Call it the lottery winner’s dilemma: When you have money, everyone else has an opinion about how you should spend it.
This should be especially familiar to investors in Citigroup Inc. (NYSE:C) stock. For months, investors have been debating the large, and growing, $55 billion pile of “deferred tax assets” that sits like a lodestone upon Citigroup’s balance sheet. Hardly a day — or at least a quarterly earnings call — goes by without some analyst or other voicing some bright idea about what Citi should do with its “DTAs.”
Amidst all this navel-gazing, I have to admit — I got curious, too. So I began digging into the issue, and just in case you’d like to know what’s up with all this “DTA” talk, I’m here to lay it out for you.
Begin at the beginning
So first step: What is a deferred tax asset, anyway, and where did it come from?
Basically, Citi’s DTAs arose from the company’s incurring losses and taking deductions during the bad old days of the Financial Crisis. As a general rule, losing money is not a good thing, but it did have one benefit for Citigroup Inc. (NYSE:C) stock — it allowed the bank to pile up tax credits that it can use to offset any profits it might earn going forward. These tax credits are what we’re talking about when we say “DTA.”
Now for the problem
Problem is, Citigroup Inc. (NYSE:C) needs to earn a lot of profits if it’s to offset $55 billion in historical “losses.” The pile of DTAs weighing on Citigroup stock has grown from $38 billion in 2009 to $50 billion in 2010 to $55 billion currently. But now that Citi has them, it has to figure out how to use them. Else, CFO John Gerspach notes, the bank’s ability to make loans, buy back stock, and pay dividends under strictures set up by Basel III rules could be restricted.
Gerspach isn’t too worried about this, however. He’s on record saying that Citi will “more likely than not” be able to use the entire DTA pile eventually, “based upon expectations of future taxable income in the jurisdictions in which the DTAs arise.”
But how? I see three options.
Sell profitable stuff …
One option: In 2009, The Wall Street Journal cited anonymous sources suggesting Citi was shopping around its Banamex Mexican subsidiary. Assuming Banamex has appreciated in value over time, Citi could book profits on such a sale and set off part of its DTAs against those profits, canceling them out and avoiding paying tax.
The downside for Citigroup Inc. (NYSE:C) stock: Latin America is currently Citi’s second most profitable division. Sell Banamex, and yes, Citi may book a big one-time profit. But it will also lose all the profits that Banamex would otherwise have been able to generate for it in years to come.
Then again, if Citi can sell a subsidiary, work a little accounting magic, and pass to its buyer part of its DTAs, along with Banamex itself, this could help it negotiate a bigger purchase price — potentially killing two birds with one stone. On one hand, the DTAs would shrink. On the other hand, a bigger purchase price for the sold subsidiary would give Citi a bigger profit to set off against the DTAs it has left.
… buy other profitable stuff …
Another way to earn profits, against which to set off DTAs originating from historical losses, might be to buy a company that’s better at earning profits than Citi is. So acquiring a smaller, more profitable company and using its profits to sop up some of Citigroup Inc. (NYSE:C) stock’s DTAs is a second alternative.
In fact, Citi has already made moves in this direction, picking up Best Buy Co., Inc. (NYSE:BBY)‘s branded credit card business from Capital One Financial Corp. (NYSE:COF) earlier this year. Granted, this move seems to contradict Citi’s old strategy of lightening up on credit cards, as demonstrated when it unloaded a $1.6 billion credit card portfolio on General Electric Company (NYSE:GE) back in 2010. But that was then, this is now, and today, DTAs are the issue that needs fixing.
… or do nothing
Of course, buying new subsidiaries may not be necessary, either. Analysts who follow Citigroup Inc. (NYSE:C) stock project that over the next five years, Citi will earn some $29.28 per share. With 3.04 billion shares currently outstanding, that should work out to $89 billion in profits — easily enough to absorb the $55 billion in DTAs.