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Bear
Stearns's ruin will shake Sovereign Funds
Andy
Mukherjee
Bloomberg
18 Mar
08
http://www.bloomberg.com/apps/news?pid=20601039&sid...
In
the end, Citic Securities Co. was lucky to sidestep the messy
unraveling of Bear Stearns Cos.
Five months ago, the
biggest Chinese brokerage wanted to buy 6 percent of the New
York-based securities firm for $1 billion.
Miraculously
for Citic, the "deal of a lifetime,'' as Bear Stearns
Chairman James "Jimmy'' Cayne then described the tie-up, was
never implemented.
That spared Citic the embarrassment of
paying 69 times the price at which JPMorgan Chase & Co.
agreed on March 16 to take over the beleaguered company.
Citic
Group Chairman Kong Dan yesterday announced that the investment
plan, as well as a proposed joint venture with Bear Stearns, was
canceled.
Citic Securities shares rose yesterday in
Shanghai even as China's benchmark CSI 300 Index fell to an
eight-month low.
While Citic may have been saved by
serendipitous inaction, some state-owned investment vehicles in
Asia and the Middle East may not have been so fortunate.
Banks
and securities firms have raised as much as $105 billion of fresh
capital by selling stakes to individuals, institutions and
governments amid subprime-related losses.
The so-called
sovereign wealth funds have provided at least half of the total,
picking up stakes in Citigroup Inc., Morgan Stanley, Merrill
Lynch & Co. and UBS AG.
After the spectacular
collapse of Bear Stearns, these custodians of public money must
now wonder whether they have really acquired sizable chunks of
great franchises on the cheap, or if, in fact, they have bought
lemons.
Only time will tell.
Attractively
designed
Several of the sovereign-fund investments in
U.S. financial companies are structured as interest-paying
securities convertible into equity at a future date.
A
drop in the share price in the short run doesn't immediately - or
necessarily - erode the return on the sovereign fund's
investment.
Even so, not all of the investments appear to
be in great shape. Take Citigroup, for example. The stock must
climb almost 72 percent from its current level for Abu Dhabi
Investment Authority to profit from its investment over and above
the very attractive 11 percent interest it will receive until
conversion.
If one assumes that the U.S. financial system
will emerge from the current gloom well before the mandatory
conversion of Citigroup equity notes that starts in the first
quarter of 2010, then it's not unreasonable to expect that Abu
Dhabi will ultimately make lots of money on its
investment.
Shadow of doubt
However, given
what happened to Bear Stearns - at the close of last week, its
stock traded at $30; by the end of the weekend, the shares were
worth just $2 - there's now considerable risk that the securities
issued by one or more U.S. bank or brokerage may convert into
shares at a loss for the white knights who rescued them.
What
if the magnitude of the loss is so large as to completely
overshadow the interest income?
That wouldn't make
sovereign wealth funds look very smart, would it?
Jim
Rogers, who co-founded the Quantum Hedge Fund with billionaire
investor George Soros in the 1970s, says sovereign funds betting
on U.S. financial stocks are going to lose money because they
opened their purse strings too early.
Rogers may have a
point.
Already there's heartburn in China over
state-owned China Investment Corp.'s $3 billion investment last
May for 9 percent of Blackstone Group LP, the world's biggest
buyout fund. That stake, according to yesterday's market price,
has shrunk to less than half its original value.
'Sweat
and blood'
Morgan Stanley shares have lost 30 percent
of their value since Dec. 20, the day it announced a $5 billion
cash infusion -- again by China Investment.
UBS stock has
fallen 57 percent since Dec. 10, when it wrote down $10 billion
of U.S. subprime investments and announced a bailout by strategic
investors, including Government of Singapore Investment
Corp.
Sovereign wealth funds are long-term investors.
They can afford to be patient.
But that doesn't
mean they have a complete license to bungle their trades in the
short- to medium-term.
Following the Blackstone debacle,
bloggers in China have questioned the judgment of state-appointed
investment managers, with one anonymous writer on Sina.com, a
popular Web portal, asking the authorities to take greater care
in investing the country's foreign reserves, "the product of
the sweat and blood of the people of China.''
'First
of many'
If there's still such a thing as
"fundamental value'' of a U.S. financial company, post-Bear
Stearns no one can claim to know just what it is.
"Bear
Stearns's demise should probably be viewed as the first of
many,'' Richard Bernstein, chief investment strategist at Merrill
Lynch, wrote in a report yesterday.
Comments like those
will make sovereign wealth funds in Asia and the Middle East
cringe. No doubt they will now be extra- cautious about investing
in U.S. financial stocks. But what about the billions of dollars
they have already committed?
The fate of those investments
is now in the domain of luck and prayers. The fund managers can
only hope they haven't bitten off more risk than their political
masters can chew.
Andy Mukherjee is a Bloomberg
News columnist. The opinions expressed are his own.
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