For M.Stanley, exit can mark a new start in China

November 3, 2009

Morgan Stanley has finally taken a step towards selling its stake in its financially lucrative but strategically frustrating investment in China. The sale will allow Morgan to start something new. True, it will have to play catch-up with rivals such as Goldman Sachs <GS.N>. But it should benefit from being in control.

China International Capital Corp. (CICC), the first real investment bank in China, is
ready to part ways with the Wall Street bank and strike out on its own. Over the years, CICC has transformed itself into a formidable competitor, becoming one of the most profitable investment banks in China, even globally. It is on track to post record results in 2009, and has started expanding in London and New York.

Morgan Stanley, which has seen its role reduced to passive investor, has been trying to sell its 34 percent stake in CICC. Other investors include China’s sovereign wealth fund CIC. Since Morgan Stanley already has one joint venture, Chinese regulators will not approve another one. The bank has collected valuable commercial banking and asset management licences, but it still cannot underwrite domestic securities.

Morgan Stanley, which is also partially owned by CIC, finally got a nod from the Chinese authorities to put its stake up for sale early last year. Private equity funds such as Bain, Texas Pacific Group and JC Flowers made the final list of bidders. However, Morgan withdrew because it did not want to sell at credit crunch prices. Now the market has bounced back. First-round bids from the likes of Bain range from $1.2 billion to $1.5 billion — at least 50 percent higher than the highest offer Morgan got last year.

But pricing still remains a sticking point. Morgan Stanley is trying to use comparable
valuations of other Chinese brokerage firms, which trade at multiples of 23 to 35 times earnings. But buyers are likely to demand a steep discount given that the CICC stake does not come with any management control. Moreover, buyers are likely to question whether Morgan Stanley’s shareholding will be significantly diluted once CICC management convert their options into shares.

What’s more, qualified buyers are hard to come by. Domestic institutions are ruled out because CICC’s management wants to keep its joint venture status, which allows it to justify Western-style bonuses. Any potential competitors are not likely to be welcomed by CICC’s powerful chief executive, Levin Zhu, son of former Chinese Premier Zhu Rongji. That means foreign private equity firms are the most likely buyers. But they are likely to be ruthless when it comes to negotiating a price.

That said, Morgan Stanley paid just $35 million for its initial 35 percent stake of CICC when the Chinese bank was founded in 1995 so it will make a handsome return. The bank’s exit from CICC may be hard. But given the freedom it will gain from a sale, it has little choice but to press ahead.

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