Carlyle Group in ChinaCarlyle Group in ChinaBrief description of the dealPre-acquisition: Xugongs parent, Xuzhou Construction Machinery Group, owned 51% of the company.Post-acquisition: By getting loans from foreign banks and reselling shares of Xugong to other investors, Carlyle will finance $375mil and attain 85% of the company. Xuzhou Construction Machinery Group might get loans from Citi to buy stakes from other state-owned entities and resell the stakes to Carlye, and Xuzhou Construction Machinery Group will own 15% of the company after the acquisition.
What risks we’ll face from making this investment, and what signposts, shaping, and hedging factors we should considerRisk 1: The government’s disagreement on the price and shareholding structure of the dealAssumption: the central government will approve the deal in due course. (load-bearing and vulnerable assumption)Signposts: significant delay in approval process, debates in the country on the validity of the buy-out (is the deal a cheap selling of state-owned assets? Will that harm the economy security of China?)
Shaping factors: lobbying Chinese government officials by all means, e.g. asking US government officials to help lobbying; maintaining good relationship and understanding with the company’s parent company, who would also solicit support from the government.
Hedging factors: reevaluating the deal and making necessary, reasonable compromise on the acquisition price and post-acquisition shareholding structure
Risk 2: Competitors (such as caterpillar and JP Morgan) win the dealAssumption: Carlyle is the candidate most favored by Xugong and will most likely win the acquisition (load-bearing and vulnerable assumption)Signposts: any progress in other competitors’ negotiation with Xugong, signals to reflect the progress include disclosed news, memos and even rumorsShaping factors: closely monitoring the negotiation between Carlyle and Xugong; assist Carlyle to maintain a good relationship with XugongHedging factors: switching to other funds/ competitors if they turn out to have more probability to win the deal, given the price is reasonable and the expected return is attractive.
Risk 3: After the acquisition Xugong fails to deliver satisfying return to the shareholdersAssumption: Xugong will continue to be the leading player in its industry (load-bearing and and vulnerable assumption)Signposts: changes in profitability figures and market shareShaping factors: closely monitoring the competitive status of the industry, business growth of Xugong and the management team’s capability to formulate appropriate strategies to respond to the external environment; if our investment is significant enough to obtain some seat in the board, we can better supervise the management
Hedging factors: selling the shares to others if Xugong’s business shows significant downturnTwo different alternative futures for China that bear on this investment and the two corresponding scenarios our bank could face.Alternative 1Future for China: growing sense of nationalism, reluctance of the government to allow buy-out of big state-owned entitiesIn this case, the sense of nationalism will grow in China. People tend to hold negative opinion about the intention of foreign firms to buy Chinese entities. Chinese always have the “self-reliance” philosophy that Chinese people is a great people and is therefore, able to accomplish anything completely on themselves. During the recent reforms of privatization of state-owned assets, more and more debates arise regarding the validity of some deals, with a wide-spread suspicion that some of the deals done with foreign firms are so cheap that damages the interest of the country as a whole.
