Citic Securities-CLSA deal gets boost as China’s outbound strategy gathers pace
Citic Securities’ pricey $1.25 billion acquisition of pan-Asian cash equities player CLSA complements the Chinese firm’s buy-side capabilities and underscores its pan-Asia wholesale banking ambitions, analysts have said.
The $1.25 billion acquisition by Citic Securities of pan-Asian brokerage CLSA from Crédit Agricole – the first major purchase of a western brokerage by a Chinese securities firm – has received a cautious welcome from analysts, citing business synergies between the two groups.
Analysts reckon CLSA’s cash equities distribution capabilities, client base and ability to intermediate capital inflows into China justify the pricey premium for the deal. However, they warn that the deal is likely to be earnings dilutive for Citic in the near term given the cyclical drop in equities trading in Hong Kong amid the eurozone crisis and CLSA’s high cost base. They also argue that cultural differences between CLSA and Citic amount to an execution risk for the acquisition.
This week, the Chinese securities firm finalized the long-awaited deal, first mooted in 2007, paying, in the first leg of the transaction, $310 million in cash for a 19.9% stake in CLSA. The second leg in the purchase agreement comprises an irrevocable put option for the remaining 80.1% equity interest held by Crédit Agricole, which is deleveraging. The deal is set to wrap up before June 30 2013.
Silvia Fan, analyst at China Construction Bank, estimates that the acquisition is valued at two times book value or more. This is double the current valuation of global investment banks and looks rich compared with Malaysian lender CIMB’s acquisition earlier this year of Royal Bank of Scotland’s Asia-Pacific cash equities and investment banking business for a net £75 million ($118 million), which was 0.98 times book value. Citic’s Hong Kong-listed shares dropped 7% following the announcement, with analysts citing the pricey valuation for the loss.
According to analysts on a conference call held on Tuesday, management stated that Citic plans to use CLSA’s international distribution network to fuel more primary deals from Chinese clients involving equities, renminbi-denominated bonds and other products, such as derivatives.
“Citic has acquired the best practices and technology of an international broker”, which is present in 15 countries, as it vies to maintain its market-leading position in China and become one of the top Asia-Pacific-based investment banking franchises, a Shanghai-based equity analyst says. The analyst adds: “It’s an expensive deal but Citic has a strong balance sheet and the deal allows it to fast-track its knowledge and execution capabilities in the pan-Asian cash equities business.” Citic also intends to boost two-way capital flows by bringing international capital market products into China, subject to the country’s capital account restrictions, with CLSA boasting a global client list of 1,700 investors. Put simply, Citic’s buy-side presence in asset management and private equity, as well as its Chinese equity capital-raising platform, will be complemented by CLSA’s sell-side business, including corporate finance, research and ex-China Asia ECM.
On the conference call, Citic management stressed that it will adopt a hands-off approach to CLSA’s day-to-day operations, amid fears that Citic, 20% owned by the Chinese government, will neuter CLSA’s fierce independence (its research analysts are noted for criticizing Chinese corporate governance, among other issues).
Cultural differences remain a significant execution risk for the deal, says a Shanghai-based analyst. “Citic will probably need to spend another large sum to retain CLSA’s existing talent, since the real value of CLSA’s business is its experienced team. CLSA’s high cost structure will also drag down Citic’s profitability in the next two years.”
The deal faces cyclical headwinds, with equities trading volumes in Hong Kong declining year-to-date – and income from Hong Kong-derived cash equities represents the bulk of CLSA’s earnings – while fees and commissions from the Asia-Pacific equities business are declining, a Hong Kong-based analyst says. According to the China Construction Bank analyst, some 90% of CLSA’s average revenue of between $700 million and $800 million recorded over the past few years comprises vanilla cash equities-related business, with three-quarters derived from secondary-market selling to institutional investors.
In many respects the deal’s practical significance is overshadowed by the symbolism: a well-capitalized Chinese institution preys on a fallen western bank as part of China’s outbound strategy. The deal has been inevitably compared with the CIMB-RBS transaction: a rare example of an Asian bank aggressively seeking to deepen its regional investment and corporate bank capabilities, heralding a shift in the balance of power from global investment banks to well-capitalized regional franchises.
Citic Securities is noted for its expansionist prowess, however, as Nazir Razak, CIMB”s group executive, told Euromoney earlier this year, in general “Chinese banks are not quite there in terms of internationalization just yet”. Citic Securities is currently the exception rather than the norm but if this CLSA deal blazes a trail for Chinese international capital-raising, this transaction will prove the first of many as China’s liberalization of its currency and capital account gathers pace.