Asian joint ventures: Will Morgan's China liaison prove dangerous?


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In their desire to expand in Asia, US investment banks have little choice but to get into bed with local partners. The most dramatic of the relationships so far forged has been Morgan Stanley's pioneering joint venture with the People's Bank of China. Will it blossom into a lasting and profitable marriage or will cultural clashes turn the partners against each other? Tony Shale reports

China International Capital Corporation (CICC) is China's first international investment bank to receive a licence from the central bank, the People's Bank of China (PBOC). Capitalized at $100 million, it was officially launched at a ceremony in Beijing's Diaoyutai State Guest House last October. It also marks the first time in its 61-year history that Morgan Stanley has entered into a formal joint-venture agreement.

The Wall Street house broke a lot of its own rules to do so. "Historically we have had no interest in going into developing markets like China which are still largely closed to cross-border investment," says John Wadsworth, chairman of Morgan Stanley Asia in Hong Kong. In almost the same breath he concedes that it is a chancy gamble: "Going ahead with CICC in a climate in which joint ventures are notoriously difficult to get right ... people could almost question our sanity."

While mostly too polite to make such accusations on the record, some observers do query Morgan Stanley's timing. "It looks ambitious at the moment. We believe it is premature to look at joint ventures in China," says Trevor Rowe, chairman and co-chief executive officer of the Asia-Pacific region of Salomon Brothers Hong Kong.

Ill-conceived or otherwise, Morgan Stanley has invested $35 million for a 35% stake in CICC. Its main partner is the state-owned specialized commercial bank People's Construction Bank of China (PCBC), with 42.5%. With total assets of Rmb1.55 billion ($185 million), PCBC has made loans worth more than Rmb2 trillion on behalf of the government since it was set up in 1954 to provide medium- and long-term credit to the industrial and infrastructure sectors.

Wadsworth is convinced he has backed a winner. "With CICC we have positioned Morgan Stanley to be in the vanguard of investment banking in China and will become the leading firm in the minds of the Chinese elite in financial, corporate and political circles. We now occupy the inside track."

At present, this is a lonely place. As China has fallen out of favour with international institutional investors since a short-lived boom in primary-market issuance between 1993 and 1994, so Morgan Stanley's investment banking competitors have retreated from the country. CS First Boston, which was the first US house to establish an investment banking office in Beijing in 1994, has scaled down to three professionals in the capital. Salomon Brothers similarly keeps only four people in Beijing.

David Walker, managing director of CSFB in Hong Kong, echoes the thoughts of many: "China business obviously looked as though it was growing very rapidly in 1993 when the markets were booming and there was a lot of interest for Chinese enterprises to list overseas. Equally obvious is that these markets have dried up in the past 18 months. Leadership transition issues have lessened the political impetus for privatization and foreign listings. The more than two-year credit squeeze meant that companies, in general, faced a tougher time. Equity capital market activity - which was everybody's major focus - has been very disappointing and debt issuance has been at best sporadic. We have taken the view that there is no point having a large coverage team in China when there is not much business to do."

Wadsworth is happy to see his rivals retrench. "The importance of China is nothing to do with short-term business opportunities for investment bankers but everything to do with the incredible impact - political, economic, pragmatic - that it will have on the development of the entire region," he says.

How big will that be? "When the Chinese markets become fully open, with the convertibility of the renminbi and the opportunity for full foreign membership of the Shanghai Stock Exchange, the impact for our industry is going to be the largest in the world since the opening up of Tokyo in 1986," says Wadsworth. "In the long run, it will be seen as 10 times more important than that because the Japanese market has never been fully subjected to the principle of supply and demand. China is eventually going to look more like New York and Hong Kong than Tokyo because of the inclination of the Chinese government and businessmen to respect both free enterprise and supply and demand."

For those who still need convincing of Morgan Stanley's commitment to the joint venture, he puts it another way: "This is simply a gigantic opportunity which, if properly taken advantage of, will change the profile of the firm that gets it right."

