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Thursday, 11 June 2009

When should governments invest in banks?

About 20 years ago a Harvard Business School professor lectured to me and others that the only logical reason why a shareholder should logically support an acquisition of another public company (in which the shareholder could have taken a stake) was for the tax benefits. As it happens, I think he was wrong, but he had 75% of a point.

Now it seems the boot is on the other foot, and if I was a US tax payer, I would want the government to take a major stake in Citigroup. Why? Because of the tax.

Citi has been reported as creating a poison pill that would deter investors and hedge funds from building up a large stake in Citi as well as deterring existing shareholders from increasing their holdings. If an investor buys a stake of more than 5 per cent in Citi, or if an existing shareholder with more than 5 per cent increases its holding by more than 50 per cent, all other investors will in effect be able to buy one share for every share held at a 50 per cent discount to the market price.

Citi people said they introduced the measure because US tax rules threatened Citi's ability to benefit from a $43 billion tax benefit. Those rules limit companies' ability to use prior year tax losses when more than 50 per cent of their shares are held by investors with stakes of more than 5 per cent. If Citi loses its right to use some of the tax benefits it has accumulated over the years, it will have to write down substantial deferred tax assets, book big losses and lose Tier 1 capital.

But if I was a US tax payer, I would be saying to myself, that is $43 billion of future taxes that may or may not be going to the US treasury.

What is the market cap of NYSE:C? About $19 bn. So a 50% stake from the US Government in Citi would run to about $10 bn, for an immediate payback of $43 billion in eradicated tax benefits, plus there might even be some upside in the shares!

Citi never sleeps, but Uncle Sam is snoozing on this one.

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