CITIC Securities Juggles Its Golden Eggs

Shares in one of China's largest brokers CITIC Securities slid January 15 on news that the firm would sell a key stake in its profitable offshoot China Securities Co. Ltd.

That same evening, CITIC Securities took another hit with news that the China Securities Regulatory Commission (CSRC) had suspended new product applications, effective January 1, for its wholly owned subsidiary China Asset Management Co. Ltd. (ChinaAMC), the nation's largest fund manager.

The suspension was ordered after CITIC Securities failed to meet a deadline for selling its ChinaAMC shares.

CITIC Securities' bad day reflected not only financial travails but also troubles for small shareholders and challenges for brokerage to pull away from government dependency.

Nevertheless, key aspects of CITIC Securities' plans for China Securities and ChinaAMC appear to remain on track. And the firm's largest shareholder, CITIC Group, stands a good chance of benefiting. Indeed, a source close to CITIC Securities compared China Securities and ChinaAMC to "geese that lay golden eggs."

Two-Phase Deal
 
CITIC Securities was motivated to sell a China Securities stake by a regulatory restriction barring any organization or controlling party from holding shares in more than two securities firms, or holding a controlling stake in more than one.

CSRC clarified the restriction in March 2008, giving securities firms that failed to meet its standards until the end of 2009 to submit readjustment plans and then complete all restructuring by December 31, 2010. An exception was granted to Central Huijin Investment Co. Ltd., which received a three-year amnesty.

Meeting the first deadline proved difficult for CITIC Securities, which held significant stakes in three brokers at the time of CSRC's decision. Those stakes are now 100 percent control of Kington Securities Co. Ltd., a 91.4 percent share in CITIC Wantong Securities Co. Ltd., and 60 percent of China Securities.

As part of a two-phase plan for selling the China Securities stake, CITIC Securities planned to first sell 45 percent of its China Securities stake to the city government's Beijing State-Owned Assets Management Co. Ltd. (BSAM) for between 7 and 8 billion yuan. In the second phase, China Securities' other shareholder China Investment Corp. (CIC) would sell its 40 percent stake to CITIC Group.

CITIC Group controls more than 20 percent of CITIC Securities. So by selling China Securities shares to BSAM through Citic Securities and buying CIC's stake directly, CITIC Group would get to keep this gold-egg laying goose. At least, that's the way it's supposed to work.

"The change in China Securities' ownership has been common knowledge for quite some time," said an inside source. "Even though the order has not yet been given to get rid of the CITIC Securities logo on business cards, new cards have been printed. And China Securities' new company calendars replaced the CITIC Securities logo with the logo for CITIC Group."

Government Shakeoff

The entire arrangement was orchestrated by the Beijing municipal government, which had previously owned a controlling stake in ChinaAMC. A person familiar with the changes said they fit a plan to help the finance industry shake off its government dependence.

The lofty proposal for purchasing a China Securities stake reflected a government policy adjustment, drawing broker and city government closer.

The city government had sold 60 percent of ChinaAMC's shares to CITIC Securities for 1.62 billion yuan. After stripping off debt and making a few superficial changes, BSAM repurchased the firm for the government for around 7 billion yuan.

Meanwhile, a new line is being drawn between the central government and the broker business as CIC – a government investment agency – prepares to officially withdraw from China Securities.

In this way, China Securities is expected to fall into the hands of CITIC Group, which would directly hold 40 percent and indirectly control 15 percent through CITIC Securities. The group's future gains could be substantial: It's been estimated that CITIC Securities's net earnings from China Securities have exceeded 4.2 billion yuan since 2006.

"In the short term, CITIC Securities' sales of these two assets will certainly increase returns for investors and raise short-term net profits," said Liang Jing, an analyst at Guotai Junan Securities.

But Liang warned of negative consequences over time. "In the long term, the negative effects on profits will be more significant," he said.

Shareholder Issues

Price has become a sensitive issue as well, especially among small stakeholders. Market analysts initially predicted that a 45 percent stake in China Securities would sell for 7 to 8 billion yuan, or 2.6 yuan per share. But that's no more than twice the stock's PE ratio and far below the current market average. Such a price would likely spark objections from minority shareholders.

Nowhere in CITIC Securities original plan to sell the China Securities stake did the idea of a related party transaction with CITIC Group appear. And as a 24 percent stakeholder, CITIC Group can use its voting rights at CITIC Securities to circumvent any disputes raised by the firm's many small shareholders about the transaction price.

Based on the current plan, CITIC Group would continue to hold about 24 percent of CITIC Securities along with its 45 percent of China Securities. Conversely, CITIC Securities would own 15 percent of China Securities and have a 91.4 percent controlling stake in CITIC Wantong Securities.

Small shareholders appear to have reason for concern: The deal has been blamed for the company stock's latest downward trend.

Price Dilemma
 
Meanwhile, shareholder control has been a key regulatory issue affecting CITIC Securities' plan to sell fund subsidiary ChinaAMC.

Since 2004, fund management firms have operated under stakeholder rules similar to those more recently assigned to brokers. The rules were written by the Administration of Securities Investment Fund Management Companies.

CSRC later clarified requirements on share percentages by declaring "with the exception of the Chinese side of Sino-foreign joint ventures, the largest shareholder for any fund management company may not own more than a 49 percent stake." As a consequence, CITIC Securities had to break up its 100 percent stake in ChinaAMC.

Since then, CITIC Securities has been busy courting domestic and overseas investors. And it was more inclined to make deals with foreign investors.

"A foreign investor entry would let CITIC bypass the restriction of owning more than 49 percent of a fund company," a source said. "Thus, CITIC Securities could sell fewer shares and ensure its majority control over the company."

Yet a source close to regulatory authorities said the sale of a ChinaAMC stake should not be decided by CITIC Securities alone. Indeed, regulators have been hesitant about allowing foreign investors into the deal.

"The CSRC's position is clear: The stake must be sold to a domestic investor," said the source.

And this regulatory edict has put pressure on price-setters.

"After it was determined that the ChinaAMC stake would have to be sold to a domestic investor, issues related to the selling price became more prominent," said a ChinaAMC source.

"The price cannot be too high, because if it is the new shareholder will inevitably demand even higher returns, putting intense pressure on management."

1 yuan = 14 U.S. cents

Full Article in Chinese: http://magazine.caing.com/2010-01-24/100110572.html