Bove Caves to Clients on Citi Rating

Rochdale Securities analyst Dick Bove is one of the foremost authorities in analyzing financial stocks, so whenever he puts out a report it is widely reported in the financial media. He recently came out with a cautious note on Citigroup (C) saying, among other things, the eventual sale of the government’s stake would limit the upside in the stock at least in the near term. He believed the 7.7 billion shares that will eventually work their way into the public marketplace would overwhelm any positive trends he saw for the stock. That is why his reversal on opinion surprised us, but the implied reason behind it was even more shocking.

“I feared that the government’s potential sale of 7.7 billion shares would cause the issue to fall before it could rise,” Bove wrote. “The clients’ view is that this is poor thinking on my part. Either I liked the stock’s long term outlook or I did not they claimed. The price of the offering was already priced in.

“There are two core questions. 1) Do you like this company or not? 2) Do you believe the price of the stock will get to $8.50 per share in the next few years or not? The answers are yes and yes. Then say clients I should have a Buy on the stock.,” he concludes. – The New York Post 3/22/2010

His reasons for the change of heart were admittedly ascertained through conversations with his investor clients. We see nothing wrong with an evolving opinion; after all, that is what an analyst is paid to do, make an educated guess with inherently incomplete information. However, it would seem a reversal should be based on new information rather than outside pressure. He reasons that Citi has effectively sold off many of its bad assets, and he has even stated Citi finds itself in a position of having too much liquidity which “gives management the flexibility to off-load the problem operations and to support longer term growth.”

Essentially, what this means is that after discussing his opinions with clients, he was persuaded to upgrade his stance on Citi and he elevated his price target from $3.75 to $5. Either his clients were able to make a more convincing bullish argument for the stock than he already had come up with, which suggests he may not be a superstar analyst in the first place (not likely, we often find value in his opinions and reasoning). Or clients, presumable some of whom would benefit from a favorable rating and higher prices, were able to persuade him to become a bull. His new long term earnings estimate calls for $.70 per share and trade at $8.50 in the next few years.

It seems to me, the original problem that Bove feared (the entrance of government shares on the market) has not been eliminated or alleviated. At some point, those shares will float onto the market and supply will almost certainly overtake demand, causing shares to languish in the near term. The government will exit their stake in Citi progressively to lessen the effect, but we think the cumulative effort will have an impact. It is a simple issue of supply and demand; the greater supply will, by the laws of economics, hold prices below where they would otherwise be other things being equal. So, it seems to us, all Bove’s comments about asset quality and liquidity are window dressing on the real reason for the upgrade: he caved.

At Ockham, we have reaffirmed our Overvalued rating on C as of this week’s report because the stock has advanced substantially ahead of any real fundamental improvement. The structure of the company has changed so greatly over the last two years that we have virtually no visibility into the long term earnings power of the bank. It is still too risky for us to sign off on it, especially considering the overhang of the government holding nearly 10x the average daily trading volume over the last ten trading days.

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