Citicorp-Travelers Merger: Value Creation and Strategic Failure

Introduction

In 1998, Citicorp acquired Travelers Group in a merger of financial services giants. The combination created the world's largest financial services company at the time, combining banking, investments, and insurance (Martin, 1998). Under the terms of the deal, it was a stock swap, with Travelers paying $70 billion for Citicorp's shares, though the deal was sold as a $140 billion transaction (Ibid). The deal paved the way for expectations that future similar deals would be allowed (Carow, 2001). This paper analyzes the deal in retrospect to determine whether it delivered value for the shareholders of the two firms. Since it was described as a merger, the shareholders of both firms were expected to benefit.

Market Expectations and Deal Rationale

In the late 1990s, there was tremendous excitement in the markets about the possibility that major mergers in the financial services industry would be allowed by Congress. Carow (2001) noted that market expectations for the allowance of such mergers were primarily reserved for major financial institutions. This could be because smaller institutions did not face barriers to merging, or because it was expected that such merger activity would primarily be conducted among larger institutions, as they might stand more to gain from this type of activity. The Citicorp-Travelers merger was essentially the first real test of the idea that Congress would allow such mergers, and indeed it was followed in 2009 by legislation that explicitly permitted such integration among major financial services companies.

Major financial services companies wanted to merge and shareholders were excited about such mergers because the perception existed that particular synergies could be achieved from such activity. Typically, merger and acquisition activity is conducted with the expectation that the combined entity will gain synergies sufficient to cover the cost of the acquisition. An example of such synergy would be the ability of a retail bank, like Citibank, to market insurance products to its customers from its Travelers unit. By creating formal links between the products of the two companies, the combined entity could generate sufficient synergy to capture enough revenue to justify the acquisition premium paid at the time of the merger. There would also be benefits at the institutional level, such as cutting costs by combining some functions under one roof and having greater economies of scale in activities like investing surplus funds.

The Merger and Its Challenges

At the time of the deal, the size of such a merger between financial institutions was unprecedented not only in the United States but in the world. The combined entity was the largest financial institution in the world at the time, ahead of Bank of Tokyo-Mitsubishi. The deal generated considerable excitement. So strong was this enthusiasm that, unusually for such a deal, the stocks of both companies rose after the deal was announced. Citicorp's stock rose to $178 (up $35.63), while Travelers stock increased to $73 (up $11.38). It was assumed that synergies would materialize, but there was the issue, as there is with any merger, of how to bring about those synergies.

When two large companies merge, issues always arise regarding mission, culture, and leadership. When two companies in different businesses merge, finding synergies in the combined entity is a very complex undertaking that requires superior management. John Reed was the CEO of Citicorp at the time of the deal and recommended that new leadership be brought in. However, the Board instead chose Travelers CEO Sandy Weill to lead the combined entity. This proved to be a mistake, as Weill was unable to run the company effectively. The combined entity saw little of the promised synergies, and Weill was entirely unable to integrate the two constituent companies in any meaningful way (Elkind, 2010).

The combined entity faced several significant issues. First, its complexity was great and there was no coherent strategy to merge the company or develop the synergies. This represented an unforgivable mistake in mergers—pursuing the combination because it was possible without thinking ahead about whether it was truly a good idea. At the time, however, the entire market was caught up in the idea that merging banks and insurance companies was the path to prosperity. The second issue with the combined entity was that it took a strange turn in terms of strategy. When the combination of two companies is as unique and exciting as this one was at the time, the temptation exists to take the combined entity into entirely new directions as a business. This is what happened with the Citi-Travelers company. The company's strategy focused too much on risk, something that would not have occurred in the two companies during the 1990s when they operated independently. The results were disastrous for the entity, and it slipped into financial difficulty. Shareholders, who won early in the deal, saw those gains evaporate completely. The deal ultimately did not deliver shareholder value to the holders of either of the merged companies.

Conclusion

For shareholders, the deal initially saw a spike in the stock price, followed by a sharp six-month decline. After that, however, the stock price of Citicorp remained above this level until late 2007 and the beginning of the financial crisis. This indicates that the combined entity, despite its struggles, was still in a good market position. The shareholders from the original deal would have been able to earn a strong return on their investments at any period from around spring 1999 onward, in part because of legislative changes that allowed Citi to maintain most of its insurance assets. In the long run, the deal appears to be a failure because there were issues with some of the insurance businesses and the promised synergies never really emerged. The share price increases also reflected strength in the banking industry in general during that period.

Based on this history, it is unlikely that a recommendation for a merger between a bank and an insurance company can be made. At issue in particular is the ability of the two entities to derive meaningful synergies from the union. The history shows that such synergies never really emerged and that several of the insurance businesses proved to be a drag on the bank's earnings during a boom time, necessitating their divestiture. Overall, the experience with Citigroup and Travelers demonstrates that the market was so excited about the possibility of bank and insurance company mergers that it did not fully understand how difficult it would be to achieve the needed synergies and to run the combined entity effectively.