Bloomberg News

Citic Buying CLSA Gives China Most Autonomous Asia Broker

August 01, 2012

Andy Rothman, a former American diplomat who now runs China macro-strategy at CLSA Asia-Pacific Markets, had a blunt message for the broker’s clients in May 2011: The Communist Party’s control of finance companies leads to “high-frequency interference.”

Now, about a year later, CLSA is on its way to being acquired by Citic Securities Co. (600030), part of a state-controlled investment group that ultimately answers to that party. On July 20, Beijing-based Citic said it had bought a 19.9 percent stake in CLSA and planned to purchase the remaining shares by mid-2013 for a total of $1.25 billion.

The acquisition would give Citic, China’s top-ranked takeover adviser and equity underwriter, access to CLSA’s research and global client list as it expands abroad and competes with rivals such as Goldman Sachs Group Inc. (GS:US) Citic’s main challenge may be both retaining key employees and preserving the autonomy at CLSA, ranked by Asiamoney magazine as the most independent research firm for nine years in a row.

“It’s going to be a big challenge for Citic to harness and smooth out their differences,” Chen Xingyu, an analyst at Phillip Securities Research Pte in Shanghai, said by telephone. “If it isn’t handled well, the friction could lead to conflict and management turmoil, and will certainly affect business development.”

Horse Racing

Citic Securities, founded in 1995, is controlled by government-owned Citic Group Corp., which holds a 21 percent stake. The parent was established in 1979 by Rong Yiren -- who went on to become a vice president of China -- to support former leader Deng Xiaoping’s experiment with open markets. Its businesses now span banking to real estate and oil exploration, and the group reports directly to China’s cabinet.

CLSA, founded in 1986 in Hong Kong, was led in its early years by two former business reporters. The late Jim Walker and Gary Coull -- who shared a love of horse racing -- found similarities between journalism and broking, mainly “getting fresh angles and moving them quickly,” Coull had said.

About 35 percent of CLSA is owned by staff and managers, while Credit Agricole SA (ACA)’s corporate- and investment-banking unit held the remaining 65 percent until last month’s sale.

Half of the Hong Kong-based company’s clients are in the Asia-Pacific region, with the rest in the Americas and Europe, UBS AG (UBSN) said on July 23. The brokerage’s 1,500 employees span 20 countries. In contrast, the Chinese investment bank has about 13,200 employees, mostly on the mainland and in Hong Kong.

‘No Precedent’

“There’s no precedent for a local company to have successfully acquired and integrated a foreign and more global target,” Jean Bao, an analyst at Keefe, Bruyette & Woods Asia Ltd. in Hong Kong, said by telephone on July 26. “If they want to bring in any revenue and cost synergies, then they will have to merge the two platforms and it will be hard.”

Another challenge to successfully combining the businesses will be Citic’s ability to retain CLSA staff, especially after buying their stakes out, Ning Ma and Bowei Cheng, analysts at Goldman Sachs-affiliated Beijing Gao Hua Securities Co., said in a July 23 note to clients.

Japan’s Nomura Holdings Inc., once the world’s biggest securities firm with a market value of $76 billion in 1987, faced that problem following its 2008 acquisition of Lehman Brothers Holdings Inc.’s assets in Europe and Asia. Tokyo-based Nomura saw an exodus of former Lehman employees, mostly foreigners, following the payout of retention bonuses in the first quarter of 2010.

Losing Independence

CLSA has already lost two senior bankers. Chairman Wu Changgen resigned at the end of June, two people familiar with the matter said on July 25. Paul Lai, who started at CLSA in January 2010 to help run investment banking in Greater China, was hired by Banco Bilbao Vizcaya Argentaria SA (BBVA), Spain’s second- biggest bank, at the end of May.

Other CLSA executives such as Rothman and CLSA Chief Executive Officer Jonathan Slone said they expect to retain their autonomy.

“They have committed to providing us the same degree of independence and the same room for creativity that we’ve enjoyed in the past,” Rothman, 52, said in an e-mailed response to queries.

Working with Citic will bolster CLSA’s operations in China amid the global rout in capital markets, Slone, 50, said last week in an interview.

“The independence of the company never has anything to do with the shares,” Slone said. The firm will continue to operate as a separate entity with its own management, Citic said.

‘Bad Deal’

Still, investors’ concerns that the companies may struggle to combine operations and keep employees erased about 6 percent of Citic’s market value over two days from July 19, the day before the accord was announced, according to data compiled by Bloomberg. The shares have since rallied 1 percent in Shanghai and 3.3 percent in Hong Kong.

