Directed Research
Spring Semester 2009
Preliminary Research on Mergers and Acquisitions with focus on Citigroup-1998.
Submitted to:
Professor Dr. Wendy Jeffus
Prepared by:
Anuraag Joshi
--04/23/2009—
Table of Contents
TOPIC / Page NumberIntroduction / 2
History / 2
Why Financial Services Merge / 4
Merger Integration Process / 6
Typology of M&A Integration / 8
Alternative Approaches to Merger Integration / 9
Integration: Information Technology / 10
Regulatory Influences / 12
Macro Economic Influences / 13
Empirical Trends / 14
Key Lessons / 17
Exhibit 1 / 18
Exhibit 2 / 21
References / 22
Introduction:
This detailed report analyzes the merger and acquisition activities in Banking and Financial Services industry with focus on Citigroup. Emphasis is laid on the first largest corporate merger of Citicorp and Travelers. The report explains in detail about Mergers as an event which benefits both the entities in future growths and profits. The after-effects and the consequences determine whether the deal was beneficial in entirety. The costs incurred by either company are also determinants in the value creation. It also talks about the concentric (related) diversification trend i.e. exploring different segments of the same parent industry, followed by most financial institutions involved in M&A activities. The merger of Citicorp and Travelers proved to be a beneficial step towards the futures of both the companies. This allowed the Citigroup to be named as the largest financial services in the world because of the synergies created by the two companies. A brief history of Citicorp and Travelers is also provided to analyze the past followed by the two companies along with the timelines.
It also describes the various driving forces behind the M&A activities by Citigroup and other financial institutions, such as the share-holder value creation, domestic competitive pressures, globalization of the financial markets, homogenization of financial products, with products being similar at various segments of the markets and also the demands of customers, both retail and commercial, who want to obtain a full range of financial services from a single institution. The type of merger and the level of integration adopted by the two companies in focus is also described in detail.
The macro-environment forces such as economic scenario during the time of merger, the political and legal factors, socio-cultural factors, technological influences, anti-trust obligations, change in leaderships and corporate structure that affect the M&A activities in the financial market is also explained in detail along with the consideration of real life M&A examples in the recent past in the analysis. It also includes the recent developments on Citigroup, the purpose and its consequences for example the recent division of Citigroup into Citicorp-retail and investment banking and CitiHoldings- brokerage and asset management.
I. History: Citigroup
The formation of Citigroup in 1998 created a new model of financial services organization to serve its clients' financial needs. Due to the regulatory forces, commercial and investment banking activities were separated. Even though the formation of Citigroup violated the regulatory norms, the deal was finalized and a holding company was formed which opened the doors to financial services conglomerates offering a mix of commercial banking, investment banking, insurance underwriting and brokerage. As the company continued to grow and evolve, it was increasingly evident that such a large, complex grouping of businesses can indeed succeed. With 275,000 employees working in more than 100 countries and territories, Citigroup's globalism and diversity contribute to its continued success.[1]
One of the largest financial services firms known to man, Citigroup or “Citi” has some 200 million customer accounts and does business in 100 countries. Citigroup offers deposits and loans, investment banking, brokerage, wealth management, alternative investments, and other financial services. The top three competitors of Citigroup are Bank of America, Deutsche Bank and JP Morgan Chase.[2] Reeling from $90 billion in write-downs and losses on mortgage-related securities and other investments, Citigroup announced plans in early 2009 to split itself in two- Citicorp and Citi Holdings.[3] Its history dates back to the founding of Citibank in 1812, Bank Handlowy in 1870, Smith Barney in 1873, Banamex in 1884 and Salomon Brothers in 1910. The different segments in which Citigroup operated before the recent split were: Global Consumer group, Citi Markets & banking, Global Wealth Management, Citi Alternative Investments & other corporate affairs.[4] Other major brand names in Citigroup's diverse portfolio which are a part of different segments, before the split included Citi Cards, CitiFinancial, CitiMortgage, CitiInsurance, Primerica, Diners Club, Citi Private Bank, and CitiCapital.
