China learns hard M&A lessons

HONG KONG (Reuters) - The unraveling of CITIC Securities' plan to link up with Bear Stearns BSC.N may prove the latest example of a Chinese deal gone bad.

Sitting on a mountain of cash, China’s government has sought to diversify its holdings and expand state-run companies by investing more in foreign assets.

But to date, many of the deals have turned out to be duds.

That point was highlighted over the weekend when CITIC's $1 billion venture with Bear was thrown into serious doubt. Facing a collapse, Bear agreed to be bought by fellow Wall Street bank JPMorgan Chase & Co. JPM.N for a mere $2 per share, a tiny fraction of its worth only a few months ago.

A CITIC Securities spokesman said on Monday that prospects for its potential investment in Bear had become very unclear.

While state-backed CITIC was lucky not to finalize a deal before Bear’s fall, the arrangement is yet another hard lesson for China’s nascent dealmaking franchise.

“It’s a tough time to be an investor and the CIC is not immune from that,” said James McCormack, head of Asia sovereign ratings at Fitch Ratings, referring to China’s sovereign wealth fund. “The mandate for CIC is to generate higher returns -- but with higher returns comes higher risk and this is becoming evident.”

Although some recent acquisition moves by state-backed corporations in the mining sector have proven bold, China's stakes in Wall Street firms, from Blackstone to Morgan Stanley MS.N have fared poorly.

That’s unlikely to stop Western investment bankers from continuing to push troubled financial companies onto Chinese investment committees. But China’s brief experience in the space makes it a tough sell and will carry bitter memories.

China said in March it was setting up a vehicle to diversify part of its $1.2 trillion of foreign exchange reserves to improve returns on its portfolio, having mainly invested in dollar bonds. Shortly after, the China Investment Corp. (CIC) formed, setting aside $200 billion to invest.

The fund’s entry into dealmaking brought the government face to face with some of the globe’s savviest players in the mergers and acquisitions market.

And it led to investments in U.S. firms with significant exposure to what Wall Street hoped was a passing credit mess.

It’s only gotten worse.

Last spring, China agreed to buy a $3 billion stake in the Blackstone Group BX.N, the private equity firm that later went public at $31 per share. Its stock is now at $15.78, as the credit crunch dried up loans for private equity deals.

Last October, Bear and CITIC announced plans to invest about $1 billion in each other and form a joint banking venture in Asia. Citic was to obtain a stake of about 6 percent in Bear, with the U.S. bank getting about 2 percent of CITIC.

That same month, China's biggest lender ICBC 1398.HK agreed to buy 20 percent of South Africa's Standard Bank SBKJ.J for $5.6 billion in cash, the biggest foreign acquisition by a Chinese commercial bank. Standard Bank shares have slid 19 percent since the deal was announced.

China is smarting from another deal involving Morgan Stanley. CIC agreed to pump $5 billion into the Wall Street bank after it posted $9.4 billion of losses in subprime mortgages and other assets. The bank’s shares have since fallen 25 percent.

And a sour taste still lingers from the failure of CNOOC 0883.HKCEO.N, a Chinese oil company, to buy California-based Unocal in 2005, after U.S. politicians thwarted the deal.

Although the long term prospects of at least some of China’s investments may be strong, few enjoy seeing a purchase drop in value so soon after making it.

“Clearly they are going to be more cautious about what they invest in,” said a Hong Kong-based banking analyst who did not want to be named.

Not all Chinese bids have landed with a thud.

Other state-backed Chinese corporates have grown increasingly bold in their M&A strategies, earning the respect of some in the deal market who say the moves are smart.

Sinosteel Corp last week offered A$954 million ($902 million) for prospector Midwest Corp MIS.AX to lock up future iron ore supplies, marking the first hostile bid by a Chinese firm in Australia's booming mining sector.

In another daring raid, Chinese state-owned aluminum company Chinalco paid $14 billion for a 9 percent stake in Rio Tinto Ltd/Plc RIO.AXRIO.L, the world's second-biggest diversified mining house. The move has threatened to gatecrash BHP Billiton Ltd/Plc's BHP.AXBLT.L> $140 billion takeover bid for Rio.