The only consolation for Western investment banks struggling to establish themselves inside China is that mainland banks, brokerages and securities companies have found it equally tough expanding internationally.
With its acquisition of CLSA, Citic Securities aims to break this trend. And its Chinese peers are taking notice.
The US$1.25 billion deal announced on July 22 has been more than half a decade in the making and is the first time a mainland financial institution (FI) will take over a Western competitor. If approved, Citic Securities will own CLSA’s secondary research and equity market expertise, giving the firm its opportunity to build a regional business with global clients without the weight a Chinese label carries.
The deal could well inspire other Chinese brokerages and banks to pursue similar plans. And opportunities exist, with Western banks having to put prized assets on the sales block as they seek to stay solvent.
“Institutions like CICC [China International Capital Corp.] or CCB [China Construction Bank] can take action anytime soon if they want it and if they find appropriate targets,” says one Hong Kong-based economist. “They have already been running for a very long time with operations outside the mainland and they have the human capital and the physical capital, which is what any Chinese bank would need for an acquisition. If I were them, I wouldn’t wait.”
Yet while opportunities abound, so do naysayers. Chinese financial institutions need to overcome resistance from foreign market practitioners and regulatory bodies to make overseas acquisitions work, and then they would have to bridge a sizeable cultural gap.
Few rival international bankers are optimistic about Citic Securities’ tie-up with CLSA; they are even more sceptical about the international aspirations of its rivals. They argue that any mainland bank working from China’s restricted financial system will be unable to work with a free-thinking, Western-led brokerage firm.
The challenge for Citic Securities, and potentially its rivals, is to prove its doubters wrong. Doing so will require patience, money and a great deal of flexibility.
Go forth and conquer
The reason China’s leading brokerages and investment banks are considering offshore expansion is simple: equity market conditions at home have been turgid for two years, competition from international securities joint ventures is rising, and key Chinese corporates are increasingly looking for overseas funding or acquisitions. Local players are particularly poorly placed to service the latter.
Added to this, market conditions mean the timing for cross-border mergers and acquisitions (M&A) is right. A combination of the global financial crisis, resolutely weak equity markets and Europe’s sovereign debt crisis has left many Western financial institutions considering asset sales, at reasonable costs.
Citic Securities has been keen to take advantage of this. The most cash-rich securities firm in China, with more than US$9.78 billion on hand according to Thomson Reuters, it has eyed international growth for years. It came close to its first major cross-border deal in 2008 with a planned US$1 billion investment for 6% of Bear Stearns, which failed because of the US bank’s collapse.
The company already has a sizeable offshore unit in Hong Kong, from which it has arranged initial public offering (IPOs) for companies including Huadian Fuxin Energy and Dynam Japan Holdings. It hopes to make 16% of its total revenue from offshore sources this year.
Citic Securities has been China’s most outwardly focused brokerage, but it’s not the only one that could make a go of it. Huatai Securities and China Merchant Securities are the next-richest securities firms in China, boasting US$6.6 billion and US$5 billion respectively. But their Hong Kong operations are much smaller.
More likely candidates are CICC, Haitong Securities and Guotai Junan Securities. All are very active in China and Hong Kong in deal flow, reputation and operations.
Haitong at least is considering global M&A options: in its prospectus for its HKD13 billion (US$1.7 billion) Hong Kong IPO on April 20, the company noted that 35% of the proceeds would go towards acquiring overseas securities companies to grow its international business. This comes three years after it acquired Hong Kong-based Taifook Securities for HKD1.8 billion (US$235 million).
CICC remains privately held and has been less vocal on expansion plans, apparently favouring organic growth. It has already spread outside the mainland by launching offices in Hong Kong, New York, Singapore and London – but with its reputation as a top Chinese arranger of deals, it will remain a contender for overseas M&A.
Other brokerages in China also appear keen to differentiate themselves. Guangfa Securities, Minsheng Bank and Galaxy Securities – which is planning a Hong Kong IPO – are all speculated to be considering the acquisition of investment bank and asset manager Piper Jaffray Hong Kong.
Representatives from the companies did not respond to requests for comment.