For a joint venture of such apparent significance, it is perhaps unsurprising that it was more than three years in the making. But sceptics say that the hurdles it faced even to reach launch are indicative of the problems Morgan Stanley faces in making CICC a success.

Wadsworth says that in the early 1990s a joint-venture strategy had been decided upon as the best route for developing the firm's business in China. He took the first step to realizing his dream in June 1992 in a letter addressed to Wang Qishan, then the number two executive at PCBC, outlining a proposed alliance. "We saw Wang as entrepreneurial and business-like enough to want to give the bank the earliest possible opportunity to develop along more commercial lines," says Wadsworth.

A year of fruitful follow-up discussions ensued before the process was abruptly halted when Wang was plucked from PCBC in June 1993. Evidently sharing Wadsworth's high regard for him, vice-premier Zhu Rongji appointed him as a deputy at the PBOC. Zhu, a former mayor of Shanghai and now widely known as China's "economic tsar", had himself been recently appointed as governor of the PBOC and he recruited Wang as part of a wholesale shake-up of the central bank.

Lim to the rescue

With Wang's departure from PCBC, the joint-venture idea got relegated to a fact file in a Beijing office drawer. It might have remained there had it not been for a mutual acquaintance who advised Wadsworth to contact Edwin Lim. Lim, then a director of the World Bank in Washington, had headed its resident mission in China between 1985 and 1990. By chance, he had also decided that an independently run Chinese investment bank should be established and had chosen PCBC as the most suitable partner in any international joint venture.

Separate discussions with Payson Cha, the son of Hong Kong businessman Cha Chi Ming, had also prompted Lim to put the idea to Zhu Rongji. And in subsequent negotiations with financial officials in Beijing, the two invited the Government of Singapore Investment Corporation (GSIC), the state-owned investment vehicle which manages most of the nation's foreign assets, to participate in a putative venture with PCBC. The younger Cha is managing director of property-to-textiles holding company The Mingly Corporation and resort developer HKR International, both of which are listed on the Hong Kong Stock Exchange.

Lim, representing this disparate group, and Wadsworth finally met in Washington in September 1993. "He showed me a letter to Zhu proposing a joint-venture investment bank which might have been a carbon copy of our own," says Wadsworth. "Both of us had identified PCBC as the Chinese partner and both of us had stressed that the foreign partner should be limited to a choice of first-class organizations with a proven international track record."

Lim's letter had suggested both Goldman Sachs and Merrill Lynch in addition to Morgan Stanley. Cha was to swing things in the latter's direction. He had been impressed with Morgan Stanley's recent lead management of a $100 million Euroconvertible bond for HKR. "It took one lunch with Lim for us to agree to combine resources," says Wadsworth.

Lim left the World Bank in January 1994 to become an adviser to Morgan Stanley, with the sole responsibility of leading the effort to establish CICC. By August of that year, draft regulations to frame an agreement for the joint venture were in place and the PBOC was also framing its version of the rules. Zhu Rongji continued to be involved in discussions and a fifth partner, the China National Investment and Guaranty Corporation (CNIGC), was brought into the equation. The first such guaranty company in China, CNIGC is owned jointly by the finance ministry and the State Economic and Trade Commission (SETC). Its primary focuses are on the science and technology sectors, while the SETC is the leading economic agency responsible for overseeing the reorganization and restructuring of China's state-owned enterprises.

The diversity of this line-up combined with the labyrinthine nature of Chinese bureaucracy to delay the official launch until August 1995. Wadsworth concedes that it was a laborious process: "If it had not been for the compelling objectives shared by ourselves and PCBC to make it work, and if the stakes had not been so high and the economic benefits so great, it would have been easy to decide to pack things in because it looked too hard."

His admiration for his partner would make any bride blush. "PCBC was the only Chinese institution which made sense for us. Its deal flow and client base, with its infrastructure, real estate and industrial portfolios, make it the JP Morgan of China. They have everything we need as a partner if you add their entrepreneurial bent, powerful connections and sound way of thinking."

