The Wall Street Journal-20080116-breakingviews-com - Financial Insight- Aid to Merrill Looks Better- Thain-s Capital Deals Seem More Favorable Than Citi-s In Case More Cash Is Needed
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breakingviews.com / Financial Insight: Aid to Merrill Looks Better; Thain's Capital Deals Seem More Favorable Than Citi's In Case More Cash Is Needed
Citigroup and Merrill Lynch both have double-dipped at the capital- raising trough. Their latest investment terms suggest Citigroup boss Vikram Pandit could be closer to exhausting his supply of new money than is Merrill's John Thain.
In November, Citigroup raised $7.5 billion from Abu Dhabi Investment Authority by selling mandatory convertible securities. Morgan Stanley and UBS have employed similar structures to raise cash. Holders of mandatory convertibles end up on a par with regular shareholders, after enjoying a better deal for a few years. ADIA's deal, for example, just became more valuable because Citigroup cut its quarterly dividend. ADIA's mandatory convertibles lock in the old, higher dividend yield.
With its latest deal, Citigroup has given investors still more comfort. The $12.5 billion of convertible preferred securities the bank is selling are senior to common shares and stay that way unless the preferred holders are bought out or convert -- which they will do only if Citigroup's shares rise significantly. There is always a trade-off between different instruments, but in this case regular shareholders are being nudged back in the pecking order, even if they will get a bite at a further $2 billion of public convertible preferred shares.
Merrill, meanwhile, raised $6.2 billion in December in straight stock from Singapore's Temasek Holdings and a U.S. fund manager, at a discount. That diluted the holdings of existing shareholders, but only a little. The Wall Street firm's latest deal, for an additional $6.6 billion, is in mandatory convertible form, similar to Citigroup's earlier deal and arguably less costly for regular shareholders than Mr. Pandit's latest move.
Both companies have, happily, addressed immediate concerns about their capital adequacy. Both may have had reasons for choosing specific instruments. Still, on their face the deal structures make Mr. Thain's efforts look less needy than Mr. Pandit's. If the economic tide reveals more financial wreckage and the companies need to raise more capital, the betting has to be on Merrill to get the better deal.
State Intervention
The New Jersey Division of Investment's participation in the latest capital-raisings by Citigroup and Merrill Lynch appears to offer the double benefit of market investment terms and protecting two companies that each employ thousands of state residents. In a sense, the same logic applies to bank bailouts in China by government-linked investors. In reality, the apparent overlap of interests is a conflict that risks negating free-market signals.
Investing public money in struggling corporations on supposedly market terms, and thereby preserving jobs, is popular with politicians on the left and center-right. In the U.S., such tactics were employed as a centerpiece of the "industrial policy" that formed the initial Democrat response to President Ronald Reagan in the 1980s.
In some states, such as Michigan, a major industry in difficulties makes the temptation particularly strong. The Michigan state pension fund has invested heavily in efforts to regenerate Midwestern industries. The bankruptcy-court experience of a number of beneficiaries, notably auto-parts maker Collins & Aikman, hasn't dimmed Michigan's enthusiasm: It may invest more. The danger is that if the investments go bad, not only does the fund lose money but local jobs disappear, too.
New Jersey Gov. Jon Corzine, a former Goldman Sachs executive, probably thinks the state's investment team is qualified to pick winners. Of course, New Jersey is hardly Michigan, and the jobs question may have played no role. The state also is participating alongside experienced investors like the Kuwait Investment Authority. Still, the risk remains that, in this and other cases, the attraction of preserving local jobs can encourage state investment teams to make risky investments with taxpayers' or state pensioners' money.
-- Richard Beales and Martin Hutchinson
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This column is by breakingviews.com, an online financial commentary site.
