China Taking A Stake In U

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China taking a stake in U.S. investment titan Beijing to invest billions in Blackstone Group to diversify its cash hoard.

By Don Lee and Walter Hamilton Times Staff Writers May 22, 2007 SHANGHAI — For years China has been the world's factory floor, churning out plastic toys, appliances and socks. Now it's entering the world of very high finance. Moving for the first time to diversify its massive foreign-exchange reserves, the Chinese government agreed over the weekend to acquire a $3-billion stake in Blackstone Group, a huge investment firm that at the same time plans to sell an additional $4.75 billion of its shares to U.S. stock market investors. The landmark deal between Beijing and Blackstone could mark a profound shift in global capital flows and speed the transformation of China's treasury into a giant money manager with the ability to shake markets well beyond its borders. "Who could have imagined a few years ago that an arm of the Chinese government would be taking a stake in an aggressive American private equity firm?" said Donald H. Straszheim, a China specialist at Roth Capital Partners, a Newport Beach-based investment bank. "I think this is remarkable." For Blackstone — which laid out plans Monday for an initial public offering 19% larger than it originally planned — the pact could open doors to vast and growing real estate and financial markets in China. Chinese companies "will bring them deals earlier than they might otherwise and will think they have the imprimatur and the protection of the government," said Steve Kaplan, a University of Chicago finance professor. Like all private equity firms, Blackstone manages investment funds that buy companies with the goal of improving their earnings and eventually selling them at a profit. Since 1987, the investors in Blackstone's private equity funds have reaped an average return of 23% a year, after subtracting Blackstone's substantial fees, the firm says. The impressive performance has attracted more investors to the funds and Blackstone now manages $88.4 billion in assets. The Chinese government, however, would be investing in the Blackstone management company, not the Blackstone funds. The current holdings of Blackstone-operated funds are diverse and include stakes in Universal Orlando, Freedom Communications, Nielsen Co., Orangina and Vanguard Health Systems. The firm was founded in 1985 by Pete Peterson, a former Commerce secretary, and current Chairman Stephen Schwarzman. If Blackstone's IPO is sold out, it would be the fourth-largest of all time, according to research firm Thomson Financial, giving stock market investors about a 14% stake in the New York-based firm.

Beijing, through its new State Investment Co., would own slightly less than 10% — below the threshold requiring U.S. government approval. Because the Chinese government would be buying non-voting shares, which are considered less valuable, it would pay 4.5% less than investors in the public offering will. The Chinese have been wary of making foreign acquisitions since a state-owned company's bid for oil giant Unocal Corp. in 2005. The reaction in the U.S. was so harsh, with critics complaining that Chinese ownership would imperil American energy security, that China dropped the bid. Buying into a savvy private equity firm could be an investment in education, helping Beijing learn how to be a sophisticated investor and avoid Unocal-like missteps. "The Chinese government is using this $3 billion to test the waters in international capital markets, to learn and see how others manage their funds" and make lucrative investments, said Yi Xianrong, a finance expert at the Chinese Academy of Social Sciences in Beijing. China has wanted to diversify some of its $1.2 trillion in foreign reserves, now held in U.S. Treasury securities and other relatively low-yielding assets. Its purchase of Treasury notes has tamped down mortgage and other interest rates in the U.S., but American politicians have been annoyed with China because of its massive trade surplus, which they say is supported by an undervalued currency, the yuan, that makes Chinese products artificially cheap in international markets. Adding a new wrinkle to the heated debate in the U.S. over China's increasing influence in global affairs, the pact with Blackstone came on the eve of economic talks in Washington, to be led by Treasury Secretary Henry M. Paulson Jr. and Chinese Vice Premier Wu Yi. In the U.S., the explosion of private equity deals has raised questions about the secretive industry's growing control over the fates of millions of workers whose companies the partnerships own. Late last year, some of the biggest names in private equity, including Blackstone, Apollo Management, Carlyle Group and Kohlberg Kravis Roberts & Co., formed the Private Equity Council in part to combat negative perceptions of the industry. The group challenges the idea that private equity owners routinely seek to pare down companies and squeeze workers to boost profitability. Douglas Lowenstein, president of the council, said at a congressional hearing last week that private equity "is about hundreds of thriving companies contributing to the economy in numerous positive ways." For China, a legitimate question is whether it is overpaying. For publicly traded mutual fund companies, the value of their stock is typically equal to 1.5% to 4% of the assets they manage, said Jeffrey Ptak, an analyst at fund researcher Morningstar Inc. So the stock market value of a company managing $100 billion could reach $4 billion.

Blackstone, however, has estimated a price for its stock that would imply the company was worth $33.6 billion — equal to 38% of its assets under management. That, Ptak said, is "off the charts." The debate in financial circles is whether it's too far off, especially given that Blackstone collects higher fees than mutual fund managers do. "Given the sheer profitability of Blackstone's business, you would expect it to command a premium valuation," Ptak said. "But the question is magnitude. How much is too much?" Kaplan at the University of Chicago compared the Chinese investment in Blackstone to Japanese investors' untimely purchases of U.S. real estate in the late 1980s. Like private equity today, real estate was widely considered a no-lose proposition in those days. But many Japanese investments went sour when property values sagged during the early-1990s recession. "It's very similar. Everyone is saying, 'Private equity is very hot — you can't lose,' " Kaplan said. "Of course, those [Japanese] deals didn't end very well."

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