China taking a stake in U.S.

investment titan
Beijing to invest billions in Blackstone Group to diversify its cash hoard.
By Don Lee and Walter Hamilton
Times Staff Writers

May 22, 2007

SHANGHAI — For years China has been the world's factory floor, churning out plastic
toys, appliances and socks. Now it's entering the world of very high finance.

Moving for the first time to diversify its massive foreign-exchange reserves, the Chinese
government agreed over the weekend to acquire a $3-billion stake in Blackstone Group,
a huge investment firm that at the same time plans to sell an additional $4.75 billion of
its shares to U.S. stock market investors.

The landmark deal between Beijing and Blackstone could mark a profound shift in
global capital flows and speed the transformation of China's treasury into a giant money
manager with the ability to shake markets well beyond its borders.

"Who could have imagined a few years ago that an arm of the Chinese government
would be taking a stake in an aggressive American private equity firm?" said Donald H.
Straszheim, a China specialist at Roth Capital Partners, a Newport Beach-based
investment bank. "I think this is remarkable."

For Blackstone — which laid out plans Monday for an initial public offering 19% larger
than it originally planned — the pact could open doors to vast and growing real estate
and financial markets in China.

Chinese companies "will bring them deals earlier than they might otherwise and will
think they have the imprimatur and the protection of the government," said Steve
Kaplan, a University of Chicago finance professor.

Like all private equity firms, Blackstone manages investment funds that buy companies
with the goal of improving their earnings and eventually selling them at a profit. Since
1987, the investors in Blackstone's private equity funds have reaped an average return
of 23% a year, after subtracting Blackstone's substantial fees, the firm says.

The impressive performance has attracted more investors to the funds and Blackstone
now manages $88.4 billion in assets. The Chinese government, however, would be
investing in the Blackstone management company, not the Blackstone funds.

The current holdings of Blackstone-operated funds are diverse and include stakes in
Universal Orlando, Freedom Communications, Nielsen Co., Orangina and Vanguard
Health Systems. The firm was founded in 1985 by Pete Peterson, a former Commerce
secretary, and current Chairman Stephen Schwarzman.

If Blackstone's IPO is sold out, it would be the fourth-largest of all time, according to
research firm Thomson Financial, giving stock market investors about a 14% stake in
the New York-based firm.
Beijing, through its new State Investment Co., would own slightly less than 10% —
below the threshold requiring U.S. government approval. Because the Chinese
government would be buying non-voting shares, which are considered less valuable, it
would pay 4.5% less than investors in the public offering will.

The Chinese have been wary of making foreign acquisitions since a state-owned
company's bid for oil giant Unocal Corp. in 2005. The reaction in the U.S. was so harsh,
with critics complaining that Chinese ownership would imperil American energy
security, that China dropped the bid.

Buying into a savvy private equity firm could be an investment in education, helping
Beijing learn how to be a sophisticated investor and avoid Unocal-like missteps.

"The Chinese government is using this $3 billion to test the waters in international
capital markets, to learn and see how others manage their funds" and make lucrative
investments, said Yi Xianrong, a finance expert at the Chinese Academy of Social
Sciences in Beijing.

China has wanted to diversify some of its $1.2 trillion in foreign reserves, now held in
U.S. Treasury securities and other relatively low-yielding assets. Its purchase of
Treasury notes has tamped down mortgage and other interest rates in the U.S., but
American politicians have been annoyed with China because of its massive trade
surplus, which they say is supported by an undervalued currency, the yuan, that makes
Chinese products artificially cheap in international markets.

Adding a new wrinkle to the heated debate in the U.S. over China's increasing influence
in global affairs, the pact with Blackstone came on the eve of economic talks in
Washington, to be led by Treasury Secretary Henry M. Paulson Jr. and Chinese Vice
Premier Wu Yi.

In the U.S., the explosion of private equity deals has raised questions about the secretive
industry's growing control over the fates of millions of workers whose companies the
partnerships own.

Late last year, some of the biggest names in private equity, including Blackstone, Apollo
Management, Carlyle Group and Kohlberg Kravis Roberts & Co., formed the Private
Equity Council in part to combat negative perceptions of the industry.

The group challenges the idea that private equity owners routinely seek to pare down
companies and squeeze workers to boost profitability.

Douglas Lowenstein, president of the council, said at a congressional hearing last week
that private equity "is about hundreds of thriving companies contributing to the
economy in numerous positive ways."

For China, a legitimate question is whether it is overpaying. For publicly traded mutual
fund companies, the value of their stock is typically equal to 1.5% to 4% of the assets
they manage, said Jeffrey Ptak, an analyst at fund researcher Morningstar Inc. So the
stock market value of a company managing $100 billion could reach $4 billion.
Blackstone, however, has estimated a price for its stock that would imply the company
was worth $33.6 billion — equal to 38% of its assets under management. That, Ptak
said, is "off the charts."

The debate in financial circles is whether it's too far off, especially given that
Blackstone collects higher fees than mutual fund managers do.

"Given the sheer profitability of Blackstone's business, you would expect it to command
a premium valuation," Ptak said. "But the question is magnitude. How much is too
much?"

Kaplan at the University of Chicago compared the Chinese investment in Blackstone to

Japanese investors' untimely purchases of U.S. real estate in the late 1980s.

Like private equity today, real estate was widely considered a no-lose proposition in
those days. But many Japanese investments went sour when property values sagged
during the early-1990s recession.

"It's very similar. Everyone is saying, 'Private equity is very hot — you can't lose,' "
Kaplan said. "Of course, those [Japanese] deals didn't end very well."