Others are not so sure. "Cut it any way you like and PCBC is still an instrument of state power which is obliged to make policy loans to ailing state-owned enterprises," says a senior banker at a rival investment bank. He refers to recent moves by international ratings agencies to underline his point.

Moody's cut the long-term bond ratings of China's four specialized banks (Bank of China, Agricultural Bank of China, Industrial Bank of China and PCBC) in April 1995 from A3 to Baa1. And the agency followed this up with an E-plus financial-strength rating for PCBC in August. According to this new calibration, which is intended to offer an independently assessed view of a bank's "intrinsic safety and soundness", PCBC is "very weak in terms of financial strength" and may have a "need for outside assistance".

Critics also say that Morgan Stanley, with a 35% stake in CICC compared with PCBC's 42.5%, is in danger of being obliged to accept business which it would otherwise deem uncommercial from its state-owned partner. "It is all very well having strong political connections in China but this can be as much of a disadvantage as it is an advantage," says the head of a foreign securities house in Shanghai. "I would like to know, for example, how Morgan Stanley would get out of an unwelcome deal foisted on them by PCBC without upsetting the powers that be there."

CICC insists that this will not happen. "As the first independent investment banking operation in China, we are not completely free-standing because we need help from our shareholders. But we get only that help which makes sense to CICC," says Harrison Young, chief executive officer at CICC in Beijing. "The construction bank has been extremely helpful in setting up the bank, but there has not been one flicker of them wanting us to do business in areas which we would prefer not to. Quite the reverse: in fact, they have from time to time made us aware of situations which have been both very sensible and very attractive for us to look into."

Young's credentials for the job seem impeccable - he worked as an investment banker for Morgan Stanley between 1975 and 1986, and was chief operating officer of the US Federal Deposit Insurance Corporation in Washington between 1991 and 1994 - but his elevation to CEO last November raised eyebrows at some Morgan Stanley rivals. His predecessor had been Edwin Lim, co-architect of the deal which set up CICC, who resigned only four months after the formal launch.

Accounts of the reasons for Lim's departure vary. Former colleagues say he was unimpressed with the 16-hour days expected of Morgan Stanley executives. Rival firms say that the Chinese authorities made clear their opposition to him. "The Chinese thought they were being short-changed," says one senior US investment banker based in Beijing. "They expected a full and free flow of technology transfer from a Wall Street investment bank and were unhappy that CICC was being led by a World Bank type."

Young says simply that Lim had "done what he had been expected to do and wanted to return to the World Bank". Lim could not be reached for comment. But his sudden exit has thrown into relief the biggest obstacle many feel Morgan Stanley faces in order to make CICC a success.

"CICC is an interesting and ambitious move, and we would certainly consider a joint venture in China for different aspects of our business," says Henry Strutt, managing director of Jardine Fleming Holdings in Hong Kong. "But it remains to be seen whether the two different and opposing cultural approaches gel into each other."

Young says all are aware of the gulf to be bridged: "The first advice anyone gives you about how to be effective when working in China is to be patient, while the first advice anyone gives you to be successful in investment banking is to be impatient," he says. "And it is true that some of my partners are not entirely familiar with market economics or capital markets, while some of my colleagues tend not to understand how to do things when public policy is an important piece of the picture. But we have made great progress, and people in CICC today do understand each other and one another's different points of view."

CICC's detractors in Beijing point to the conflicts they claim are inherent in a five-partner joint venture operating in a country notorious for its addiction to bureaucratic procedure. "From where I am standing, the whole thing looks like a goddamn mess," says one long-time foreign banker there. "It took more than three years to get off the ground because of infighting between the partners, and there are strong rifts within the management structure."

Money well spent?

Young says otherwise. "Each of our partners plays an important role and all have contributions to make from their particular area of expertise. All of them have turned out to be good directors and shareholders who are constantly thinking about the success of the company, and there is very good dialogue among the board of directors."

