Mayo Is Right About Citigroup

Mike Mayo, a former colleague from Credit Suisse, is one of the few analysts that is brave enough to speak the truth about stocks. The smear campaigns that companies and Wall Street banks run on Mike for his candor are deplorable. After seeing reports on the Research Puzzle Pix of the recent “freeze out” of Mr. Mayo by Citigroup, I decided to see how Citi fared under the New Constructs microscope.

Recently, Mr. Mayo has highlighted the fact that Citigroup is milking an inappropriately large Deferred Tax Asset to boost earnings as it tries to pull itself back into stock-market favor. Our detailed analysis of the Notes to the Financial Statements found Mayo’s assertion about Citi’s overstated Deferred Tax Asset (details below) to be true as well as a few other interesting RED FLAGS (our report on Citi has all the details, esp in the appendices):

  1. Over $7bn in off-balance sheet debt
  2. $2.2bn in under-funded Pension liabilities
  3. Over $10bn in Asset write-offs

Our discounted cash flows analysis reveals another RED FLAG – a Very Dangerous Valuation. At $3.67, Citi’s stock price implies the company will grow its NOPAT (Net Operating Profits After Tax) by over 15% per year for each of the next 25 years. In other words, to justify the current valuation of its stock, Citi has to grow its NOPAT by 15% compounded annually for 25 years. As explained in , Citi’s performance must meaningfully exceed the current expectations of a 15% CAGR for NOPAT over 25 years in order for (long) investors to make money in the stock.

Per our current report on Citi and our call back in March (per my interview on theStreet.com) our Rating for the stock is Dangerous.

Details on Citi’s Deferred Tax Asset:

Under SFAS 109, companies are supposed to write-down their deferred tax assets if there is a greater than 50% chance that some of them won’t be realized.
Citi has no valuation allowance for its $46B in net deferred tax assets (as of 12-31-2009).

Per SFAS 109, a three-year cumulative loss is significant negative evidence that the deferred tax assets will be realized. This negative evidence must be more than overcome by significant positive evidence.

Considering that Citi’s five-year average pre-tax income was a loss of $16 billion, Citi must have some overwhelming positive evidence that it can realize its deferred tax assets. Citi lists the following positive evidence:

1. Citi states that “the Company would need to generate approximately $86 billion of taxable income during the respective carryforward periods to fully realize its U.S. Federal, state and local DTAs.” Maximum carryforward periods are usually 20 years, so this conservatively implies that Citi expects to generate $4.3B in taxable income per year for the next 20 years.

2. Citi also states that if it doesn’t generate enough taxable income before its net deferred tax assets expire,it may sell of some of its assets (just to generate
enough taxable income to use its deferred tax assets–not to enhance shareholder value).

RED FLAG: Despite significant negative evidence and questionable positive evidence, Citi hasn’t written down any of its deferred tax assets. Citi is NOT EMPLOYING conservative accounting.

A large write-down of its deferred tax assets could be devastating for Citi– over 30% of its total book value is comprised of net deferred tax assets.

Citi issues this warning in its filing (see red font section in this excerpt from Citi’s latest 10K):

“The amount of the DTA considered realizable, however, could be significantly reduced in the near term if estimates of future taxable income during the
carryforward period are significantly lower than forecasted due to deterioration in market conditions.”

Please click here for Citi’s full discussion of its deferred taxes.

Per our current report on Citi and our call back in March (per my interview on theStreet.com) our Rating for the stock is Dangerous.

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