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November 29, 2007
E-Trade: Citadel Investment Analysis, Part I
I've been spending some time this morning mulling the Citadel investment in E-Trade. I'll post some positive components first, and then follow up with another post on some of the more worrisome aspects.
On the one hand it is a savior, of sorts, for E-Trade, which had been wobbling badly because of the problems, real and perceived, in its portfolio of subprime/ABS assets. This Citadel deal helps solve some of those problems, first by taking those asset-backed securities off E-Trade's books, and second by putting some new cash onto E-Trade's balance sheet.
Further, the investment, even more so than the Abu Dhabi deal at Citi, will mark, in many people's minds, a bottom for the struggling subprime mortgage sector. If Ken is willing to buy, so am I, goes the logic. Granted, there is half-trillion more of subprime resets to come in 2008, but there is a growing consensus out there that at 26 cents on the dollar -- the effective valuation in the Citadel pricing for E-Trade -- we are likely already valuing subprime assets at levels that more than reflect the likely default rates.
With the preceding in mind, this is likely a great deal for Citadel. It gets asset-backed securities -- read:subprime -- at a low price, one that will likely turn out to be very smart a few years from now as default rates turn out to be considerably lower than most market nihilists expect today. At the same time, it gets paid for doing the deal by getting an attractive interest rate on an associated note.
This will go a long way toward reassuring E-Trade investors and customers that the company isn't disappearing immediately. While Citadel has no real strategic interest in E-Trade as a business, it also likely doesn't want to see the company disappear into bankruptcy.
Some more critical comments shortly.
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Hi, I think etrade sold their ABS portfolio to Citadel for a lot less than 27 cents on the dollar. The 20% equity stake was built into the price. They likely structured it this way to mark it "high."
You mentioned that Ken is buying now but my hunch is that Ken is actually selling between now and Jan 15. In essence, he is getting 16 or 17%(in addition to the 2-3% Citadel already owns) of the company in the form of new shares for $150 million by Jan 15 (a very sweet deal given that shares are trading in the $5 range). Between now and then my hunch is that they will be shorting the stock in anticipation of getting those shares in January.