Whether fired by jealousy or disdain, Morgan Stanley's rivals remain unconvinced that it's all worthwhile. "We are yet to see a transaction out of CICC," says the director of investment banking for China at an investment bank in Hong Kong. "They could have spent $35 million a lot more wisely. If they believe China business is going to be so important, then for that money they could have hired 200 Chinese nationals for a couple of years and created a stand-alone operation that would have been second to none."

Wadsworth counters that: "Though everything is about six months behind where we would like to be, it is still very much on track. We now have 50 people on the ground in Beijing, of whom 16 are investment bankers. We have had to spend a huge amount of time on things like accounts payable, treasury operations, compensation and evaluation systems, essentially returning to 'Business 101' [going back to basics] to get things done."

CICC's business remit from the PBOC is broad. It spans restructuring, mergers and acquisitions, structured finance, capital markets, "B" share offerings and direct investment. Its deal roster to date has been less impressive. Although Wadsworth says that direct investment worth $12.5 million has been approved and that CICC has six fee-paying assignments, only one deal to date has reached the public eye.

It has signed an engagement letter with the state-owned Jilin Oil and Gas company with a view to finding a foreign strategic investor to help develop what is China's only onshore oilfield. Said to be worth between $500 million and $700 million, no further details are yet available. Nor will CICC comment on its other mandates except to say that they involve a large electricity-generating project, a highway financing and a handful of potential securities offerings both for existing and new "H" share companies (Chinese companies listed in Hong Kong).

Morgan Stanley's heightened profile through CICC also does not seem to have helped it in its wider Chinese activities. When the People's Republic of China returned to the international capital markets in January with a $400 million yankee, for instance, it chose JP Morgan and Merrill Lynch as joint bookrunners. And when PCBC issued a seven-year HK$1.2 billion ($155 million) floating-rate note last October, HSBC Markets acted as bookrunner.

And though these might be viewed as one-offs at a time of relative dearth for Chinese international issuance, critics add that it is still far from clear how or if CICC will be used - and benefit - if Morgan Stanley does begin to win such mandates. "With only 35% of the pot in CICC, it is questionable, for example, whether fees for a large debt issue or an "N" share issue [Chinese companies listed on the New York Stock Exchange] would be shared by CICC," says the head of investment banking at one foreign bank in Beijing.

Morgan Stanley will continue to do deals for its own account which involve "market-ready" financings, while all other investment banking business in China is in CICC's realm. And within six to 12 months all deals should rest with CICC. Wadsworth says, "I want to make it clear that our bet in China is CICC and that we believe that when the market opens CICC will be hugely successful. The only serious question we face then is whether to sell down or to increase our stake in it. In the meantime, we hold a huge advantage over all our competitors by being on the inside."

Playing it cool in Indonesia

Wall Street's investment banks are busy forging joint ventures and informal alliances throughout Asia. Some say they are looking mostly to access local connections and contacts, some are in search of strategic stakes, and some are buying off-the-shelf sales and research operations to graft onto their fledgling Asian networks. This has created an increasingly complicated maze of affiliations.

Goldman Sachs, for example, has acquired a 28% stake in Indian securities house Kotak Mahindra; has an alliance with brokerage company Phatra Thanakit in Thailand in which the Thai house executes Goldman's trades and both share research information; and has acquired a small stake (less than 5%) in the China-backed securities firm New China Hong Kong.

JP Morgan similarly has a 40% stake in a joint-venture securities house with India's ICICI, called ISEC; a long-standing 20% stake in Bank of the Philippine Islands in the Philippines; and is negotiating a 30% investment in a joint-venture fund management business in Korea with Samsung.

But no country has caused the banks as many headaches when considering joint-venture partners as has Indonesia. Its attractions are numerous. Capital market growth has been spectacular, with the market capitalization of the Jakarta Stock Exchange rising from $23.4 billion in 1990 to $75.7 billion at the beginning of this year. A privatization programme estimated to be worth more than $40 billion in the next decade is also a tantalizing prospect for the investment banks. As a result, many have spent the past three years courting different partners.

