March 17,2008

Crisis and Opportunity in CIC's "Fire Sale" Acquisitions

By Ma Wenluo

China's companies are working hard to build financial muscle by expanding abroad. Success brings flowers and the pop of fine champagne.  But it can also bring pain and exposure to risk and downturn.

Blackstone Group L.P., a leading US private equity group, in its March 10 report on its 2007 results, announced that for the quarter ended December 31, 2007, revenues totaled $345.0 million, a decline of 73 percent from a year earlier.  Expenses totaled $1.06 billion and net loss totaled $170.0 million.

Blackstone was the object of the first investment foray by China's new sovereign wealth fund, the China Investment Corporation (CIC), which saw its investment dive to a low of USD 15 per share, half its buying price,handing the Chinese investor a huge paper loss. CIC's initial investment into Blackstone, $3 billion in May 2007, now has a paper value of only $1.5 billion

But Stephen Schwarzman, Blackstone Group's CEO, called the results "terrific, even though we had a weaker fourth quarter, of course. The firm doesn't have financing for companies coming due for years." He stressed that the markets are in the midst of a severe financial crisis that had runs from sub-prime loan defaults to degrading CDOs and panicked selling of even investment-grade assets. "We believed the market's credit woes would worsen. On this front we were unfortunately proven correct." He added.

Right now, CIC's senior management has little choice but to agree with his opinions.
China is striking a number of increasingly ambitious deals overseas.From its initial capital of $200 billion, CIC also spent $5 billion to acquire 9.9% of Morgan Stanley. The two big overseas stakes have since performed poorly thanks to America's financial turmoil. Wang Jianxi,CIC's Deputy General Manager and Chief Risk Officer, doesn't take the investment to Blackstone for a loss. "CIC does not pay much attention to short-term price fluctuations as the company has made a long-term financial investment into Blackstone and Morgan Stanley. We can gain not only from the stock price but also from dividends"' he noted in a March 4 comment.

Blackburn's Schwarzman gave confidence to his Chinese shareholder with a note of optimism, saying there are good chances to invest even amid such a bleak environment. "There is no conceivable run on the firm. We have never been forced to sell any assets at the wrong time. We buy companies with the intent of holding them for an average of five years," he said, adding that, "Generally this kind of severe unwinding and panic, anxiety and heightened overreaction doesn't tend to last very long." At the moment CIC plans to hold its Blackstone stake for five to seven years. The minimum term of CIC's investment in Blackstone is four years.

But Bear Stearns Co.,the fifth-largest U.S. investment bank, is providing China's investment companies further instruction in roiled markets.

Back in October, CITIC Securities, China's top investment bank,was flexing its muscles on Wall Street with reports that it was negotiating to take a stake of almost 10% in Bear Stearns. Success would have meant that CITIC Securities had become the largest single shareholder of the US investment bank.

Fortunately, CITIC's plan came not to fruition. On March 14,the same day Blackstone announced its hit, Bear Stearns' shares had fallen to a five-year low.

That same day, the Federal Reserve announced it would supply secured funding to Bear Stearns for an initial period of 28 days, allowing JP Morgan Chase, a bulge-bracket US bank, to borrow from the Fed's discount window and put up collateral from Bear Stearns to back up the loans. The Fed pledged it would provide even more help to ease a liquidity crisis at Bear Stearns and combat its credit crisis. Also, last week the Fed announced that it would supply up to $200 billion in loans to cash-strapped US financial institutions.

The Chinese banker was back in talks over the weekend to get a bigger stake in Bear Stearns as the Wall Street bank's shares have tumbled. CITIC said on March 16, it couldn't guarantee it would reach a final agreement to buy into Bear Stearns after the triggering of the bailout plan. Kong Dan, Chairman of Citic Group, CITIC's parent company, said earlier in the day that CITIC was rethinking its deal to buy into Bear Stearns and would conduct an "overall evaluation" of the deal.

But it's all probably too late as JP Morgan Chase went ahead on Sunday and bought out Bear Stearns, at $2 a share, for a total of $270 million, which is about a third of the IPO price when Bear went public over 30 years ago.  Whether they will want a partner now is anybody's guess.  It is thought they may want at least to hang on to Bear Stearns's prime brokerage unit, which provides loans and processes trades for hedge funds. Kong said Citic Securities had been in touch with the US bank on the matter, but he referred to the communication as "technical" in nature and didn't elaborate.

The prospects of the cooperation are not regarded as promising. Analysts thought that CITIC could itself not only not save Bear Stearns but might also have run into its own trouble. China's companies like to talk about "opportunities coexisting with risks", but the two cases above speak more of risks than opportunities.

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