Thursday, December 20, 2007
Great Wall Street of China
Morgan Deal Underlines
The New Capital Flow;
Who's Playing Whom?
By RICK CAREW in Beijing, LAURA SANTINI in Hong Kong and JAMES T. AREDDY in Shanghai
December 20, 2007
Beijing's plan to invest $5 billion in Morgan Stanley caps a milestone year for China's deal makers: For the first time, Chinese companies and the government bought more overseas than foreign buyers have invested in China.
Chinese buyers have spent $29.2 billion acquiring foreign companies so far this year, while investors from the rest of the world have bought $21.5 billion of Chinese companies, according to Thomson Financial.
The investment in Morgan Stanley will give state-run China Investment Corp. -- a sovereign-wealth fund, essentially the government's money pile -- as much as 9.9% of the Wall Street giant.
It is the latest in a string of bailouts of financial giants by foreign investors as the firms struggle with souring mortgage-related investments. Indeed, yesterday Morgan Stanley reported a $9.4 billion write-down for its fiscal fourth quarter on its U.S. subprime and other mortgage investments.
Citigroup Inc. and UBS AG received sizable help from Middle Eastern and Singaporean investors in recent weeks. Wall Street firm Bear Stearns Cos. agreed in October to swap $1 billion investments with China's Citic Securities Co.
The question now is, are these investors the smart or the dumb money? Historically, foreigners are the suckers who allow the locals to sell out at the market's peak.
Already, the Abu Dhabi Investment Authority, which invested $7.5 billion in Citigroup, told executives at the bank that it wasn't pleased by Citigroup's move to bring $49 billion in assets onto its balance sheet, people familiar with the matter said. The investor also expressed concern that Citigroup might have to raise more capital, potentially diluting its investment.
[chart]A person aware of the matter said Citigroup's relationship with Abu Dhabi remains good and that Abu Dhabi officials didn't disagree with the bank's actions.
And there has been a political backlash in China against the government fund's $3 billion investment in Blackstone Group LP's initial public offering, a high-water mark for the private-equity boom. Since then, Blackstone shares have lost more than a fifth of their value, erasing $633 million in the paper value of China's investment.
Consequently, CIC's senior managers emphasized they were looking to take a slower, more passive approach. Only last week, CIC started the selection process for money managers to funnel some of the $67 billion they have allocated from the $200 billion fund for overseas investment into global equity markets.
But then, the fund seized opportunity to make the Morgan Stanley investment, an aggressive move at a time when Wall Street banks look more like distressed assets.
"This deal is a big surprise," said Stephen Green, a senior economist at Standard Chartered in Shanghai. "The U.S. subprime crisis created an opportunity, and they jumped at it." For CIC, the deal with Morgan Stanley, its second-largest overseas investment, could provide access to expertise the giant fund is keen to acquire.
Following widespread domestic criticism over the Blackstone loss, CIC characterizes itself as a "passive investor" and will have no representation on Morgan's board. That is likely meant to address concerns over political sensitivities surrounding China's investment in a blue-chip Wall Street firm.
Two years ago, strong political opposition in Congress derailed a bid by Chinese oil company Cnooc Ltd. for Unocal Corp., of California. Since then, Chinese firms have shied away from efforts to buy majority stakes in big U.S. companies.
Still, the sheer size of China's investment in Morgan Stanley will likely give it clout.
Days before Charles Prince decided to step down as Citigroup CEO amid massive credit-market losses, he had lost the support of a longtime backer, Saudi Prince Alwaleed bin Talal, described similarly as a passive investor in Citigroup.
China made its biggest overseas foray to date in October when its biggest bank, Industrial & Commercial Bank of China Ltd., announced the purchase of a $5.6 billion stake in Africa's largest lender, South Africa's Standard Bank Group Ltd.
China has the money to spend because of its ballooning trade surplus with the rest of the world, as well as a local stock-market boom that has raised tens of billions of dollars for giant state-owned firms. China's foreign reserves rank as the world's largest at more than $1.4 trillion.
The terms of the Morgan Stanley deal guarantee CIC a 9% annual return, well above the fund's 5% cost of funding until it converts its investment to shares in 2010.
For Morgan Stanley, the deal could offer it some measure of goodwill in a country that has remained elusive to Wall Street.
In the 1990s, Morgan Stanley formed the first onshore investment-banking joint venture, China International Capital Corp., with a Chinese state bank. That venture later suffered from disagreements between the two partners, and Morgan Stanley became a passive investor, still holding a 34% stake.
[chart]Reaching out to Chinese money is a natural move for Morgan Chairman and Chief Executive John Mack, perhaps the top U.S. financial executive left with deep ties to China.
Since returning to Morgan Stanley from Credit Suisse in the summer of 2005, Mr. Mack has pushed his China team to build a broader platform in China. He recently signed a deal to re-enter the Chinese domestic markets, while Morgan Stanley has also bought a small Chinese bank and a stake in a fund-management venture.
All of those deals beef up the bank's China presence at a time when Morgan Stanley, like most of its rivals, still does most of its China business out of Hong Kong by linking Chinese companies to global capital markets.
Still, striking deals in China has become increasingly difficult, as Beijing fears some Chinese assets have gone to foreign investors too cheaply in the past. Skyrocketing stock prices have contributed to this feeling and prompted regulators to scuttle deals by Western firms.
Though China continues to attract the world's highest levels of foreign direct investment -- $61.68 billion in the first 11 months of this year, an increase of 14% on the year -- the size of the biggest outbound investment deals have this year far exceeded inbound investments.
The top five outbound investments from China were for an average of $3.1 billion, according to Thomson Financial, while the top inbound deals were for an average of $202 million.
Write to Rick Carew at firstname.lastname@example.org, Laura Santini at email@example.com and James T. Areddy at firstname.lastname@example.org