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Wall Street Warms to China Story By GREGORY ZUCKERMAN Wall Street Journal January 2 2011 Visiting China was considered an indulgence for most financial executives just a few years ago. But when Berkshire Hathaway Inc.'s Warren Buffett, J.P. Morgan Chase & Co.'s James Dimon, Kohlberg Kravis Roberts & Co.'s Henry Kravis and Carlyle Group's David Rubenstein all visited China in recent months, the trips were seen as something else entirely: crucial steps to keep their respective companies growing. China has been important to global economic growth for years, of course. The country likely emerged as the world's second-largest economy in 2010. It is expected to show close to 10% growth in both 2010 and 2011. Until recently, however, China was something of a sideshow for many financial professionals. Global growth was key to China's health, and the country had an impact on many economies. But China didn't seem to matter much to most deal makers and wealth creators. That's all changing. China is opening its markets, slightly loosening the reins on its currency, and is emerging as a key to the future of almost every Wall Street firm. It's also a linchpin of the investment strategies of a growing number of hedge- and private-equity funds. Consider that global initial public offerings of Chinese companies amounted to $104 billion in 2010, according to data-tracker Dealogic, up from $54 billion in 2009. Last year's tally amounts to $126 billion if Hong Kong companies are included, though it includes domestic markets not fully accessible to foreigners. By comparison, less than $34 billion of U.S. IPOs took place in 2010, the second consecutive year that Chinese companies topped U.S. companies in IPO issuance. Bankers that didn't participate in Chinese IPOs risked seeing smaller bonuses. No Chinese investment bank has emerged as a global power, reducing alibis for not establishing a presence in deals available to foreigners. Meanwhile, mergers-and-acquisitions specialists are racing to China to work with companies like China National Offshore Oil Corp., known as Cnooc, and China Petroleum & Chemical Corp., or Sinopec, among the biggest deal makers in 2010. Chinese companies completed 3,235 acquisitions valued at nearly $190 billion, or 9% of all global deals in 2010. That was more than any other nation except the U.S. and more than the $162 billion of deals by U.K.-based companies. China also was the second-most frequent target of purchases by foreign companies in 2010, after the U.S. In currency markets, analysts say more traders are laying big bets on whether the yuan will be allowed to appreciate further in 2011. Stock-trading volume on Chinese and Hong Kong exchanges now rivals that of U.S. markets. And some strategists, such as Tobias Levkovich of Citigroup, view the Shanghai market as a leading indicator for U.S. shares. The Chinese economy is expanding so quickly it's helping to offset stagnant growth elsewhere in the world for a growing number of companies. And Chinese demand increasingly drives global commodity prices and shares of commodity providers. That all helps explain why some of the largest investors are boosting wagers on—and against—China. The bulls say power will continue to shift to developing makets from developed countries. They cite China as exhibit A of this trend, arguing there are more opportunities in China and elsewhere in Asia than in the U.S. or Europe. Already, some of the hottest investments over the past year, including rare-earth shares like Molycorp Inc. and Rare Element Resources Ltd., get their mojo from tightening Chinese controls or rising demand in the country. Daniel Arbess, who runs a hedge fund for Perella Weinberg Partners, has been profiting by buying shares of global companies helped by Chinese growth, a strategy he calls "Shake Hands With China," and betting against those having a hard time competing with Chinese rivals. Mr. Arbess is focused on companies like Solutia Inc., Apple Inc. and Yum Brands Inc. that are growing quickly in China, as well as those that produce commodities in demand in China. For example, Yum, the owner of KFC, Pizza Hut and Taco Bell brands, saw same-store sales rise in each division for the first time since the end of 2008. China enjoyed a 6% gain, while the U.S. and other international locations posted 1% growth. But many investors find it challenging to directly wager on China. Few companies have enough shares outstanding, or trade with sufficient activity, to make larger investors feel comfortable making a substantial investment. A relative lack of financial and regulatory transparency also is a hindrance. A recent incident is a reminder of the need to be wary: China Gas Holdings Ltd., a large natural-gas distributor, announced in late December that two of its executives were escorted from the company's offices by people claiming to represent the Shenzhen Municipal Public Security Bureau. China Gas said it hadn't been able to get in touch with executives, nor has the company been told why the executives were detained. The incident has flummoxed firms providing analytical coverage of China Gas. UBS, for instance, produces estimates of China Gas's results through 2013. But as of last week, the firm, along with investors, had no details about the executives, and told clients it wasn't sure if the incident would affect the company's operations. The matter hadn't been resolved as the year ended and the stock remains suspended from trading. That's all part of the reason China also is the target of some of the biggest short-sellers, such as James Chanos, who runs hedge fund Kynikos Advisors. The bears also point to China's expensive real-estate market and so-called ghost cities that relatively few inhabit, despite billions poured into them by Beijing. Mr. Chanos is shorting Chinese property companies based in Hong Kong, among other shares. "Large-scale capital projects grow sillier by the day," Mr. Chanos said at a recent conference, in which he focused on what he called a "record lending spree in China" that is "fueling a speculative boom." Indeed, fixed-asset investment grew 23.5% last year, and is forecast to grow 20% this year; analysts say banks far exceeded China's central bank's cap on lending in 2010. Meanwhile, many private-equity firms are racing to cut deals in China, to tap into the nation's growth—and to demonstrate to clients that they're capable of finding opportunities in China. Mr. Kravis's KKR is putting the finishing touches on a $1 billion fund to invest in fast-growing companies in China, its first China-focused fund after several years of investing in China through broader funds. Rivals like TPG and Carlyle, which have long has been active in China, are stepping up activity. TPG recently announced plans to raise two Chinese currency-denominated funds, each sized at more than $700 million. To be sure, a number of private-equity and hedge-fund chiefs privately share frustrations about China, even as they search for opportunities in the country. The rule of law is weak, some say, making it harder to resolve disputes. Others question the reliability of data published by private and public bodies, or aren't sure who controls Chinese companies, which usually are influenced by Chinese government officials. Still other private-equity executives worry that assets in the eastern part of the country are so picked-over that they're heading to central and western hinterlands to find opportunities. Some see this shift as a sign that these investors are embracing risk. Indeed, experts say it's even more difficult to obtain reliable data or gain influence over local businesses in these parts of China. There's some rationale to the strategy, however. Although the eastern region has long dominated the country, central and western China surpassed the eastern region on most measures of economic growth in 2010, according to Nomura International, including gross-domestic-product growth, retail sales growth, export and imports. "The western region's growth is accelerating, thanks to rising demand for and rapid development of resources and related industries," Nomura says. At the same time, it's risky to bet against an economy with $2.6 trillion of foreign currency reserves and where the majority of the population is only beginning to fully urbanize and embrace higher standards of living, a trend likely to bring more investment opportunities. The open question for 2011 and beyond is whether Chinese authorities can keep the country growing apace, even as they press the brakes on inflation, which is growing at a clip of more than 5%. Strong future growth may come only if Chinese leaders can transform the nation into a consumer-focused economy. But it may be hard to spark much more spending among a populace that has a relatively flimsy safety net, though the government is aiming to boost social welfare spending. Whether Chinese development and growth can continue without major setbacks could be more important to global markets and financial firms than anything the Federal Reserve or European Union do in 2011. "The transition to a consumer society in China represents the single biggest challenge for the global economy," says Perella Weinberg's Mr. Arbess, "and the biggest opportunity for markets." ________________________________________________ Send list submissions to: Marxism@lists.econ.utah.edu Set your options at: http://lists.econ.utah.edu/mailman/options/marxism/archive%40mail-archive.com
