Dealwatch: China and sovereign wealth funds

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Published October 5, 2007 at 12:29 PM

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OPEN FOR BUSINESS

On Sept. 29, China became the latest country to launch a sovereign wealth fund -- in this case a staggering $200 billion investment vehicle, China Investment Corp., Asia's largest and one that seeks to capitalize on $1.41 trillion worth of currency reserves. The Deal contributor Sean Daly points out Asia's reserve total $3.5 trillion -- accounting for two-thirds of the world's -- and are targeted to add $200 billion to $300 billion per year, which made the fund's creation look "absolutely inevitable."

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The country holds $405 billion, or 18% of foreign-owned U.S. treasuries, a figure eclipsed only by Japan, Bloomberg points out.

Indeed, as Daly asserts: "The U.S .Treasury believes official FX reserves and sovereign wealth fund (SWF) assets for the year 2006 totaled $1.2 trillion, though net issuance of U.S. treasuries and other typical reserve paper totaled only $461 billion. With more than $720 billion left without a parking space that year, foreign reserves have simply reached saturation."

So what's the plan?

China has already deployed a chunk of capital into Blackstone Group LP, swapping $3 billion for a 9.7% nonvoting stake ahead of the firm's IPO earlier this year, and later said it would stand firm behind an investment in Barclays plc, despite the outcome of its long-shot prospective buyout of ABN Amro NV.

And even though China has taken a hit with its Blackstone investment as the New York private equity firm's share price has dropped, it seems to be a rather savvy strategic move on both sides.

Rewind to 2005. China's state-owned oil company CNOOC Ltd. had its sights on U.S. oil company Unocal, only to lose out to Chevron Corp. and its $17 billion buyout of the oil explorer. The deal met tremendous opposition from U.S. regulators citing national security concerns. An investment in Blackstone could enable China to bypass such restrictions, The Economist points out. Further, for the private equity firm, the relationship may likely improve its footing on Chinese soil, where LBOs are notoriously difficult. (See more below.)

However, Daly argues that since "the agency cannot afford to be seen as being in the pocket of foreign financiers, particularly after the furor over Carlyle Group's attempted buyout of machine tool maker Xugong Group Construction Machinery Co. Ltd., the CIC will probably play, at least for the first few years, the role of understudy to buyout firms such as Blackstone and other sovereign wealth funds."

WIDE OPEN STRATEGY

In the near term, Daly points out, a large swath of the fund will go toward mainland banking concerns. China will spend at least $65 billion to absorb Central Hujjian Investment Corp. and $63 billion as it disperses funds to Agricultural Bank of China, the China Development Bank and China Everbright Bank, leaving $73 billion for overseas deals.

Further, "The agency's creation has spurred speculation of a flood of Chinese investments into overseas companies and resources such as oil and metals," a Bloomberg report indicated, citing a source arguing China needs to turn toward exporting capital, away from manufactured goods.

UP NEXT

The CIC joins a long list of sovereign investment vehicles. Citing Morgan Stanley figures from March, The Economist points to other funds including: the Unite Arab Emirates' ADIA with $875 billion in assets, Singapore's GIC with $313 billion, various Saudi Arabian funds with a collective $300 billion and Norway's $300 billion government pension fund.

Beyond just a responsibility to capitalize on these pools, there's an added allure for states, The Economist says, taking Singapore's Temasek Holdings Pte. as an example. "The heady combination of state-control, success and secrecy, entranced other governments."

Taiwan and Japan will likely embark upon state-run funds before year's end, while South Korea already did so in 2006, and Russia's and Kazakhstan's stabilization funds have warped into state-run investment vehicles, Daly writes, adding that global wealth held in such funds will jump from near 2.5% to more than 9% in 2010, with China leading the way.

OUTSIDE LOOKING IN

In July, The Deal contributors Vinit Bhatia and Michael Thorneman offered private equity investors a few words of advice about dealmaking in China: Choose carefully, "exercise quiet influence," do your due diligence homework, and then some, and remain nimble. In early September, The Deal contributor Howard Chao and Howard Zang weighed in on the difficulty of doing private equity deals in China. So why is it so hard? Politics, legal hurdles, buying state-owned enterprises is hard, and the state pushes for onshore deals.

And going back to the Blackstone-China relationship, perhaps the tie-up will pave the way for an easier take-private road in the country. Indeed, Blackstone and other major PE shops are at the gate, having put nearly $8 billion into the country last year, Bhatia and Thorneman point out. Stay tuned. -- Carolyn Murphy

Dealwatch executive summary
The Date	The Action
10.05.07	The Deal contributor Sean Daly weighs in on China's "big bopper."
9.29.07	China: What to do with $200 billion?
9.2007	Why are LBOs in China so hard?
9.2007	A look at the challenges to LBOs in China.
7.11.07	China Development Bank vows to invest in new stock regardless of whether Barclays wins ABN Amro.
7.2007	In China, tread lightly.
5.21.07	China swaps $3 billion for 9.7% in pre-IPO Blackstone.
5.2007	The Economist calls sovereign wealth funds world's most expensive club.
3.16.07	The Deal examines whether China is protectionist or just picky.
2.10.06	A look at the CNOOC-Unocal-Chevron deal saga.
Source: The Deal