Assets up for grabs
Given the tough market conditions, there has rarely been a better time for Chinese financial institutions to gain offshore assets.
The past two years have seen several investment-banking asset sales, with Royal Bank of Scotland (RBS) the most active seller. Malaysia’s CIMB bought most of the Scottish bank’s Asia investment banking and cash equities business for US$142 million in March, Sumitomo Mitsui Financial Group paid US$7.3 billion for its aircraft leasing arm in June, while Mitsubishi UFJ Financial Group had already acquired RBS’s project finance assets for US$6.4 billion in 2010.
Getting the size of an acquisition right is important. Raymond Lee, Citic Securities International’s head of strategy and business development, describes CLSA as “bite-sized” – neither too big for the firm to handle nor too small to make an impact. There are few similarly sized firms out there.
One would be struggling Piper Jaffray; its US parent company has said it intends to close the Hong Kong office this month. A much larger possibility is Macquarie. The Australian bank has declining profits, but a strong funds and investment business, which might work well with ambitious Chinese clients looking to invest offshore. As Asiamoney reported in June, value could be unlocked if the bank were to break up.
Asset sales from French bank Société Générale are also possible at the right price. And likewise, UK-headquartered Lloyds Banking Group sold some distressed assets in Australia to a private equity conglomerate in June. It could sell more in other geographies.
Piggy-bank syndrome
Would these banks sell to China’s securities companies? The leading mainland operators have one material advantage over most existing owners: they’re cash-rich.
Citic Securities offers a key example. While CLSA’s former parent Crédit Agricole is struggling to stay financially strong amid the eurozone debt crisis, and many international banks are trimming their teams, Citic Securities intends to invest capital to help CLSA expand into new areas.
“It’s about adding products to CLSA,” Citic Securities’ Lee tells Asiamoney. “CLSA is concentrating on cash equities in Asia, but if we create fixed-income capabilities and … investment-banking capabilities much more than it has for the moment… it can be even more productive with a stronger commitment from Citic.”
Of course, money alone doesn’t guarantee success. In July, Bank of China (BoC) announced that it would abandon its four-year attempt at setting up a private bank in Switzerland, claiming weak performance with less than CHF1 billion (US$1.04 billion) in assets. It sold the Geneva-based unit to Julius Baer for an undisclosed price – the first time the bank has sold an overseas arm – and scurried back to Beijing to re-focus on Asia.
The experience highlights that Chinese financial institutions still have a thing or two to learn about business offshore.
“Overseas banks participate in business lines that Chinese banks have not had much exposure to, such as private banking, asset management, securities and brokerage services, and specialised financing like leasing,” says Tjun Tang, senior partner and managing director of The Boston Consulting Group in Hong Kong.
Improving operations
For Chinese banks looking offshore, the challenge is integrating assets, not paying for them.
Mainland securities companies rightly worry that they lack the skills and cultural aptitude to seamlessly take over Western financial institutions.
Even basic communication makes Chinese acquisitions difficult.
“It’s not easy to come across such an acquisition,” says Citic’s Lee. “You hear about other Chinese securities firms looking to acquire, but both CLSA and Citic Securities are in the cash equity business, so [CLSA CEO] Jonathan [Slone] and us speak the same language. Moreover, Jonathan speaks Mandarin and understands Chinese culture.”
The differences extend well beyond the linguistic. Bankers who have worked in both Chinese and Western financial institutions say that compensation, corporate governance, technology, upper- and middle-management capabilities, the pace and even quality of work at Chinese banks are inferior to Western institutions.
They differ strategically too. Chinese banks typically focus more on reaching objectives and less on the path taken to do so. Such single-mindedness is not necessarily advantageous when clients increasingly want quality services and support before they assign business.
“When it comes to a partner, I treasure the corporate access and the individualities of their ideas,” says William Fong, Asian equities investment director at Baring Asset Management in Hong Kong. “I don’t need updates daily, but I do need to know that they’re doing the groundwork and can give me their sell-side analysis at any point. It’s a question of quality and quantity…that’s a broker who is working hard and doing their job.”