i. Citicorp:
Prior to its merger with Travelers Group, Citicorp was the #3 US bank and the world's #1 issuer of credit cards. Bank of America pioneered the industry followed by JP Morgan Chase. American Express was also a strong competitor for CitiCorp.[5] With some 3,400 locations in 98 countries and territories, Citicorp was the world's only truly global consumer bank, offering customers worldwide the same set of banking, savings, and financing services. These operations accounted for half of its sales; the balance came from commercial banking, including corporate finance and trading. Citicorp was made the holding company of Citibank in 1974. In 1997 Citibank became the first US bank in China to conduct Yuan-based transactions, serving local corporations and registered foreign enterprises from its offices in Shanghai.[6]
ii Citicorp (NYSE:C) and Travelers Merger (NYSE:TRV)
On April 6, 1998, the merger between Citicorp and Travelers Group[7] was announced to the world, creating a $140 billion firm with assets of almost $700 billion. The deal would enable Travelers to market mutual funds and insurance to Citicorp's retail customers while giving the banking division’s access to an expanded client base of investors and insurance buyers.
Although presented as a merger, the deal was actually more like a stock swap- which will be explained in detail later on in the paper, with Travelers Group purchasing the entirety of Citicorp shares for $70 billion, and issuing 2.5 new Citigroup shares for each Citicorp share. Through this mechanism, existing shareholders of each company owned about half of the new firm.[8] While the new company maintained Citicorp's "Citi" brand in its name, it adopted Travelers' distinctive "red umbrella" as the new corporate logo, which was used until 2007.
The chairmen of both parent companies, John Reed and Sandy Weill respectively, were announced as co-chairmen and co-CEOs of the new company. The remaining provisions of the Glass-Steagall Act - enacted following the Great Depression - forbade banks to merge with insurance underwriters, and meant Citigroup had between two and five years to divest any prohibited assets.[9] The passing of the Gramm-Leach-Bliley Act in November 1999 vindicated Reed and Weill's views, opening the door to financial services conglomerates offering a mix of commercial banking, investment banking, insurance underwriting and brokerage. Below is a basic chart explaining the stock price movements for C & TRV before & after the merger.
Chart 1: Citigroup + Travelers Stock Prices[10]
Source: Compiled by Anuraag Joshi from Yahoo Finance (Prices are adjusted for stock split)
Event A: Indicates a sharp spike in the stock price of CitiCorp (pre-merger) at the time of the announcement of the merger.
Event B: Indicates a slight drop in the stock price at completion of the merger.
II. Why Financial Services Merge
Various environmental developments have made existing institutional configurations obsolete in terms of financial firms’ competitiveness, growth prospects and prospective returns to the shareholders. The regulatory and public policy changes that allow firms broader access to clients, functional lines of activity or geographic markets and technological scaling are responsible for triggering corporate actions in the form of M&A deals. Along with the benefits, the merging firms have to incur huge initial costs to formulate and process the deal. Other than the price of the M&A, the costs may include re-structuring costs, integration costs and regulatory fees. Below is the breakdown of some of the factors influencing an M&A transaction.
