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November 29, 2007
E-Trade: Citadel Investment Analysis, Part 2
I posted some (quick) positive aspects of the Citadel deal for E-Trade assets this morning, and now some more critical commentary -- as I listen, for the second time, to the E-Trade conference call.
First things first, the price on E-Trade's ABS book. We just had a major mark-to-market event, in effect. As more than a few people have argued to me via email, if most of the industry had to mark their ABS books to 27 cents on the dollar, the U.S. banking business would be in deep, deep trouble.
Second, there is a troubling absence of specifics about the E-Trade loan book, and about some of the more nitty-gritty specifics of the deal, like the loan loss provisions embedded in the portfolio. While the management team is ducking the question on the conference call, there were 60 Citadel staffers apparently pouring through E-Trade's books, so I have a hard time buying that they don't have a very specific view of what is going on among these troubled assets. (Relatedly, there is no Edgar filing yet on the deal. Why not?)
Related to the preceding, why no info on the breakdown of the $1.6-billion infusion between equity and notes? That seems, you know, big and material, but I am old-fashioned that way.
Next, E-Trade CEO Mitchell Caplan has made out nicely, which will piss off shareholders to no end. Not that he needed to be hung over a river for E-Trade's subprime misadventures, but it's deeply galling that he has been able to cash out so completely from a wobbling business.
Finally, this deal is awfully dilutive to existing shareholders. The total dilution from the deal is something like $0.50, which, on top of lost customers (most of whom were more active and sophisticated) over the last few weeks, pretty much takes E-Trade's earnings power to zero.
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Overall, this deal shores up E-Trade, but it's tough to tell what more (or less) it currently does. We just don't have enough specifics, and management was light on facts in the conference call. In the absence of more data I'll call it mildly positive for E-Trade, great for Citadel, and near-term negative for the industry (if only because it will drive more mark-downs), but that's it -- and, of course, subject to change as we see more specifics.
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The reason there is no breakdown between equity and notes is simple. Citadel picks up 84 mm new shares for free in return for earning 12.5% on its senior notes and buying $3 billion in securities for $800 mm. What a great country. Heads I win, tails you lose.
If the real estate loans continue to deteriorate, Citadel is protected as senior in the capital structure. If the business can be saved and sold then Citadel participates through a 12.5% coupon and 20% equity participation. Existing equity shareholders figured this out in the afternnon when the stock sold off.
Thanks for the great analysis! I saw the news in the premarket, and was wondering what it meant for the financial companies bogged down by the sub prime mess.
Many of the companies are having to write-off their equity CDO portfolio completely, so a mark to market floor of 27 cents to a dollar might be a welcome change.
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."
ETFC does need to be more forthcoming with details of the deal and loan book, but with $40 billion of mortgages left on the books and over $220 billion in customer assets under management, to say ETFC has no earning power implying it has no value is a little hyperbolic. This infusion of capital by Citadel may not be the cure all for ETFC, but it will stablize things and stem customer defections in its core business. Whether or not a takeover occurs, well that is anybody's guess. Time will tell.
nice set of posts paul. tx...