China, the Bear, and the Overseas Carpet-Bagger

The news late last week that Bear Stearns (BSC) and Citic Securities are re-pegging their share-swap deal led to fevered media speculation over whether China’s largest state-run brokerage has ice-cold feet.

Lots of talk, too, that if Citic bails, Bear Stearns would have no choice but to do a last-ditch merger to save the Wall Street brokerage from extinction. The speculation caused Bear’s shares to gyrate last Friday, with shares closing at $83, up from $78 the day before. We kicked this around with Liz Claman and David Asman on their show, boy those two are good.

The Bear-Citic story has generated lots of talk, too, about the desperate straits U.S. financials would be in if sovereign wealth funds (SWFs) didn’t come to the rescue with carpet bags stuffed with cash.

It’s beyond a misapprehension, however, for some armchair critics who never ran a business and who never had any skin in the game to suggest the Bear-Citic deal is merely another story of a SWF parking itself with suitcases full of cash on the doorstep of yet another dying Wall Street firm.

The issue of foreign money increasingly washing up on US shores is a big, controversial issue. I urge you to read through to the bottom of this blog to get a cheat sheet on this important issue in this presidential election year. Neil Cavuto has been all over the SWF story asking the really hard questions, so have Alexis Glick and Peter Barnes on Money for Breakfast, Dagen McDowell and Stuart Varney on their noon show, and Fox Business news director Ray Hennessey.

The issue of foreigners picking off US assets will only get even more scrutiny now as Bain Capital and Huawei Technologies -- a telecom with links to China's government -- are expected to now back out of their $2.2bn acquisition of 3Com, after they failed to satisfy US national security concerns (though 3Com says the three are trying to "construct alternatives" to a deal that would assuage these concerns).

3Com supplies computer anti-hacking and network-security services to the Pentagon. The Pentagon believes hackers in China carried out a massive cyber assault on its systems last year. Huawei, China's largest computer networker, is run by a former mid-ranking officer in China's army.

Back to Bear-Citic. Some odd sound-bites on this one seem to be tendered by ivory tower nosebleeds with an extraordinary talent for dissimulation, who devote more time trying to sound smart rather than trying to examine the terms of a deal now yellowing, as the deal was struck months ago in October.

Reminds me of what the author Virginia Woolf, irritated by the tiresomely arid, sherry mien of Noel Coward, who once said to the playwright that she “hoped to save him from being as clever as a bag of ferrets and as trivial as a perch of canaries.”

Citic is not China's sovereign wealth fund. It’s China's biggest publicly traded securities firm. China’s $200bn sovereign wealth fund is called the China Investment Corp., which has its own squad of investment executives; CIC at times turns to, and yes, invests through Citic. 

And the Bear-Citic deal isn’t a one-sided cash infusion from China. Both sides are injecting $1bn into each other. The deal still stands, Jimmy Cayne, Bear Stearns chairman tells me.

Bear gets a toehold in the world's fastest growing securities market; Citic gets a bigger pipeline into Wall Street. The two sides are essentially talking about a reciprocal adjustment that could change the size of the stakes they eventually hold in each other. Cayne told me the deal is “naturally resetting” because both companies’ share prices have fallen since last October.

Cayne says the $1bn is a fraction of Bear’s $17.4bn in cash and equivalents on its balance sheet. A balance sheet, to be sure, potted with a number of blastholes Bear needs to plug, given record subprime write-downs and possible future settlement costs from shareholder lawsuits for things like the collapse of two hedge funds.

It remains to be seen whether any SWF injects Bear with a separate capital infusion or Bear is eventually taken over. Cayne did tell me that if the firm was in merger discussions, he certainly would not go trumpeting it to the media. Fair enough.

Now onto China’s SWF. China, which cares greatly about saving face, has been mortally embarrassed, given that its $5bn stake in Morgan Stanley last December and its $3bn stake in Blackstone last May have flown south faster than a goose in winter. China’s SWF now wants to instead park $4bn with JC Flowers, the US private equity group, to let it do its investment picking for it.