Investors say that Chinese banks tend to not service investors as well as their western counterparts in such areas.
“Chinese banks put less energy and focus on secondary research capabilities because they rely less on secondary research to generate sales. But it’s this research that can really win them investor support,” said one Hong Kong-based equities banker. “It’s the packaging, the delivery, the servicing and the standards that all need to be top-notch to win over clients.”
Some Chinese institutions have tried hiring westerners to rectify these weaknesses, which has not been difficult given the talent made available as a consequence of the global financial crisis. Success has been limited, largely because the banks only tend to add a smattering of Westerners rather than restructuring entire businesses. As a result, these expensively assembled Western bankers don’t tend to last long as frustrations with their new employers mount.
Bank of China International (BoCI) offers one example. In 2010 it hired some Western equities bankers to improve its Hong Kong presence. Many of them, including Mark Bamber, global head of institutional equities, and Tim Franks, head of equities sales, lasted only a year before BoCI decided the new strategy wasn’t working and ushered them out.
Likewise, Doug Morin, head of institutional sales at CCB in Hong Kong and formerly of Bear Stearns, and Mark Jolley, Asia strategist formerly of Deutsche Bank, both exited the bank on June 27 this year.
Easing into an alliance
To remedy this, Chinese banks should invest more into their human capital and service support. That means paying competitive rates for managers at every rung of the ladder, and allocating enough money to integrate and grow the business.
Doing so would take Chinese banks one step closer to having their goals aligned with those of a Western FI. And that would make mergers and offshore expansion that much easier.
Of course, such changes will take time – most likely two or three years at a minimum.
Given this, ambitious Chinese securities houses would be wise to consider making offshore alliances with profitable institutions, backed by minority equity investments of 10%, 20% or 30%, in which they can learn the ropes, just as Citic Securities considered with both Bear Stearns and did with CLSA before it made its final purchase.
Such an arrangement would provide mainland companies with direct experience with overseas brokerages and banks, while offering a struggling Western house cash and links to mainland China.
The latter in particular may be alluring. According to data provider Dealogic, China outbound M&A increased 26% in the eight months to the end of August versus the same period in 2011, transacting US$42.1 billion worth of deals.
Also in 2012, 45 Chinese issuers engaged in new equity listings, amounting to more than US$5 billion in markets such as the US, UK, Malaysia and Germany. And in Hong Kong – the destination for many of these new IPOs – five of the 10-largest equity capital market deals in 2012 had Chinese bookrunners.
These are decent levels of business, but Western houses struggle to access them alone, even when they have mainland securities joint ventures. But allying internationally with a Chinese securities firm would combine the former’s knowhow with the latter’s guanxi, or key relationships. That’s an appealing option at a time when equity trading and new deal volumes are sliding downwards.
Small steps
Citic Securities has set a precedent for Chinese securities firms, but it’s unlikely to be the only one to grow abroad. Eventually its rivals will too, through ambition or necessity.
It’s a good time to consider expansion. Many Western assets are relatively cheap. But Chinese firms should be prudent; cultural integration won’t happen overnight. Taking small steps through alliances would be a good start, helping Chinese houses gain exposure to international market practices and operating norms. That, in turn, will make it easier for them to integrate international assets further down the road.
Most importantly, Chinese securities firms with international aspirations need to be patient. They had best be prepared to lose money for at least a year or two, and potentially see the flight of senior staff after lock-up periods end.
If they can weather this short-term pain and stick to a slow-burn strategy, their efforts should eventually be rewarded. This is a game for long-term players – Wall Street wasn’t built overnight.
Creating a roadmap for China M&A
CLSA and Citic Securities are about to write the playbook for Chinese banks looking to acquire overseas – but only if they can demonstrate their ability to integrate business and culture.
The most-asked question for CLSA in the aftermath of the announcement that it has been acquired by Citic Securities is how it will maintain its integrity as an independent secondary research provider.
Jonathan Slone, chairman and chief executive officer (CEO) of CLSA, insists that the deal would never have got off the ground if its autonomy were in jeopardy.
