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Citadel Sale Looks Like E*Trade Rally Killer

The decision of E*Trade's largest investor, Citadel Investments, to trim its considerable stake in the company looks like a real rally killer.



) -- The decision of

E*Trade Financial's

(ETFC) - Get E*TRADE Financial Corporation Report

largest investor, Citadel Investments, to trim its considerable stake in the company looks like a real rally killer.

That's the view of analysts at FBR Capital Markets following Wednesday's news of Citadel's massive secondary sale. Originally announced at 170 million shares, the offering swelled to 172 million shares when it priced this morning at $1.75 per. E*Trade shares have predictably fallen in line with the roughly 5% discount to Wednesday's closing price of $1.84. They were off 6.5% late in Thursday's session on volume exceeding 250 million, more than six times the issue's trailing three-month daily average.

"Although the company is not raising capital in this offering, we believe this could create some significant selling pressure in the near term," FBR Capital says in its note to clients, continuing: "

Many investors who are sitting on recent gains in the stock may choose to take profits to avoid the potential risk of additional sales by Citadel, which owns stock and debentures that are convertible into nearly one billion shares."

E*Trade shares were up 4.6% year-to-date through Wednesday's close, and the stock made a run earlier this week at getting above $2 on an intraday basis for the first time since late September but stalled at a high of $1.99 on Monday. The close at $1.90 last Friday was the stock's highest finish of 2010.

FBR Capital breaks down the sale in its note, saying the amount of stock coming into the market represents about 17% of Citadel's total E*Trade stake, which consists of 185 million common shares, along with zero-coupon convertible debentures convertible into another 795 million common shares.

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Noting that last time around Citadel sold E*Trade stock between Sept. 22, 2009 and Oct. 9, 2009 it unloaded 202 million shares at an average price of $1.91 per share, FBR Capital says timing of this announcement with the shares near $2 suggests that level is a near-term ceiling for the stock that "investors are likely to discount."

The firm also points out that Citadel's cost basis on the convertible debentures is roughly $1.03 per share, so it's sitting on a substantial profit even if the stock pulls back in the wake of this announcement.

As always seems to be the case with E*Trade, the acquisition question also comes up in FBR Capital's comments. The firm notes that Citadel, despite its roughly 34% stake (pre-secondary) in the company, is essentially a passive investor because regulations prohibit it from having management control over the company's bank. In that context, FBR Capital believes selling some of the stock at these levels makes sense, but like the idea of a buyout would be better.


A slow unwind of such a significant position over the course of E*Trade's turnaround seems to be a prudent move," the firm says. "Nevertheless, we believe the most favorable exit strategy for Citadel would be through a sale of the entire company, thereby avoiding having to dribble out such a large number of shares into the market over time."

A detail that investors with a long-term horizon can take heart in is that Steven Freiberg, who came on board as CEO in late March, is putting his own money on the line, purchasing $1 million worth of the stock in the sale. Freiberg, a former


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executive, has annual salary of $1 million with a cash bonus target is $3 million as well as equity incentives, but it's still a good sign to see top executive reach in his own pocket to buy the stock.


Written by Michael Baron in New York.