The Bear-Citic story and the China SWF gaffes are tangents to the bigger controversy of overseas carpetbaggers in the form of the $2.9tn sovereign wealth funds from Asia and the Middle East investing directly in beleaguered financials such as UBS (UBS), Merrill Lynch (MER), Citigroup (CIT) and Morgan Stanley (MS).

The roughly $70bn the SWFs have already invested in the world's biggest investment banks has attracted suspicion from Congress and US presidential candidates. I’ve spotlighted the questions and concerns:

Do the SWFs have a hidden geopolitical strategy of wrecking the US economy?

Will SWFs, at minimum, try to use their investments to snuff out competition in favor of homegrown companies?

Is it fair for the US markets that the US lets foreign governments invest in US companies through secretive SWFs, when the US refuses to let its own “sovereign wealth fund,” the Social Security Trust fund, invest in the stock market because it doesn’t want elected officials or government bureaucrats meddling in the free market?

Is it fair that Russia or China can invest in US companies with apparent ease when both countries have exceedingly tight restrictions on foreign investments in their own companies and markets?

Barings Bank and Societe General had their rogue traders—why does the world think that foreign SWFs, with little accountability and little transparency, won’t have their own Nick Leesons or Jerome Kerviels?

Couldn’t SWFs destabilize US companies by threatening to yank their equity stakes over things they don’t like, as Norway did with Wal-Mart over allegations the retail giant violated child labor laws, workers rights, discriminates against women and wouldn’t let workers unionize?

Ok, let’s put it in the extreme.

Should the US let a “Russia Macroeconomic Investment Authority for Putin in Perpetuity” or a “Venezuela Growth Fund for the Enactment of Chavez’s World Vision” invest in Exxon Mobil (XOM)? Should the US let China’s SWF invest in Merck or Pfizer and then force those drug companies to open its doors to a conveyor belt out of China’s dubious drug factories that have already allegedly killed, maimed or sickened people?

A little history—SWFs have been investing for decades. But they are now bigger and have grown in number. Lately they have been limiting their stakes in US companies to less than 10%, below the threshold that prompts investigations by the Committee on Foreign Investment in the US, a multi-agency group that reviews foreign investments.

The first sovereign-wealth fund, the Kuwait Investment Office, created in 1953, invested in Daimler Benz and British Petroleum. Libya bought into the car maker Fiat in the ‘70s. Not much debate, until the late ‘80s, when the Kuwait fund divested half its 20%+ stake in British Petroleum, then recently privatized, after the Thatcher government raised a ruckus that it was losing a national oil-producing treasure to foreigners.

Fast forward to the US in the new millennium, when efforts by China National Offshore Oil Corp. to buy Unocal, a California oil company, in June 2005 aroused opposition.

China has been accused of spying on US companies for years, in a bid to collect trade secrets and information about US defense operations. Four Chinese nationals—one a former Boeing engineer, the other a former Rockwell International and Boeing worker-- were recently arrested on charges of spying for China in two separate cases, one involving the space shuttle.

It wasn’t charity that led Aluminum Corp. of China to invest with Alcoa a total of $14.05bn in Rio Tinto (RTP). It did it to counter BHP Tilliton (BHP) moves to buy out Rio Tinto, the world's second largest iron ore producer (Alcoa contributed just $1.2bn to the stake). China needs iron ore to make steel to keep its economy growing, which keeps its unrestful population happy.

So, China needs to keep in check Rio Tinto’s pricing power. Rio Tinto owns the world’s biggest iron ore operations, in particular those at Pilbara in Australia. A huge chunk of Pilbara’s iron ore is sent to China.

These cases are exacerbating already heightened US scrutiny of foreign purchases of US companies through SWFs, which continue to grow. For instance, last year, China bought $226.6bn worth of US assets, more than 16 times the 2006 level of $13mn, says research company Dealogic PLC. So far this year, it announced $162.7mn in deals.

Given all this, you may ask yourself: Why do laissez-faire freemarketers refuse to force sovereign wealth funds to, at minimum, disclose their top ten holdings? Why put ideological hobby horses above common sense?

If you want to play in US markets, what is so wrong about playing by the rules?