Skittish CIC Sits Out Morgan Stanley Deal
Morgan Stanley was too expensive for China’s sovereign wealth fund CIC, which has lost a lot of money in the past year.
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By Li Jing – Caijing Magazine
9 October 2008
Morgan Stanley was too expensive for China’s sovereign wealth fund CIC, which has lost a lot of money in the past year.
While Lehman Brothers was declaring bankruptcy and Merrill Lynch was being taken over by Bank of America, the general manager of China’s sovereign wealth fund China Investment Corp. (CIC) arrived in San Francisco for a meeting organized by a private equity tycoon.
Gao Xiqing’s trip September 15 was understood as a sign that CIC intended to acquire Morgan Stanley, another U.S. investment bank which, like Lehman and Merrill, was shaken down by the global credit crunch.
The government investor Gao manages already owns a 9.9 percent stake in Morgan Stanley through convertible equities. And in a teleconference the next day, Morgan Stanley’s CEO for the Asia-Pacific region said the bank was negotiating possible deals with organizations including CIC.
But no deal emerged. On September 19, through the official Chinese news agency Xinhua, CIC denied any possibility of a Morgan Stanley buyout. And three days later, that denial proved true as Japan’s Mitsubishi UFJ Financial Group announced that it would buy up to 20 percent of Morgan Stanley and win a seat on the bank’s board.
Did the Japanese beat the Chinese to the punch? Or was CIC, which has lost several bets over the past year, worried about another investment failure?
A Wall Street Journal report said CIC missed an opportunity because of the agency’s slow decision making process. But China’s importance to Morgan Stanley was made clear September 26, when the bank’s CEO John Mack hurried to Beijing to personally explain the Mitsubishi UFJ deal to officials at CIC.
Sources told Caijing that CIC’s decision to reject the additional investment sought by cash-strapped Morgan Stanley was based on price and risk concerns. “The price offer was too expensive,” one source said.
Indeed, CIC was unwilling to meet Morgan Stanley’s demands, at a price close to what the Chinese paid for the 9.9 percent stake last year. If the latest offer had been right, the source said, CIC would have been willing to buy another 20 percent.
CIC paid US$ 5 billion for the minority share in December 2007. Under the agreement, CIC’s stake can be converted within 31 months to stock valued at between US$ 48 and US$ 58 – prices about 60 percent higher than the stock’s recent trading range.
The opportunity to boost the Morgan Stanley investment put CIC’s savvy to the test, just one year after it was formed through a reorganization of the Chinese government’s investment offices.
CIC is now in a good position to wait out the current market turmoil. But it might have earned more by buying additional shares in Morgan Stanley during the latest slump.
It’s not the first time CIC has faced a critical decision.
Over the past year, the sovereign fund has focused on a private operations model despite a controversy related to its use of special Chinese treasury bonds as a capital base. The Ministry of Finance issued some 1.55 trillion yuan worth of bonds with annual interest rates between 4.3 percent and 4.69 percent, and based on maturity periods of 10 years or 15 years, to get CIC off the ground.
According to unofficial information last year, CIC was supposed to pay all interest-related costs. In February, however, the finance ministry asked CIC to make the first six months in interest payments in one shot. The ministry eventually had mercy on CIC by agreeing that profits paid to the government from CIC investments could be used to pay the interest.
But CIC suffered other blows as the yuan appreciated against the U.S. dollar. The sovereign fund’s losses have mounted as the currency exchange rate fell 7 percent over the past year.
Indeed, all of CIC’s major investments targets in the past year – Bear Stearns, JC Flowers and Morgan Stanley – have lost book value.
The Chinese agency’s eyes have focused on North America, although some experts say the portfolio could be better balanced through stakes in South America, Asia and Africa. Moreover, CIC’s investments concentrated on financial institutions – an arena that requires significant money-management experience that some say the agency lacks.
Apparently, CIC has been unable to accurately estimate the asset quality of these financial institutions. At the same time, its managers have been unwilling to hire independent advisors to guide their steps.
Some industry experts say CIC, as a young sovereign fund, should be more cautious with overseas investments, while giving priority to improving governance and investment decision procedures.
Yet CIC is operating somewhat in a vacuum. Launched without a review by the National People’s Congress, the sovereign fund has no legal framework for operations, governance or allocating profits. It has neither a mission statement nor specified long-term objectives.
And CIC has stumbled while sovereign funds in other countries have succeeded.