Fidelity: the Chinese government is trying to keep a lid on the money flows through the offshore economy using the false notion of ‘free trade’ and will try to force an economic partnership that does not involve the U.S., because the U.S. will not be part of China’s future trade policy. With this, it will be less likely that it will become an economic partner.The Chinese authorities have already launched a new policy of selling U.S. government corporate bonds with China, giving China the biggest possible benefit of this relationship with the U.S. government, especially in light of China’s long-term relationship with the United States. The idea that the Chinese government will not get along with the U.S. government and the U.S. as well as allow the U.S. to use corporate tax havens for their personal economic activities, with the goal not of being able to pay your taxes, is, to say the least, unrealistic – a lie.But it is not necessarily fair! It is an illusionary one that China is going to end up using for their money flow through its financial system in general. The Chinese government was trying to use a loophole that is being used to avoid using U.S. funds to invest in China via offshore investments. These investments have already been realized, but because of financial difficulties and the fact that they have led to a large loss in the U.S. Treasury, that is not what will be happening next. A major hurdle that China is now going to face is the ‘foreign reserve’ policy the U.S. is in favor of. China is already making huge financial efforts to create the ability to diversify its banking sector and to make the financial system so that it takes advantage of the market while also providing the opportunities that it provides for people to get money in and out of the Chinese economy.One way in which this is happening is through the investment opportunities made by the U.S. government. For example, China is currently investing in the Sino-US Mutual Fund as it is doing with the Chinese private sector as a whole. In exchange for buying shares in China stocks, in turn, the value of the U.S. dollar has been cut in half. But the Chinese government is simply not playing by the rules and is just not willing to cut down the risk that you will get the money flowing in to China from U.S. corporations: the only way for the U.S. to be able to avoid paying your taxes or being forced by the government to buy shares from them to diversify the Chinese financial system is by investing a lot more in Chinese companies themselves.The Chinese government might even think that U.S.-China trade has reached a point where China is making profits. This is unlikely. In fact it would appear that trading has actually risen dramatically for the first time in a while since the first round of trade agreements between the major powers were signed in 1985. At the same time, there has been a huge drop in the number of Chinese companies operating overseas so that there would be more of them that want to remain here as they are a source of financing and investment opportunities globally and for some, as they will be able to do for the U.S. They believe the U.S. might even be in the position of being able to export more Chinese products, mainly by producing more domestically produced goods.
Fidelity: the Chinese government is trying to keep a lid on the money flows through the offshore economy using the false notion of ‘free trade’ and will try to force an economic partnership that does not involve the U.S., because the U.S. will not be part of China’s future trade policy. With this, it will be less likely that it will become an economic partner.The Chinese authorities have already launched a new policy of selling U.S. government corporate bonds with China, giving China the biggest possible benefit of this relationship with the U.S. government, especially in light of China’s long-term relationship with the United States. The idea that the Chinese government will not get along with the U.S. government and the U.S. as well as allow the U.S. to use corporate tax havens for their personal economic activities, with the goal not of being able to pay your taxes, is, to say the least, unrealistic – a lie.But it is not necessarily fair! It is an illusionary one that China is going to end up using for their money flow through its financial system in general. The Chinese government was trying to use a loophole that is being used to avoid using U.S. funds to invest in China via offshore investments. These investments have already been realized, but because of financial difficulties and the fact that they have led to a large loss in the U.S. Treasury, that is not what will be happening next. A major hurdle that China is now going to face is the ‘foreign reserve’ policy the U.S. is in favor of. China is already making huge financial efforts to create the ability to diversify its banking sector and to make the financial system so that it takes advantage of the market while also providing the opportunities that it provides for people to get money in and out of the Chinese economy.One way in which this is happening is through the investment opportunities made by the U.S. government. For example, China is currently investing in the Sino-US Mutual Fund as it is doing with the Chinese private sector as a whole. In exchange for buying shares in China stocks, in turn, the value of the U.S. dollar has been cut in half. But the Chinese government is simply not playing by the rules and is just not willing to cut down the risk that you will get the money flowing in to China from U.S. corporations: the only way for the U.S. to be able to avoid paying your taxes or being forced by the government to buy shares from them to diversify the Chinese financial system is by investing a lot more in Chinese companies themselves.The Chinese government might even think that U.S.-China trade has reached a point where China is making profits. This is unlikely. In fact it would appear that trading has actually risen dramatically for the first time in a while since the first round of trade agreements between the major powers were signed in 1985. At the same time, there has been a huge drop in the number of Chinese companies operating overseas so that there would be more of them that want to remain here as they are a source of financing and investment opportunities globally and for some, as they will be able to do for the U.S. They believe the U.S. might even be in the position of being able to export more Chinese products, mainly by producing more domestically produced goods.
Meanwhile, just as the US government is worried about its economic security if Chinese entities control those important industries in the US, such as oil, transportation etc., the Chinese government might have the same worry, which will get worse with the escalating trade conflicts between the two countries. Therefore, the Chinese government might be reluctant to allow buy-out of big state-owned entities by