Untangling the Bear Stearns China Buy-in

The Buy China syndrome is alive and well among the world's biggest global banks desperate for a piece of the Middle Kingdom's growth story. A whole caravan of Western players including Bank of America (BAC), Citigroup (C), HSBC, Goldman Sachs (GS), and American Express (AXP) have ponied up more than $20 billion in all to buy equity stakes in Chinese banks over the past couple of years. Last fall, China Construction Bank raised a head-turning $9 billion-plus in a highly subscribed global initial public offering in Hong Kong. And other big mainland lenders such as Bank of China and Industrial & Commercial Bank of China (ICBC), are planning similarly big offerings this year as well.

That's why a report in the Wall Street Journal that China Construction may invest anywhere from $2 billion to $4 billion for a sizable equity stake (perhaps as much as 20%) in Wall Street broker Bear Stearns (BSC) seems so surprising. China Construction lacks the kind of balance sheet -- and the competitive muscle in lending and equity underwriting -- to go against the big boys in U.S. investment banking. A deal, if it comes, is really about helping the Chinese lender strengthen its position at home.

So why pay for a strategic partnership with Bear Stearns when so many other Western lenders have forked over serious cash for the privilege of linking up with a big Chinese lender?


  From China Construction's point of view, the investment might make sense if it enhances its reputation as an up and coming quality Chinese bank that has sealed partnerships with the biggest names in global banking and brokering. Bank of America last year paid $3 billion for a 9% stake in China Construction, the mainland's third biggest bank, with about $521 billion in assets and a $293 billion loan portfolio that includes some of China's biggest companies.

The fifth biggest U.S. brokerage, Bear Stearns, may not be as well known as Goldman Sachs, Morgan Stanley, or Merrill Lynch outside of the U.S., but it enjoys a lucrative franchise in Europe and is a huge prime broker to global hedge funds. It desperately needs to play catch up in China -- and a friendly shareholder with a 20% stake could prevent the brokerage from becoming takeover bait for bigger global players looking to expand.

Bear Stearns' know-how in wealth management, fixed income, and equities could come in handy for China Construction. "You are going to be buying into expertise in different sectors," says Shaun Rein, founder and managing director of the Shanghai-based China Market Research Group."It is showing the world that Chinese banks are ready."


  Bear Stearns, of course, would get access to what is sure to become one of the 21st century's most lucrative financial markets. China is sitting atop roughly $2 trillion in household savings and boasts a savings rate of close to 50%. Its hyper growth economy, which clocked more than 10% growth in the first quarter, is generating even more wealth and deposits flowing into the banking system.

In fact, now that China Construction is listed, and awash in deposits and IPO proceeds, it may be looking for a safe place to park some of that cash and earn a decent return, suggests May Yan, vice-president and a senior analyst with Moody's Investors Service in Hong Kong. Deposit growth has been in the 16% to 17% range, and now China Construction "is trying to lower its risk profile." Investing some excess cash in Bear Stearns' convertible bonds, as suggested in news reports, may make sense as an investment, she thinks.


  Whether a deal ever comes to pass is far from certain. China Construction spokesman Yu Baoyue told BusinessWeek Online that to his knowledge "the bank does not have such a plan" for an equity investment in Bear Stearns, and the Wall Street firm is also refusing to comment on the report. (Still, investors took the report seriously: Bear Stearns shot up 3.3% to record levels in New York trading on Apr. 17.) China Construction is still majority-owned by the government, and Beijing would have to sign off on any high-profile foreign investment.

Another issue is just how Bank of America, the largest retail bank in the U.S., would react to a China Construction alliance with Bear Stearns. Bank of America is a minority shareholder with only one board seat, but it is key to China Construction chairman Guo Shuqing's strategy of refashioning the mainland lender from a lumbering state-owned financial player into a competitive full-service outfit.

Bank of America gave up the right to make strategic investments in other major mainland lenders -- and has promised to dispatch 50-odd executives to help China Construction upgrade its operations. A falling-out with Bank of America would be a setback for China Construction -- and likely would hit the bank's stellar post-IPO stock performance. Its shares traded in Hong Kong have vaulted about 50% since early November.


  A lot is riding on a successful transformation of China Construction and other big lenders into viable businesses. Since the late 1990s, the Chinese government has pumped $259 billion into China Construction and three other big state-owned banks: Bank of China, ICBC, and the Agricultural Bank of China.

China Construction has one of the strongest balance sheets in mainland banking, but still needs help improving its lending practices and loan collection efforts. About 25% of its loan portfolio is tied to the highly volatile residential and property development markets at a time when many worry about a painful real estate bust in overheated cities such as Shanghai.

In an interview with BusinessWeek last fall, Guo insisted China Construction "was well-positioned to capitalize on the growth in China." That is probably true, but it will need a lot of help from Western players. So far, Guo has let others pay for the privilege. Now, he may be willing to whip out the checkbook to bag the right partners and secure the bank's future prosperity.

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