CIC/JCF Team to Target Wall Street Fire Sale Deals

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CIC, backed by its $200 billion pool of cash, has signed a deal with JC Flowers & Co (JCF) to launch a $4 billion private equity (PE) fund, to focus investment on the US financial assets of banks distressed by the snowballing credit crisis, according to Economic Observer, a weekly based in Beijing.

 

CIC will be a limited (non-management) partner in the new fund, for which it will provide about 80 percent of the capital. The New York-based PE firm, run by former Goldman Sachs banker Christopher Flowers, will put up the other 20 percent.

 

The fund structure has passed muster by both the US and Chinese governments. With the US financial sector continuing to seek recapitalization funding, the Fed and other domestic sources are limited, and the SWF can be counted on as a vital source of capital. The US government needs to find a way that is both politically and financially acceptable to allow SWF capital, from China and elsewhere, to flow into Wall Street and to hold shares of iconic US financial institutions. 

 

For the Chinese government, the limited partnership PE structure has several advantages.  It will make good use of experienced financial talents, which China is sorely short of.  And it is hoped that its non-management role for CIC will not much rattle American political cages. But a big advantage to this structure is that the owners are generally not liable for the debts of the company. In case of the failure of a leveraged buyout by the new fund, CIC may be fire-walled from debilitating debt.

 

JCF’s extensive experience in investing across the board of financial institutions fits perfectly with CIC’s appetites. Among JCF’s eleven major investments are north European regional bank HSH Nordbank, Shinsei Bank of Japan, and FPK, a US based international investment bank. Its investors include leading global financial institutions. JCF has boasted a 50% return rate for all its investments.

 

The founder J. Christopher Flowers, who worked at Goldman Sachs until 1998 as Head of its Global Financial Institutions Group, has 25 years of experience in the investing and advising business. The company is based in New York, with offices in London, Hamburg and Beijing.

 

For CIC and many inside China’s financial circle, it seems a good time to buy into the US, but its problematic investment in Blackstone has cast a shadow on its investment strategy and made it a bit gun shy. But CIC was impressed by JCF’s (and others� risk free purchase of distressed Long-Term Credit Bank of Japan, Ltd. (LTCB), which was renamed Shinsei Bank and relisted for huge return.

 

Shinsei was listed on the Tokyo Stock Exchange in 2004. In '04 and '05, the investors sold two-thirds of their equity to the public, reaping $5 billion for their investment. David Rubenstein, co-founder of private equity firm Carlyle Group, said the share sales made LTCB/Shinsei "the most successful private equity deal in history.''

That would seem to be a good recommendation.

 

Details of the deal

 

JCF trumped Texas Pacific Group (TPG) in competing for investment from CIC. Right after its establishment, CIC intended to entrust billions of dollars to a foreign private equity firm and TPG was to begin with the sole candidate on CIC’s list. Newbridge Capital, under TPG, had bought into the Shenzhen Development Bank in 2004.

 

Negotiations with TPG were begun but gradually the field widened to include other firms. CIC managed to wring concessions out of JCF, especially on its share of the profits and the management fees. According to the PE industry practice, 20% of returns go to the management and 80% to investor, with management charges of 1.5%-2%. Sources said JCF yielded more preferential conditions to CIC.

 

CIC will put $3.2 billion into the $4 billion fund as the limited partner, and of the other $800 million, half comes from other funds and related institutions of JFC, and the other half from general partners of JFC.

 

Although CIC will not participate in the management of the fund, it does have a say in the choice of investment targets, including target countries and even target projects.

 

JCF CEO Flowers was said at first to be out of favor with the terms for the impact they might have on JCF’s rate of return. But, according to Xuan Changneng, the managing director of JCF, he saw it as a good opportunity to make JCF a household name with its first deal in China. On the CIC side, Gao Xiqing, General Manager and Chief Investment Officer, oversaw the negotiations while Chairman Lou Jiwei had the final say. Li Yingru, the director of private equity at CIC’s department of alternative investment, was involved in the deal. His JCF counterparts were Xuan Changneng and a partner from a New York law firm. Mr. Flowers was also involved in the negotiations.

 

One of JCF’s advantages over other PE firms is its legal ability to hold 25% or above of stakes in American banks. According to US federal law, PE firms not specializing in financial institutions cannot hold more than 25% stakes of financial institutions. JCF is raising $10 billion for the third fund focused on financial sector.