which disclosed a US$75 million stake in the bank in February, has been building those holdings over the past four or five months, according to a quarterly investor letter obtained by Bloomberg Monday. ValueAct said it's continuing to add to its position.

"Based on the share price at which we have been able to accumulate our stake in the company, we do not believe the market views Citigroup in the same way we do," ValueAct said in the letter.

Citigroup's shares rose 2.6 per cent to US$70.24 as of 10.01am in New York, valuing the bank at US$179 billion.

ValueAct's stake could have big implications for the bank, according to Mike Mayo, a New York-based analyst at Wells Fargo & Co.

Citi's sum-of-its-parts valuation is 63 per cent higher than its market value at about US$112 a share, Mr Mayo wrote in a note to clients Tuesday. The bank also has worst-in-class returns, meaning there's an opportunity to improve its structure, execution or both, he said.

"Like ValueAct Capital, we see strong upside to Citigroup," Mr Mayo wrote.

ValueAct believes the bank has about US$50 billion in free cash it could easily return to shareholders over the next two years in dividends or share buybacks without affecting its ability to achieve its earnings growth targets.

Beyond that, the New York-based bank has the ability to return US$18 billion to US$20 billion of capital a year, ValueAct said.

Capital payouts by major US banks are subject to their passage of annual stress tests by the Federal Reserve, which have forced them to build large buffers in recent years to ensure their ability to weather another financial crisis.

"We have been having constructive conversations with ValueAct and welcome them as investors," Jennifer Lowney, a Citigroup spokeswoman, said in an emailed statement. A representative for ValueAct declined to comment.

Mr Mayo also noted that the bank's chairman is required to retire by year-end and its lead director faces mandatory retirement after this year.

"This creates an opportunity to bring another experienced leader to complement CEO Michael Corbat, who we think might only get the chair role if Citi delivers good results ahead," Mr Mayo wrote.

Possible Earnings

ValueAct argues the company is misunderstood and that investors are too focused on short-term quarterly volatility rather than the firm's long-term prospects. The bank could generate a return of 15 per cent or more on tangible common equity and deliver earnings per share of at least US$10 by 2020, or more than double the earnings per share produced last year, according to ValueAct.

That's largely the result of restructuring efforts that aren't well understood by the market, ValueAct said.

"Over the last 10 years Citigroup has exited over 20 global consumer markets and shed nearly US$800 billion in non-core assets, all while maintaining scale and investing heavily into its attractive institutional franchises," ValueAct said.

"Citigroup is now growing in a sustainable fashion, is less exposed to both earnings volatility and risk of capital impairment, and is better capitalised and more securely funded than at any point in our lifetime."

ValueAct noted that Citigroup provides the global cash management, payments and receivables processing as well as corporate payroll needs for 80 per cent of Fortune 500 companies. It also facilitates about US$4 trillion in client flows daily, and provides clearing and custody services in more than 60 markets, the fund said.

Sector's 'Laggard'

"Some of our most successful investments have been made in situations where other investors cannot seem to shed their past perceptions of a company's prospects," ValueAct said in the letter.

"This was the case with Microsoft and we believe it is also the case with Citigroup, which has long been regarded as the laggard of the large universal banks."

It isn't the first time ValueAct has taken a position in a major US bank. In 2016, it took a stake in Morgan Stanley before selling down its position after a run-up in the financial stocks in the wake of the US election that year.

ValueAct held about a one per cent stake in Morgan Stanley at the end of December, according to data compiled by Bloomberg.

The Wall Street Journal was the first to report on the size of ValueAct's stake.

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