i. Cross Selling/Synergy: Cross-selling is defined by as the action or practice of selling among or between established clients, markets, traders or that of selling an additional product or service to an existing customer. The merger of Citicorp and Travelers to form Citigroup was largely revenue driven to take maximum advantage of the two firms’ strengths in products and distribution channels dispersed in different geographies.[11] After the merger Citigroup was able to provide a package of financial services instead of the individually characterized service. For example Citicorp with a number of new mortgage orientations every year was able to bundle travelers insurance in a package for customers. Citicorp's private banking also offered clients such services as trust and estate planning, which Travelers did not have. Cross selling alone enabled Citigroup to generate over the next two years an additional $600 million in earnings.[12] The arrangement solved Citicorp's and Travelers' biggest problems. Citicorp could get a stronger U.S. direct-sales force to market Citi checking accounts, mutual funds, and credit cards. In addition, while Citi had private bankers catering to the very wealthy, Travelers has 10,300 Salomon Smith Barney brokers, 80,000 part-time Primerica Financial Services insurance agents, and 100,000 agents that sold Travelers insurance.[13]
ii. Economies of scale: In an information-intensive industry with high fixed costs such as the financial services, there is a huge potential for scale economies. This refers to the fact that the combined company can often reduce duplicate departments or operations, lowering the costs of the company relative to theoretically the same revenue stream, thus increasing profit. Benefits from the economies of scale can be realized in the company’s information flow. If a company has a larger customer base, the cost per customer base can be reduced with economies of scale facilitating cross selling. In the banking sector of the financial industry, there is a strong need to manage huge databases containing information on demographics, transaction history etc. The software based costs are huge. The global information technology spending by financial services institutions will reach $353.3 billion in 2009, representing a decline of 1.3% over 2008, when the research firm recorded IT spending at $358 billion. This figure is substantially lower than the 4.5% growth achieved in 2008 and 6.4% growth in 2007.[14] Hence, a larger database would offset these costs as the marginal cost of adding a new customer is negligible.[15] Hence, cost can be distributed over a larger customer base. This also avoids costs related to duplication of information.
iii. Revenue economies of scope: This refers to the savings in the overall cost to the buyer of multiple financial services from a single supplier as compared to that from separate suppliers. The costs may include the transaction costs, monitoring costs and costs associated with separate contracts. Secondly, if the buyer receives service through the same supplier he might be willing to pay for the service at a premium.
iv. Diversification: Greater diversification of income can be achieved from multiple products, client groups and geographies. Combining the two institutions will make them less dependent on volatile earnings streams. For e.g. earnings of a firm under Travelers umbrella as a percentage of travelers overall earnings would fall as the earnings would now be a percentage of the larger Citigroup. This smoothens the earnings result of a company, which over the long term smoothens the stock price of a company, giving conservative investors more confidence in investing in the company
v. Explore/Dominate new markets: In addition to operating economies and revenue synergies, financial firms will also seek to dominate markets. The two merging firms may take advantage of the monopolistic and the oligopolistic returns. It gives them an opportunity to grow and explore new markets and market segments. This may also give rise to the possibility of an anti-trust action to prevent exploitation of the monopoly positions in the financial sectors. Post merger Citigroup became the world’s largest financial institution. The deal between Citicorp and Travelers gave Travelers instant access to Citi’s 750 offices outside USA and made it an international financial service provider.[16]
vi. Regulatory support: The failure of any major financial institution could cause unacceptable systematic consequences. Hence, there is high possibility of that firm being bailed out directly by the governing body and indirectly by the tax-payers. In US, this policy came into limelight during early 1980s. In the present scenario this action is driving the global economy. In October 2008, the US govt. announced Emergency Economic Stabilization Act of 2008, commonly referred to as the bailout of the U.S. financial system. It was a law enacted in response to the global financial crisis of 2008 authorizing the United States Secretary of the Treasury to spend up to US$700 billion to purchase distressed assets, especially mortgage-backed securities, and make capital injections into banks.[17] In the political environment and any market crisis these plans help to create a public sector safety to limit damage to the shareholders of damaged banks or any financial firm.
vii. Sustain market pressures: Most financial services merge to avoid market pressures to lose its active status in the industry. The financial industry is consolidating at an accelerating speed. Merrill Lynch merged with Bank of America primarily to strengthen its survival possibilities in the industry.[18]
III. Merger Integration Process:
The traditional approach of applying the post merger integration phase after the deal may lead to frictions and delays in the results foreseen in the pre-merger phase. This also might diminish the benefits of the transaction. Applying the integration process at an early stage can yield disciplined results. Following the announcement of the merger in the month of April, all Citicorp and Travelers Group divisions merged to form Citigroup on 8th October.[19] Therefore, it took six months for Citigroup to be formed and all its segments to be integrated in a new holding company. Similar integration of Barclays-Lehman Brothers was complete in 90 days and the recent Bank of America- Merrill Lynch integration was slated to be complete within 60 days.
i. Type of Merger:
Multifunctional financial firms’ merger and acquisitions may take a number of distinct forms listed below:[20]