“If they fail to keep the staff after spending so much money, that will make the acquisition a bad deal,” said Hong Jinping, an analyst at China Merchants Securities Co. in Shenzhen. “This is the market’s biggest worry.”

The companies still have time to craft their retention plan. Credit Agricole has a put option to allow the Chinese bank’s Hong Kong-based subsidiary to acquire the remaining 80.1 percent in CLSA for $942 million in cash, and they plan to complete that by the middle of 2013. The 19.9 percent stake acquired last month, following talks that began more than two years ago, cost Citic $310.3 million.

Brokerage Income

The deal will give the Chinese investment bank CLSA’s cash equities business, its global client-list of institutional investors and research focused primarily on Asia-Pacific markets. CLSA generates 75 percent of its revenue from “plain vanilla” brokerage income, Deutsche Bank AG estimated on July 24.

Citic’s problems following the acquisition may include managing a higher cost-to-income ratio because of expenses tied to staff retention, competing with global rivals that have a stronger track record, and coping with the slower pace of growth outside China, Judy Zhang and Tracy Yu, analysts for Deutsche Bank in Hong Kong, said in research notes last week.

“Citic Securities still has a long way to go,” Hong of China Merchants said. “It will take more than five years” for the investment bank to compete with the likes of Goldman Sachs and Morgan Stanley (MS:US), she said.

Nomura, Macquarie

Still, the Chinese company is already Asia’s largest securities firm by market capitalization, valued at about $21.3 billion as of yesterday. That is 60 percent more than Nomura (8604), which is valued at $13.3 billion, and more than double the size of Sydney-based Macquarie Group Ltd. (MQG), which is at $9.15 billion, the data show. New York-based Goldman Sachs is valued by investors at $51 billion, and Morgan Stanley at $27 billion.

Citic will generate 20 percent of its revenue from overseas operations after it acquires all of CLSA, the company said. That’s up from the 5 percent that it gets now, primarily from the Hong Kong unit.

In its home market, the investment bank is the top-ranked adviser this year on takeovers where the sellers and the buyers were Chinese companies, according to data compiled by Bloomberg. It had an almost 20 percent share of a market with $37 billion in transactions, the data show.

It’s also No. 1 among managers of share sales and rights offers in China, and No. 5 on domestic debt underwriting, the data show, partly because of rules that limit foreign investment banks’ participation to joint ventures.

Outside China, Citic hasn’t done as well in the past.

Global Rivals

On the $372 billion of takeovers this year involving companies across the Asia-Pacific region, Citic was ranked No. 31 among advisers in a market dominated by Morgan Stanley and New York-based JPMorgan Chase & Co. (JPM:US), the data show. On share sales, Citic was ranked No. 10, trailing Zurich-based UBS, JPMorgan and Morgan Stanley.

Combining operations with CLSA will help “create a business model which our competitors cannot match,” the Chinese company said in an e-mailed response to questions. It can “better assist our Chinese clients as they tap into the global financial markets and help foreign investors to gain better access to our home market in China.”

CLSA’s research operations will be key to helping Citic win those mandates abroad, according to Hong of China Merchants.

“In the overseas market, research has a more important role and CLSA is highly respectable with a very good track record,” Hong said. “Citic Securities has to expand overseas because that will help it better serve its clients as Chinese companies grow and expand.”

Wood, Mayo

CLSA’s research unit is well-regarded in part because of analysts such as Christopher Wood, chief equity strategist and author of the Greed & Fear report, as well as Mike Mayo, who covers U.S. lenders and wrote “Exile on Wall Street: One Analyst’s Fight to Save the Big Banks From Themselves.”

Rothman, who joined CLSA in 2000 after 17 years as a U.S. diplomat, provides economic and political analysis to investors and is author of the weekly “Sinology” report.

In the May 2011 research note, which he co-authored with Julia Zhu, Rothman said that while the Communist Party’s control over Chinese banks doesn’t mean they are “incompetent or insolvent,” the scope of its involvement makes policymaking by the party the “biggest near-term risk” to China’s financial system.

“The Party is probably the world’s most liquid financial institution,” according to that report. “But the high level of control leads -- as it does in any bureaucracy -- to high- frequency interference or intervention.”

To contact Bloomberg News staff for this story: Aipeng Soo in Beijing at asoo4@bloomberg.net

To contact the editor responsible for this story: Chitra Somayaji at csomayaji@bloomberg.net


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