Supermarket Sweep?

Citigroup spun off its Smith Barney wealth management business into a joint venture. Morgan Stanley, will hold a 51% stake in the combined business and pay $2.7 billion.

Citigroup spun off its Smith Barney wealth management business into a joint venture. Morgan Stanley, which will initially hold a 51% stake in the combined business, is paying $2.7 billion and contributing its Global Wealth Management Group. The bank also has a call option to buy the remainder of Citi's stake, at fair value, in three increments over a five-year period. Marketwatchers are debating whether the sale represents Citi's first move as part of a larger unraveling of the bank or is rather a one-off fix driven by a need for capital.

The new venture - to be called Morgan Stanley Smith Barney - was largely expected, however. And most analysts viewed the exit of former Treasury Secretary Robert Rubin from the Citigroup board as a sign that even more changes could be afoot.

"Both actions suggest an end to the dream that John Reed and Sandy Weill had when they merged legacy Citicorp with legacy Travelers in an attempt to build a monolithic global financial company," Ladenburg Thalmann analyst Richard Bove wrote in a research note, obtained on Thomson One Analytics.

Indeed, the only major division from the original Travelers deal is Citi's consumer finance operation.

Most analysts view the Smith Barney deal as being driven by a need for capital. A similar motivation, analysts say, will likely drive other divestitures, although sister publication American Banker cited sources yesterday dismissing any talk of a "fire sale."

The conventional wisdom is that sales of Citi units Primerica, Citifinancial, and certain private label cards could also be in the offing, although there is some debate as to whether such divestitures would equate to the undoing of Citi's supermarket model.

Fox Pitt Kelton analyst David Trone, for instance, wrote in a research note that the Smith Barney sale "is neither a major split-up of Citi, nor an end to its pursuit of a financial supermarket... it is merely in line with our existing view that Citi will continue to sell more mid-sized units to boost common equity."

Trone also argues that sales of Citi's major business units, such as consumer and corporate banking, credit cards or investment banking, are not even feasible given the market pressures facing potential buyers.

Ladenburg Thalmann's Bove, however, notes that the company's divestitures "are being matched by internal moves" that also reflect an effort "to decouple the old Citicorp from the old Travelers." He cites in particular a pullback in Citi's risk management activities and slowed expansion at the bank's Japanese brokerage subsidiary.

Through the Smith Barney sale, Citi will recognize a pretax gain of roughly $9.5 billion and an after-tax gain of roughly $5.8 billion. The merger of the two units is expected to create around $1.1 billion in estimated cost savings.

The combined business, employing over 20,000 financial advisers, will oversee $1.7 trillion in client assets, generating pro-forma pretax profits of $2.8 billion on combined revenue of $14.9 billion.

Morgan Stanley co-president James Gorman will serve as chairman of the new company, while Charles Johnston, president of Citi's North American wealth management business, will serve as president at the JV.

Wachtell Lipton Rosen & Katz provided legal advice to Morgan Stanley throughout the proceedings, while Citi sought counsel from Davis Polk & Wardwell. The transaction is expected to close in the third quarter.

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