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By Christine Benz | 03-15-2012 04:00 PM

5 Tales of Luck, or Lack Thereof

Morningstar markets editor Jeremy Glaser takes a look at who might--and might not be--seeing green after recent events.

Christine Benz: Hi, I am Christine Benz for Morningstar.com and welcome to the Friday Five. Spring is in the air. St. Patrick's Day is around the corner, and Morningstar markets editor Jeremy Glaser is here to share five tales of luck or maybe a lack of luck.

Jeremy, what you have today?

Jeremy Glaser: Well, Christine, today, we are going to talk about Cisco, Citigroup, dividends, retail sales, and finally, Ireland.

Benz: So Jeremy, Cisco this week announced a big acquisition. You think that this could go either way. Shareholders could get lucky, but they might be unlucky?

Glaser: Yeah. I think it certainly could. Cisco is spending $4 billion to buy video software maker NDS. This is not a deal that is crazy or that doesn't make sense. I think it certainly does make sense for Cisco. The firm has a set-top box business, with Scientific Atlanta. This kind of software really fits into that business and kind of fits into Cisco's idea that video is going to become more and more important. The firm wants to be there and make sure that it creates that infrastructure to deliver that video to consumers. But for some of the other comments that Cisco made around the acquisition, CEO John Chambers talked a little about how Cisco wants to do more acquisitions and wants to do bigger deals. The firm is going to become more acquisitive. I think this could cause shareholders to wonder if the luck is going to start running out for Cisco.

A few years ago, Cisco really got into trouble by doing a lot of these acquisitions that didn't make sense. These included things like the Flip video cameras and a lot of even the consumer routers. These items just weren't core to their business and weren't areas where the firm had good competitive advantages. Cisco has really been spending the interim period kind of getting rid of some of those businesses, becoming more shareholder-friendly, and doing things that would really make people trust management to be better capital allocators. And if Cisco goes out on another acquisition spree and just tries to spend that money because it can, I think that consumers could find themselves somewhat unlucky. I think certainly it's key to make sure that when these acquisitions are announced, that they actually are a core part of Cisco's business, are really bolt-on acquisitions, and aren't just there for growth at any price.

Benz: Another company that has been more working hard to earn or rebuild investor trust is Citigroup. This week, this firm is maybe not feeling quite so lucky in terms of its results on a recent Federal Reserve stress test?

Glaser: Absolutely. I think Citi probably was not terribly pleased with these results and was not pleased with what they're going to see as a case of bad luck. What happened here is that the Federal Reserve is now doing a yearly stress test, where it says in the case of really another severe recession--one that was even worse than what we saw in 2008--what would capital ratios look like at these largest financial institutions that they consider to be very important to the operation of the U.S. economy. And the Fed also looks to make sure that these banks hold enough capital. The banks also then submit capital plans in which they say, "We want to pay out this large a dividend. We want to do the share buybacks. We are going to issue shares, or whatever it might be."

The Fed then says to the banks, "If you execute this plan, and you have this big downturn, what would your capital look like?"

Citi with its plan that was somewhat aggressive--to start returning capital to shareholders--failed by just a hair. Citi needed to have a 5% capital ratio; it had 4.9% under the Fed test. The bank was basically told that it will have to go back, resubmit its plan, and find ways to keep its capital levels up.

I think this is not a case where the Fed was saying that Citi was in big, big trouble and needs to go out and raise a ton of capital. But it definitely was a rebuke to management which had really hoped to rebuild investor confidence, like you were saying, by paying out these bigger dividends, by showing that the bank really intends to have good returns for investors over time and that Citi is really out of woods in terms of kind of getting past the crisis and getting past a lot of those bad loans that were on its books for a long time. Certainly, this was not a stroke of luck for Citi to fail by just that small amount, and the bank will have to go back and redo that capital plan. I think certainly, it's just going to make it that much more difficult to convince investors that Citi is really back.

Benz: But some other bank investors got pretty lucky this week. The stress tests were good news for other firms that had wanted to increase dividends and share buybacks.

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