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Monday, October 8, 2007

Too late for Citi breakup?

Each time Citigroup (C) disappoints investors, the calls go out for breaking up the company. The window for doing that is shrinking.

When Citi announced with great fanfare their expense reduction initiative, led by Bob Druskin, many analysts focused on the staff reductions. Citi was very clear, however, in describing that they are looking at a completely different way of doing business.

The following quote is from the NY Times:

"Many departments will be consolidated or fashioned into utility groups... Instead of serving an individual business, like investment banking or consumer banking, they will provide services for an entire country or region."

This next quote is also from the NY Times:

"Streamlining the company's technology systems is expected to generate an additional 35 percent of the expense reductions. Citigroup said it was planning to cut its 42 data centers in half by 2009, consolidate its mortgage origination systems, and also reap savings from an ambitious five-year project to integrate its consumer-banking systems."

What this means is that Citi is becoming more unified. As each line of business begins to rely on the "utility groups" as described in the first quote, that line of business will now be dependent on Citi for certain kinds operational support. Looking closer at the second quote you can see that lines of business are expected to share and integrate their mission-critical software systems and move their hardware into a smaller number of data centers.

This fabric of inter-relationships will make it harder and harder to extract a line of business from the Citi corporate structure in the event a breakup strategy is pursued. Essentially, a buyer would have to recreate many support services, from HR to call centers to tech support. A buyer would also have to move much of the system hardware out of Citi data centers and make arrangements to acquire the core system software and possibly staff up to support it. The Times article also mentioned how more and more back-office functions are being staffed in India. This implies that a buyer might have to replace staff for entire functions or accept outsourcing companies (and associated contracts) put in place by Citi.

How far will Citi go in creating "utility groups"? This is a strategy that seeks expense control via economy of scale benefits. Citi could logically pursue this strategy to the point where back-end functions like general ledger, loan servicing, billing, etc. are shared across many lines of business. As all customer facing organizations cross-sell Citi products, line of business sales teams
may even be reduced.

As Citi's strategy is implemented it will change the value proposition for the lines of business effected. The pool of buyers will shrink -- only certain companies would be willing or able to take the business to be bought and fill in the pieces that were subsumed into Citigroup. This will tend to reduce the price placed on any line of business to be sold.

Citi is well launched on this strategy but the implementation will not be complete overnight. As the strategy progresses, the window for breaking up Citi gets smaller and smaller.

Disclosure: author owns Citi shares

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