China to Buy $3 Billion Stake in Blackstone

ANDREW ROSS SORKIN & DAVID BARBOZA
/ New York Times 20may2007

The Chinese government said today that it would acquire a $3 billion stake in the Blackstone Group, the private equity firm, in the country’s first effort to diversify its $1.2 trillion in foreign-exchange reserves beyond United States Treasury bills and into commercial enterprise.

The deal, which is set to coincide with Blackstone’s $4 billion initial public offering this year, will give China a roughly 8 percent stake in Blackstone, which owns companies that have 375,000 employees and $83 billion in annual sales.

It would also represent a watershed for the booming private equity industry as it tries to gain a foothold in China.

“It’s a historic change. It’s a paradigm shift in global capital flows,” Stephen A. Schwarzman, a co-founder of Blackstone, said in an interview. He called the Chinese government’s decision “huge” and even “surprising” to him.

China will invest in the Blackstone firm itself, not in its fund, which invests in companies. But the relationship opens the door for China to invest in Blackstone’s fund in the future.

China has been grappling with how to invest its foreign reserves more aggressively. In March, China said that it would set up a special investment arm — the State Foreign Exchange Investment Company — to handle a portion of those reserves, which are now held by the central bank, in the hopes of earning a higher return.

The agency is not yet operating, but the Blackstone deal suggests that the Chinese government is eager to put its vast reserves to work outside of China. Still, as Blackstone begins to invest in emerging markets like China, the deal offers the prospect that at least some of the money could find its way back to China. Indeed, Blackstone is planning to open offices in Hong Kong and Beijing this year.

For years, China has invested in foreign currency, particularly United States Treasury bonds, which have earned a safe but modest return. But now, with the American dollar in decline and the Chinese government willing to take on more risk to earn higher returns, the new agency is being modeled, in part, on Temasek Holdings, Singapore’s state-owned investment firm, which has invested billions of dollars around the world, particularly in China.

A similar investment agency in China would effectively create the world’s largest hedge fund. Some analysts say that the China fund’s investment of billions of dollars in the global financial markets could push global asset prices higher, affecting American and European stocks, bonds and interest rates, as well as the value of energy and natural resources in Africa and the Middle East.

The Blackstone Group, which is based in New York, has been moving aggressively in recent months to find investments in China. Blackstone is trying to catch up to the Carlyle Group, which has a large operation in China.

In January, Blackstone hired Anthony Leung, the former Hong Kong financial secretary, to run the group’s business in China, Hong Kong and Taiwan. And last month, Reuters reported that Blackstone was seeking to acquire a stake in the Guofeng Group, one of China’s largest makers of plastic products.

Under the terms of the Chinese government’s investment in Blackstone, it will buy nonvoting shares as part of the firm’s initial public offering at 95.5 percent of the public-offering price. It has agreed to keep its stake for at least four years.

China may reduce its ownership after the public offering so it holds fewer than 10 percent of Blackstone’s shares. The public offering is expected to value Blackstone at as much as $40 billion.

While the investment may presage further Chinese investment in private equity firms in the future, China has promised not to invest in a competing private equity firm for a year.

Blackstone — which has led multibillion-dollar buyouts of Equity Office Properties, Freescale Semiconductor and Michaels Stores — manages a $15.6 billion buyout fund, the second-largest in the industry. In its prospectus, it reported $2.3 billion in profit in 2006.

source: 22may2007

China Seeks Bigger Bang For Its Bucks

JUSTIN LAHART / Wall Street Journal 22may2007

The key thing to take away from the Chinese government's plan to take a $3 billion stake in private-equity firm Blackstone Group: If you're paying for the fuel, you might as well get some of the heat.

China's huge trade surplus with the U.S. and other countries has given it plenty of cash — and a problem figuring out what to do with it. Because China lets its currency, the yuan, fluctuate only in a narrow band against a basket of foreign currencies, it can't easily convert all the money it makes overseas into yuan; to do so would send the yuan higher. So China has been sticking its money into overseas assets.