“What’s going to happen is what happened under [CLSA’s majority stakeholder] Crédit Agricole. Our management group had autonomy day to day over our business and I don’t anticipate there will be much change with Citic,” Slone tells Asiamoney. “I don’t anticipate any conflict in terms of our research either. We have an existing corporate finance business and there’s a clear differentiation between our research. If there’s ever a day in which research doesn’t like a deal, then it will say so regardless of who is working on it.”
This is the crucial test for Citic and CLSA – and only after investors and clients are convinced that CLSA’s operations are untainted will the partners be able to move toward their subsequent goals, including bolstering CLSA’s fixed income and investment banking business and expanding its brand through new geographies in Asia and beyond.
A long courtship
Citic Securities and CLSA may both profess to be confident that the latter’s secondary research will remain intact, but not everybody is as sanguine.
“Culturally I suspect Citic is very different from CLSA…There’s always a suspicion that maybe the new owners will be a bit more hands-on, which might or might not be detrimental,” says the Asia Pacific CEO of one global asset management company that does business with CLSA.
Raymond Lee, head of strategy and business development at Citic Securities International, dismisses such concerns, insisting that too much time and effort has gone into the deal to jeopardise it now.
“It’s not about dismantling CLSA and slapping Citic’s label on it,” he says. “I don’t think it’s necessary because I actually think that investors would like this type of model whereby we can give a very unique view, a local view, on Chinese products, and CLSA will have a very clear view of the same Chinese equity products from an international perspective.”
Citic has been courting CLSA since 2006, at which time French bank Crédit Agricole was 65% owner. By 2011, the plan solidified to Citic buying 19.9% of a combined package of CLSA and sister brokerage Cheuvreux from their French parent.
The parties have since veered away from these initial plans, and on July 22, Citic Securities and CLSA announced that Citic would fully acquire CLSA from Crédit Agricole in two tranches, first a 19.9% stake for US$310.3 million, which was completed by July 20, and the remaining share for US$941.7 million pending regulatory approval. The firms aim to complete the deal by June 2013.
The whole cost is US$1.25 billion, representing two times CLSA’s book value – seen as high in the market.
Cheuvreux was not included in the deal, despite CLSA having struck up initial cooperation with the European brokerage over the past year. Sources close to the transaction say the brokerage was hampering the deal and was taken off the table on March 30. Cheuvreux will instead merge with Dutch rival Kepler Corporate Finance.
Aligning goals and culture
Assuming all goes as planned, Crédit Agricole will remain involved in CLSA for a two-year transition period, after which Citic and CLSA are on their own.
By that point, if the partnership is to work, the two companies will need to have harmonised their cultures and management styles while retaining talent. That will take compromise and flexibility.
“We need to China-ise the international thinking and internationalise the Chinese thinking,” says Lee, noting that Citic Securities is already on its way given that it has a strong international division in Hong Kong from which it arranges big-ticket equity deals with other global banks.
International investors would be forgiven for having some pause over the idea of CLSA accommodating a more Sino-fied mindset. CLSA’s irreverent research style has largely been possible because it lacks much corporate finance heft, which means it has little deal-making business to lose if it upsets major companies with ‘sell’ recommendations or comments that cut close to the bone.
But that is not the way Chinese brokerages operate. Maintaining such independence on Chinese companies could be a particular challenge if CLSA is aiming to get investment-banking business from them in concert with Citic Securities.
Ultimately, if CLSA’s staff and clients become discontented with the new arrangement, then its dreams of a growing business will be endangered.
For now, CLSA and Citic Securities appear to be trying to ease any misgivings among the former’s staff by maintaining the status quo.
Citic Securities plans to keep CLSA’s operation intact and independent, and doesn’t plan to impose its own appraisal programme on CLSA. And Slone insists that there will be no change to CLSA’s retention policy and equity scheme.
For all the stated confidence of both Citic Securities’ and CLSA’s managers, neither knows for sure exactly how much their plans will resonate with staff and clients. The best way Slone and Lee can maintain the confidence of both will be to live up to their bullish promises, and truly protect the vaunted independence of CLSA’s research and sales teams.
Even basic communication makes Chinese acquisitions difficult.
