Some Details on the Citigroup – Abu Dhabi Deal

The article below from the WSJ goes into some of the details of the cash injection that Citigroup received from Abu Dhabi. We will see just how good a deal this is in a decade or so. Unlike those of us in the US, everyone else has a much longer time horizon on their investments. Text in bold is my emphasis.

At first glance, Citigroup looks like it paid a dear price to the Abu Dhabi Investment Authority for its $7.5 billion capital infusion.

This week Citigroup, in exchange for Abu Dhabi's investment to buttress Citigroup's coffers, agreed to issue convertible preferred shares to the Middle Eastern sovereign wealth fund. The shares will convert to a 4.9% stake in the bank in about three years and Citigroup will pay Abu Dhabi an 11% interest rate in the interim.

Critics said Citigroup was taken to the cleaners by Abu Dhabi and pointed out that even companies rated junk only pay 9% interest rates.

But looks can be deceiving.

Details of the deal, which is private, are scant, and therefore analysts say it is difficult to value. However, many agree that the dividend on the preferred shares isn't unreasonable compared with the 7.4% dividend yield on Citigroup's common shares at the time the deal was announced.

Looked at this way, Abu Dhabi is getting a 3.4 percentage-point premium for stepping up when everyone else was fleeing the sector. In addition, the structure of the deal limits Abu Dhabi's upside and the potential dilution of Citigroup shares, other reasons why the investment fund should get a premium to the dividend. Finally, Abu Dhabi's ability to sell its shares will be restricted through 2014.

In this deal, Abu Dhabi's shares will convert into Citigroup common stock between March 2010 and September 2011, with the amount of the shares to be determined by where Citigroup shares are trading. The terms include a lower strike price of $31.83 and a cap of $37.24. The lower strike price limits Abu Dhabi's downside but also caps its upside if the share price increases sharply.

The number of common shares granted to Abu Dhabi falls as the share-price rises. If it rises to $37.24 or above, Abu Dhabi will receive a maximum of 201.4 million shares, but if it falls to $31.83 or below, the fund receives 235.6 million. If the price is within the range, Abu Dhabi gets some amount of shares in between, depending on an undisclosed formula. Traders call this range, which limits Abu Dhabi's upside, the "dead zone."

For its part, Citigroup managed to raise tax-deductible, tier-one capital. It has also locked in a long-term investor who has promised not to meddle much in its daily affairs, which, in this age of shareholder disgruntlement and activism, could be worth its weight in gold.