China's foreign-exchange reserves have swelled to about $1.2 trillion. Close to three-quarters of that is in dollar-denominated assets, split between Treasurys and other traditionally safe assets like mortgage-backed securities and agency bonds, estimates Roubini Global Economics senior economist Brad Setser. Earlier this year, the Chinese government indicated that it planned to put some of its cash in higher earning, potentially riskier assets. Its Blackstone investment is the first move in that direction.

The 10-year Treasury note yields just 4.79%, less than the rate of 5.25% that the Federal Reserve has set on overnight bank loans. Mortgage-backed securities and agencies don't yield much more. A key factor behind those low yields has been that Chinese demand has kept prices propped up. (Prices and yields move in opposite directions.) Those low yields are part of what has driven demand for riskier investments such as junk bonds, emerging-market debt and, yes, private-equity firms. That's driven up prices and driven down yields on these securities, making it cheaper for private-equity firms to borrow and invest.

There's a certain irony in Chinese authorities' decision to put money in Blackstone, points out Deutsche Bank Securities senior investment advisor Gerald Lucas. "For the past five years, they've been pushing other investors out the risk spectrum, and now they've decided to go out there themselves," he says.

China's decision may make perfect sense. By taking a stake in Blackstone, China is taking a stake in one of the main beneficiaries of its massive U.S. securities purchases.

While $3 billion remains a pittance to China, equaling just 0.25% of the country's $1.2 trillion in foreign reserves, the investment gives Blackstone even more fodder to tap into the low-interest-rate environment China helped create. It may also help spur interest in Blackstone's initial public offering of stock, set for June.

On the other hand, Blackstone has such a high pedigree that the Chinese investment could have a trophy quality. That means future returns could be slim or worse.

Before jumping on the Blackstone IPO bandwagon, investors might do well to remember what happened the last time a flush Asian investor plunked down billions of dollars on a high-flying U.S. asset. Japan's Mitsubishi Estate Co. acquired an 80% stake in Rockefeller Center from 1989 to 1990. In 1995, the company walked away from the investment with nearly $2 billion in losses.

p.C1

China's Blackstone Investment Is a
Late Bet With Bad Precedent

Wall Street Journal 22may2007

Beijing is handing over $3 billion from its huge foreign-exchange reserves to take a stake of less than 10% in Blackstone Group. This will add further firepower to private equity. But talk of a market "melt-up" is overdone. Foreigners often arrive when bubbles are near their end. In this case, there may be no greater fools than the Chinese bureaucrats who are taking this buyout bet on the private-equity firm's nonvoting stock.

The Chinese authorities want their $1.2 trillion of foreign-exchange reserves to earn more. These reserves are invested in U.S. Treasurys, which yield little above inflation and even less when the dollar's decline is factored in. So Blackstone's recent returns from its near-$80 billion under management must look mouth-watering.

Leveraged buyout groups already have enough ammunition to take out half of the S&P 500's market cap, according to the strategists of ISI Group. Should buyout shops such as Blackstone get hold of Asia's vast foreign-exchange reserves, they'd be able to acquire every company in the galaxy. No wonder that's led to talk of a "melt-up."

But history suggests that Beijing is repeating a mistake made many times before. The peak of past market manias is often associated with the arrival of foreigners attracted by the stories of easy fortunes to be made. In the early 18th century, Scottish noblemen lost their estates in the Mississippi bubble, and the Swiss city of Bern famously made a late investment in South Sea Company stock.

More recently, as the Nasdaq approached its peak in 2000, a number of European companies — including Vivendi, Deutsche Telekom, and Marconi — were busy snapping up overpriced U.S. tech firms. Only a couple of years ago, Europeans and South Americans jetted to Miami to put deposits down on condo developments.

The Chinese officials making this wager on the alternative-assets boom aren't just risking money. If the Blackstone bet turns sour when the LBO boom subsides, questions are likely to be asked why the Chinese chose to add still more to Blackstone founder Steve Schwarzman's already copious fortune.

