Is Citigroup Looking to Sell Smith Barney? - January 12, 2009

Is Morgan Stanley trying to become the largest retail brokerage in the world? If today’s talks continue as a possible deal with Citigroup is discussed, then that possibility could become reality.

If the talks, about combining Citigroup Inc. (C) and Morgan Stanley’s (MS) brokerage operations, continue to deepen then the merger could trigger more consolidations within the troubled banking industry.

Over the past several months, Morgan Stanley has had to revamp their business models as the economy has taken its toll on the company’s finances. In that time, MS has become a bank holding company, along with Goldman Sachs Inc. (GS), while other big named companies such as Merrill Lynch & Co., which was sold to Bank of America Corp. (BAC), and Lehman Brothers Holdings Inc. filed for bankruptcy.

As for the terms of the deal, in it MS is looking to pay Citigroup between $2B and $3B in cash for a 51% stake in the company’s Smith Barney brokerage operations. Once the deal is complete, MS would have the option to purchase the remaining percentage of Smith Barney over the next three years. If the deal goes through, Citigroup is looking to gain upwards of $10B in pre-tax gains, once Smith Barney is revalued.

"If Morgan and Citi get together, they would be able to put together a retail brokerage unit that is larger than Merrill's thundering herd, which could position them well in the marketplace," said Chris Probyn, chief economist at State Street Global Advisors. "This may be a way of staying competitive."

Citigroup, which over the past several months, has been pummeled by the ongoing demise of the housing and credit crisis, just recently received $45B worth of funds granted by the government as part of their $700B financial rescue plan.

Over the past year, Citigroup has amassed losses of more than $20B and is expected to post an additional loss for their upcoming 4th quarter. In that quarter, analysts are anticipating that the struggling bank post a loss of nearly $10B. That total was calculated by analysts foreseeing a loss for Citigroup of $1.14 per share, multiplied by their total outstanding shares, comes to $6.21B. The remaining $4B is said to derive from Citigroup’s potential gain from the sale of their German retail banking operations, which were sold late last year.

Clearly you can see why Citigroup is looking for the sale to go through as the bank is in dire need of cash in order to maintain operations. However, the deal would be prosperous for Morgan Stanley as well. MS is looking to build their retail deposit base by increasing their number of salesman as improving deposits has become a top priority once MS became a bank holding company.

By the close of trading, shares of Citigroup had fallen 17%, or $1.15, to trade at $5.60 per share, while shares of Morgan Stanley were down as well, slipping 1.4%, or $0.27, to trade at $18.79 per share.

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