Tuesday, May 22, 2007

China at the Barbarians' Gate

As previously noted, China recently created a fund to invest some of its $1 trillion of foreign exchange reserves. The fund's first big US purchase is a $3 billion stake in Blackstone, a private equity firm. Firms like Blackstone buy the shares (equity) of corporations thereby taking them off the public markets like the New York Stock Exchange (hence "private equity"). The companies are usually restructured - sometimes by merging them, sometimes by splitting them up, and almost always with massive layoffs - and eventually re-sold on the stock market. Often private equity transactions are financed with a large amount of debt ("leverage"), both from banks and from the "junk bond" market, which ends up on the balance sheet of the company itself (not the private equity firm).

There's recently been quite a boom in private equity (a prominent example is the recent Chrysler deal) for two main reasons: (i) low interest rates, which means that banks and investors are desperate for anything with a higher return and (ii) probably of less importance, the increased regulation and scrutiny of publicly traded companies in the wake of the corporate governance scandals (Enron, Worldcom, etc.) a few years ago has made operating privately more attractive. Oh, and maybe some "animal spirits" too.

The first big wave of what we used to call "Leveraged Buy Outs" (LBOs) back in the 1980's was famously chronicled in "Barbarians at the Gate." Supposedly the Chinese word for "foreigner" really means "barbarian"... so now the barbarians have Chinese at the gate.

Here's Daniel Altman's comment on the deal. Bloomberg's William Pesek says its a "Marriage of Two Bubbles" (if you read it you'll see that Asia's richest man has a very appropriate name, indeed).

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