Keeping one's distance

Until recently, though, only Merrill Lynch had cemented a lasting relationship. It has 80% of a joint-venture securities house with local tycoon Hashim Djojohadikusmo. But while Goldman Sachs continues to woo state-owned Bahana Pembinaan Usaha Indonesia, with which it has a joint operating agreement in the securities and investment banking businesses, the two-year liaison has yet to be formalized. Morgan Stanley likewise has had an agreement of cooperation for more than 18 months with local securities house Makindo and businesswoman Indra Rukmana, with a view to setting up an investment bank to concentrate on privatization issues. But there the relationship rests.

Others have chosen to avoid local affiliation altogether. JP Morgan, for example, says it has not looked for a partner since it sold its stake in the joint-venture Marincorp to fellow shareholder Sumitomo Bank. Bank Export Import was its erstwhile domestic associate. CS First Boston and Lehman Brothers have also opted to stay away.

"There is still the perception that local partners in Indonesia are at their most useful only if they are connected to the first family [indicating both Hashim, who is president Suharto's son-in-law's brother and Indra Rukmana, who is his eldest daughter], and we feel that such relationships can come back and bite you if regimes change," says the managing director of an investment bank in Hong Kong.

Adds the head of investment banking for Asia at another: "Though I like Indonesia as a place, I am still suspicious of the way business is done there. Privatization mandates, for example, have been won on terms that have little to do with pricing and valuation, and everything to do with odd connections and peculiar payments. We operate an acid test on joint-venture partners: would we like to see our name next to theirs on the front page of the Wall Street Journal ? And there are few potential candidates in Indonesia who would pass that test."

Perhaps mindful of these concerns, Salomon Brothers was careful to keep clear of any first-family connections when it chose its Indonesian partner. The house entered into a joint venture with the Bakrie Group in March. The largest pribumi - or indigenous - Indonesian conglomerate, Bakrie has total consolidated assets of more than $1.5 billion and is active in industries ranging from steel and plantations to telecommunications and strategic investments.

The joint venture, which will be 60%-owned by Salomon, intends to engage in the international capital-raising and financial-advisory businesses in Jakarta for Indonesian public- and private-sector companies. "We thought it vastly preferable in the long term to be associated with an indigenous partner," says Trevor Rowe, chairman and co-chief executive officer for the Asia Pacific region at Salomon Brothers Hong Kong. "I have had a personal relationship with [chairman] Aburizal Bakrie which stretches back 20 years. As chairman of the Indonesian Chamber of Commerce, he is one of the country's most respected businessmen."

In addition to the personal ties and commercial strength that Bakrie brings to the joint venture, local analysts say that its pribumi status has often helped it win government-related business. "The government is sensitive to the fact that the Indonesian Chinese community is by far the biggest in commercial and financial circles and has often looked favourably on Bakrie as a result," says the research head at a securities house in Jakarta.

Others expressed surprise at Salomon's choice. "Though the group has banking, stockbroking, insurance and leasing components, these have traditionally contributed only a very small portion of overall earnings," says the conglomerates analyst at a foreign house in Jakarta. "Its profile in the domestic and international securities markets is very low. The joint venture will start pretty much from scratch."

Given misgivings about other Indonesian joint ventures, Salomon would no doubt prefer it that way. It has indicated as much in the hiring of "outsider" Bharat Parashar as the new house's president-director. Previously the chief executive of American Express Bank in Bombay, he has also served as head of merchant banking at Chemical Bank in Singapore.

And Salomon has already reaped tangible rewards from its alliance. It was lead manager of a $100 million floating-rate note issue for Bakrie & Brothers in March. More significant - in the light of the widely held view that first-family connections determine who wins the biggest deals - was its appointment in late May as the lead manager for the Republic of Indonesia's inaugural sovereign bond issue.