How the Citi stock offering flopped

By Felix Salmon
December 17, 2009
much worse than planned, is a prime example of the difference between primary and secondary markets. A lot of investors simply assume without thinking too much about it that a rising stock price is always a good thing for the company in question, and they're right to do so. But there are two kinds of stock price, and sometimes it can be hard to tell the difference.

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The Citigroup secondary offering yesterday, which went much worse than planned, is a prime example of the difference between primary and secondary markets. A lot of investors simply assume without thinking too much about it that a rising stock price is always a good thing for the company in question, and they’re right to do so. But there are two kinds of stock price, and sometimes it can be hard to tell the difference.

The first type, which is based on perceived fundamentals, is the price that investors are willing to pay to own a stake in the company over the long term. The second type, which is based on markets, is much more speculative, and is fundamentally a bet on what other people will be willing to pay for the stock in the short term.

If you have a type-1 stock, it’s pretty easy to sell new stock at or near the secondary-market price. If you have a type-2 stock, however, it can be very hard. And a lot of people looking at the rise in bank stocks since March were wondering, in the back of our heads, how much of it was momentum trading and speculation, and how much of it was based on fundamentals.

Certainly a large part of it was speculative — a large part always is. Speculators are short-term liquidity providers, but you need long-term fundamental investors to represent a significant share of the market in order to be sure that the share price won’t collapse overnight. One of the tell-tale signs that the dot-com boom was a bubble was the tiny free floats on some of the most high-flying stocks: they might be up enormously, but that was only because the IPOs had been minuscule, and there was a mad rush for the very small number of shares available to the public. When those companies were reluctant to try to cash in on their soaring share prices by selling off more of their stock, it was a sign that the inflated capitalizations weren’t real.

Similarly, today, shares in AIG can bob around in significantly positive territory for as long as they like, but there’s no way that the company could ever get a secondary stock offering away.

Which brings us back to Citigroup. Eric Dash explains what happened:

Badly misreading the financial markets, the company struggled on Wednesday to raise the money it needed to repay its bailout funds…

Citigroup officials maintain that they did a good job considering the tough market conditions and should be lauded for pulling off the largest equity offering in American history. Some analysts have their doubts.

Shouldn’t those officials have considered the tough market conditions before they made the decision to attempt  the largest equity offering in American history?

At least now it’s a bit more obvious why Vikram Pandit couldn’t make his scheduled meeting with the president on Monday: he really was desperately trying to drum up interest in this share sale. Obviously he and his capital markets team didn’t do a particularly good job: Treasury told them it wouldn’t sell any of its stake at a loss, they tried to make sure that Treasury wouldn’t have to, and they failed, so Treasury withdrew its stake from the stock offer.

None of this is going to help relations between Citigroup and its largest single shareholder, the US government. Indeed, as Treasury tries to sell down its stake in the company over the next six to 12 months, it might not even use Citigroup’s equity capital markets team to do so, given the unimpressive showing that team made on Monday.

And I suspect that the real problem here was that Citi’s bankers started believing their own share price, thinking that there was much more fundamental demand for ownership of this behemoth than actually there is. Citigroup stock trades at a low nominal price on very high volume, which is like catnip to speculators who can make huge returns on relatively small changes in the share price. As a result, the nominal price is a relatively weak indication of the fundamental demand for Citigroup ownership. And debacles like yesterday’s result.

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