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Asia-PacificDecember 1 2004

The winning ways of a profit generator

Morgan Stanley’s China business is highly profitable, says co-head of China investment Jonathan Zhu. He tells Karina Robinson, in Beijing, about the bank’s winning strategies.China may be slowing down as the authorities cut back on credit availability but foreign investment banks’ business is being boosted: as the government puts the brakes on credit, domestic companies are turning abroad for their funds and Morgan Stanley is one of the beneficiaries.The US-headquartered investment bank ranks number two in Chinese equity capital markets in the year-to-date with a deal value of $2589m, giving it a 19% market share, according to data provider Dealogic.
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Morgan Stanley’s joint venture with China Construction Bank, China International Capital Corp (CICC), had a deal value of $575m.

Goldman Sachs ranked number one with a deal value of $3550m.

“[The credit controls] make no difference to deal flow. If you look overall, domestic capital raising slowed down but we are on the international side, which has not slowed down,” says Jonathan Zhu, co-head of Morgan Stanley China investment banking. “More companies are raising money in international markets, given that it is difficult in local ones.”

Between January and August this year, capital raised through Chinese A shares was $5772m, while overseas it was $5839m.

New listings ahead

The upcoming initial public offering (IPO) pipeline and a general hunger for funds look as if they will keep the investment banks busy. Among others, national airline Air China is forecast to go to market with a $500m IPO in early 2005. Bank of China could well be the first of the large state banks to list overseas later in the year, according to some bankers, although others believe that China Construction Bank will be the first to do so.

Mr Zhu sees Goldman Sachs as Morgan Stanley’s most consistent competitor in China. The two banks share product capabilities in equities and mergers and acquisitions, along with a global franchise, he says. So far, fixed income capability has not been that important but demand for specialised securitisation and structured finance is increasing.

The Shanghai-born banker sees Morgan Stanley’s August $300m senior notes offering for Sino-Forest Corp as indicative of the ability of Chinese private sector issuers to access international markets and of the appetite for high yield Chinese offerings. With an order book of nearly $1bn, 3.1 times oversubscribed, demand was such that the deal size was increased from the initial $200m launch. Almost 50% of the orders came from US high yield and emerging markets accounts.

Another winning strategy for the bank has been staying power. The highly cyclical nature of investment banking in China has led some banks to wax and wane in their enthusiasm for the country. Mr Zhu points out that Morgan Stanley’s commitment means that he has seen at least three cycles in the eight years in which he has been covering China. Morgan Stanley started its investment banking business there in the early 1990s.

M&As boost business

In the merger and acquisition (M&A) market, the new trend for Chinese firms to buy companies abroad has been giving a boost to investment bank fees. With a total value of $1.4bn this year, Chinese companies have spent 40% more on foreign acquisitions than in 2003, according to data provider Thomson Financial.

In October, the Chinese authorities made it easier for companies to purchase assets abroad by removing a layer of bureaucracy. Chinese corporates no longer need to have a government feasibility study done.

“M&A is going to be a major growth driver for us and others: inbound M&A and an increasing flow of outbound,” says Mr Zhu.

For full-year 2004 announced M&As, Morgan Stanley ranked second with eight deals valued at $10,655m, according to Dealogic. CICC ranked first with 11 deals worth $12,600m.

Gaping hole

Foreign direct investment into China reached record levels this year and shows no signs of slowing down. It grew 11.34% year on year to $25.91bn in the first five months of 2004. There are two major impediments to the investment banking business in China, in Morgan Stanley’s view. One is the lack of access to domestic capital markets for the foreign firms. As these markets evolve and become more sophisticated, investment banks are ever more frustrated by this prohibition. It leaves a gaping hole in the services they can offer local companies.

China’s accession to the World Trade Organization included a timetable for lifting restrictions on the operation of foreign commercial banks in the country. However, there is no agreement on the securities side.

Team work

The second obstacle to doing business in China, in Morgan Stanley’s view, is the high demand for qualified personnel. Recently, a number of firms have been trying to enlarge their China teams. This demand has led to a surge in the price of the scarce number of professionals around. The bank recently lost Zhizhong Yang, a managing director in investment banking, to Lehman Brothers, which is trying to beef up its franchise.

Morgan Stanley has a team of more than 35 professionals who spend a substantial amount of their time on China business. The much smaller core team, consisting of three directors, two vice-presidents and various associates, is based in Hong Kong rather than China, although they spend most of their time somewhere on the mainland. The investment bank has seven staff, with various levels of expertise, based in Beijing and one in Shanghai. For regulatory reasons, investment banks are not allowed to have branches in China.

In response to criticism that the bank’s joint venture, CICC, has not been as productive as expected or as tension-free, the bank notes that it no longer posts staff there because the transfer of technology and expertise, which took place over almost a decade, is now complete and CICC has become a model for a truly independent Chinese investment bank. Morgan Stanley’s strategy involves working with CICC and its other parent, China Construction Bank, in every area that local regulations permit.

As for the perennial question for foreign companies doing business in China – are Morgan Stanley’s operations there profitable or are they a loss-making bet on the future, Mr Zhu says: “We do not have a China P&L [profit and loss] so for us this is somewhat hard to judge. However, I would say our firm’s China business, not just investment banking, is highly profitable. We have generated hundreds of millions in revenues over the years.”

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