Capitalia

Italian bank deals can be notoriously tortuous affairs. But UniCredit's acquisition of Capitalia seems to have been wrapped up in double-quick time. In part, that reflects the strategic logic of combining these two businesses. But the deal has also been smoothed by the willingness of UniCredit boss Alessandro Profumo to go the extra mile.

He is paying a decent price. At €8.41 ($11.36) a share, Capitalia is valued at €22 billion, or 2.3 times book value. That's a 15% premium to the average for recent Italian bank deals, according to Keefe, Bruyette & Woods. Capitalia investors will get more than half the estimated €7 billion of synergies Mr. Profumo believes the deal will create. The offer price represents a 23% premium to Capitalia's share price before news of UniCredit's interest emerged. But that's probably an underestimate, since Capitalia shares were already inflated by approaches from Banca Intesa and Holland's ABN Amro Holding last year.

Importantly, Mr. Profumo has smoothed some nonfinancial issues, too. There's a job for Cesare Geronzi, Capitalia's chairman, who will be deputy chairman of the enlarged UniCredit. That will have helped neutralize a possible sticking point.

Mr. Profumo's generosity has two advantages:

First, it reduces the risk the deal falls victim to a change in the political support — always critical in Italy — or to an interloper. Spain's Banco Santander Central Hispano, which owns nearly 2% of Capitalia, had appeared a credible rival until ruling out a bid last month. It could return if thwarted in its alternative strategy to buy ABN's Antonveneta.

Second, the sooner UniCredit gets this deal done, the sooner it can get on with the next one. With UniCredit having 16% of the Italian market, Mr. Profumo's domestic deal-making days may be over. But U.S.-based fund firm Putnam Investments, Germany's Landesbank Berlin, and France's Société Générale have all been on his radar in the past six months. The sale of shares in Mediobanca, the Italian investment bank, should ensure UniCredit's capital batteries are quickly restored. Mr. Profumo, who went two years without big acquisitions before bagging Capitalia, may not need to wait so long before doing his next.

Siemens

The Siemens supervisory board wanted a clean break. In the past month, both the board's chairman and the German conglomerate's chief executive have been forced to resign amid a widening bribery scandal. Gerhard Cromme, the acting chairman, was ready to take that job permanently, but the CEO spot was trickier to fill.

What Siemens needed was a dynamic leader who had not been seduced by Germany's cozy national governance style, and someone who would keep up the pace of restructuring. The only obvious domestic candidate, Linde's Wolfgang Reitzle, publicly said "no."

So Mr. Cromme and the board turned to Peter Loescher, the heir-apparent at Merck, the U.S. pharmaceutical producer. He fits the bill, sort of. He is an outsider who brings an international perspective but, as an Austrian, German is his native tongue. That matters, because Siemens is still seen as a pillar of the German industrial establishment. Further, during his time at Hoechst, Mr. Loescher led a successful restructuring.

But he isn't ideal. His pharmaceutical expertise is useful in only one of Siemens' 11 divisions. Nor has he held the reins of a major corporation, let alone one the size of Siemens, which has revenue five times as large as Merck. No wonder, then, that Siemens' shares closed slightly down yesterday. Investors are relieved but not ecstatic.

Mr. Loescher's two years of experience at General Electric, Siemens' trans-Atlantic rival, may help him find his feet at this complicated company. But it will clearly take some time for him fully to understand the intricacies.

One key test will be how he handles the disposal of Siemens' VDO auto-electrics division, valued at around €9 billion. Mr. Loescher may want to flush out a trade or private-equity buyers, rather than going ahead with a September flotation.

Whether Siemens benefits from Mr. Loescher's outside perspective, the new boss has certainly managed his own career well. He was No. 2 at Merck for only a year before being snatched up for one of the biggest jobs in Europe.

—Edward Chancellor, Mike Verdin and Una Galani