Photo by Mike Licht, NotionsCapital.com

Photo by Mike Licht, NotionsCapital.com

I read on the front page of the Straits Times on February 28 that GIC had decided to convert its US$6.88bn (S$10.6bn) in CitiGroup preference shares into ordinary shares at a price of US$3.25 per share instead of the original conversion price of US$26.35.  According to the article, GIC’s conversion at this time would pare its losses from 80% to 24%.  As a result of the lower price, GIC’s stake in CitiGroup has increased from an original 4% to 11.1%.

Without knowing all the facts behind the decision but just based on what is publicly disclosed, I think this is a bad decision by GIC from a timing perpective.  In the February 25, 2009 of Today, I was quoted in an article GIC’s CitiGroup shares – A preferred choice, I opined that GIC should not convert it shares yet until the shares of CitiGroup have stabilised.  I also highlighted the risk of a share price collapse when this conversion occured as was the case with Fannie Mae and Freddie Mac.  CitiGroup shares fell 39% last Friday when this conversion was announced to US$1.50 per share.  At US$1.50, GIC’s investment is now down 53.8% not 24% any more.

Why do I think its a bad decision on a timing basis ?

The US economic and asset cycle continues to turn down.  Negative economic growth, higher levels of retrenchments – means more bad loans for banks from mortgages, personal loans, credit cards and corporate loans.  So I expect US NPLs to continue to rise sharply and that is not including any toxic asset provisions they have to make.  They dont have enough existing Tier 1 capital to survive – ie a lot more losses and a lot more fund raising is required.  Just look at Freddie Mac and Fannie Mae.   This means further price weakness and more dilution for GIC in the coming months unless they keep on pumping in capital.  This is another mistake – as it could be a “black hole”.  I would have preferred GIC to hold onto its preferred shares until all the bad news is out and the recapitalisation is over and then convert once the share price has stabilised at that level.

That is my theoretical view but there could have been other reasons that prompted the conversion which has not been disclosed.  Some possible reasons:

a) CitiGroup was going to stop its dividend payment of 7% or US$482mn for GIC.   Was this a breach of the Preferred share agreement ?

b) was this cancellation of the dividend compensated via a lower strike price for the shares of US$3.25 instead of US$26.35

c) did GIC have no choice in this conversion as all the other preference shareholders were going to convert and it was a precondition by the US Government of additional financial support.

The list of reasons can go on and without knowing them – we can only make a qualitative judgement which for now and on what I know – its a bad decision.  Maybe GIC can disclose more reasons behind the conversion decision to Singaporeans who will then be less critical of their decision.

Source: NRA Capital – Kevin’s Blog