China's 10% Stake In Blackstone Group: Should We Start To Worry?

Last month, the nine men who run China siphoned off a huge chunk of their foreign exchange reserves to form the new Chinese State Investment Company. They now control what is essentially a hedge fund worth hundreds of billions of dollars before adding any leverage.

Their first publicly disclosed move was to take a 10 percent ($3 billion) stake in one of the world's premier private equity firms, Blackstone Group (BX).

Should anyone be worried?

BHP Billiton (BHP) might be worried, according to Bell Potter research chief Peter Quinton in a report published on Thursday in The Herald Sun, Australia's largest daily newspaper.

Mr Quinton said yesterday he believed the Blackstone investment was a forerunner to bigger things - including a possible tilt at BHP, which analysts have valued at more than $200 billion.

"They've acquired that 10 per cent stake in Blackstone to learn the mechanics of private equity takeovers," Mr Quinton said.

"Twelve months down the track, they've now learned how to do mergers and acquisitions, and if you were the Chinese Government what would you do?" he said, pointing to China's concern about commodity supplies.

"If they get BHP they've got a diversified resource company, they've got oil, they've got iron ore, they've got base metals."

Analysts have agreed that Blackstone will provide a good training ground for the Chinese, and natural resources are tipped to be high on the fund's shopping list.

Naturally, the Chinese government recently offered assurances that the purpose of the fund is to improve its returns on overseas investments rather than to wrest control of foreign companies.

For years, foreign exchange reserves had been directed toward ultra-safe but low-yielding U.S. debt. However, that is now changing as the rapidly developing country seeks to secure its future needs for raw materials and energy.

A recent study by Merrill Lynch showed that a private equity deal for the $160B diversified natural resource company would not only be feasible, but profitable. A huge, ongoing share buyback program has contributed to soaring share prices in recent months as the company continues to bet on higher demand for its products.

BHP Billiton is the world's leading supplier of core steelmaking raw materials, key ingredients to ongoing economic development in China.

It is also the third largest copper producer, second largest exporter of energy coal, third largest producer of nickel, fourth largest producer of uranium, sixth largest producer of primary aluminum, and maintains substantial interests in diamonds, silver and titanium as well as being a significant producer of oil and natural gas.

Such a takeover bid would raise much concern over how global resources are allocated in the longer term and may be greeted with the same sort of resistance that China's bid for U.S. oil giant Unocal saw in 2005.

Since the company is listed in Australia, where most of its shares are traded, an increasingly protectionist U.S. Congress will have little say over how such a deal might develop.

The combination of China's massive foreign exchange reserves, a private equity mania sweeping the globe, and a possible takeover bid for the world's largest natural resource company speaks volumes about the state of the world in mid-2007.

Full Disclosure: Long BHP at time of writing.

BHP 1-yr chart:

Comments

[JW:]

a cold-war-minded essay

2007 Jun 11 08:15 AM

[izomax:]

So as long as U.S. does it it's OK and when China does it it's a threat?

2007 Jun 11 10:34 AM

[The Kennel:]

We agree that securing commodity supplies is indeed a major strategic motivation for the Chinese government, presiding over the biggest buildout in human history. But there is also a strong tactical incentive for them to convert as much as possible of their huge hoard of dollars into tangible assets before the greenback's inevitable demise.

This is a complex and fascinating balancing act, because at this point it is still in the interest of the Celestial Kingdom to leverage the addiction of the US consumer for cheap goods to continue to nurture their own industry, and buying more time for the growing Chinese middle class to step up to the plate consumption-wise. To that end, they still need to prop up our spendthrift ways by financing our debt, which means they must continue to buy dollars. Not to mention the fact that buying dollars maintains their value - or, at least, slows the decline - and affords them more time to convert dollars into something with real value.

Once the consumption capacity of domestic Chinese approaches that of the US - which could happen sooner than we might otherwise expect should there be a precipitous decline in US consumer spending - then the game will be up.

The takeaway here is that in the interim, in order to get the most for their dollars, we could see Chinese investments moving outside the commodity sector. Florida beachfront property may be overvalued here given the probable coming decline in US economic fortunes and rising sea levels, but if you are paying with dollars that will manifestly be worth drastically less in a few years and you can't otherwise get rid of, it starts to look good at any price.


Brad Hessel
Manager, The Kennel

2007 Jun 12 08:50 AM