November 29 2007: 9:49 AM EST
Email | Print    Type Size  -  +

A stake in Citi is just the start

State-backed foreign entities will continue to try to snap up ailing Western firms. Fortune provides a helpful list of do's and don'ts.

By Colin Barr, senior writer

(Fortune) -- So you're lousy with petrocash or other export-driven windfalls, and itching to put your depreciating dollars to work. Where to start? Here's Fortune's handy tip sheet:

DO look for an iconic property. It's no mistake that when Abu Dhabi's investment fund took a big stake in a U.S. company this week, it chose as its target perhaps the world's best-known financial institution: Citigroup (Charts, Fortune 500).

Other recent purchases by overseas investors have run along this same big-name theme. Deals this year include Dubai's purchase of a nearly 5% interest in electronics giant Sony (Charts), Abu Dhabi's acquisition of a 7.5% stake in the well-connected private equity outfit the Carlyle Group, and China's $3 billion bet on wheeler-dealer Blackstone (Charts).

The search for icons goes back at least to the 1980s, when Japanese investors bought Rockefeller Center and the Pebble Beach golf club. Like this week's Citi stake sale, the Japanese real estate grabs were the source of some alarm at the time, as wags wondered if the U.S. was consigning itself to a future of economic serfdom.

Since then, property markets have boomed and Rockefeller Center and Pebble Beach have changed hands yet again, putting them back in American hands and removing much of the sting of the late 80s upheaval.

But James Post, a management professor at Boston University, warns that Americans shouldn't underestimate the implications of the surge of foreign investment in U.S. companies. He says the magnitude of the Citi deal -- which gives Abu Dhabi 4.9% of the bank for $7.5 billion -- is "a splash of cold water" that should wake Americans up to the consequences of the bad choices they've made in the past decade. He cites the massive rise in consumption that has crushed the value of the dollar, for starters.

He also cautions that nowadays, deep-pocketed foreign buyers aren't just looking for visibility or ego gratification. They're becoming stakeholders in U.S. businesses and, by extension, in American society -- like it or not.

"This is more about long-term influence," Post says of the Abu Dhabi-Citi deal, which brought the struggling bank an expensive -- yielding 11% -- slug of much-needed capital. He says Americans' orgy of overconsumption in recent years led to a rash of U.S. borrowing from China and the oil exporters in the Middle East. Now, as these creditors look to put their piles of cash to work, "inevitably we'll see Middle East political influence rising," Post says.

So who's next? The Citi deal and a recent Abu Dhabi investment in chipmaker Advanced Micro (Charts, Fortune 500) suggests the oil czars are looking closely at beaten-down stocks. Some second-tier U.S. banks like Countrywide (Charts, Fortune 500) and Washington Mutual (Charts, Fortune 500) are trading at steep discounts to book value, making them potentially interesting to investors willing to take a gamble.

A Morgan Stanley report suggests the sovereign wealth funds would be more likely to be interested in big securities firms like UBS and Deutsche Bank, as well as outfits that have exposure to fast-growing emerging markets.

DO consider a local partnership. Take the example of Bear Stearns (Charts, Fortune 500), the stumbling U.S. brokerage firm linked to the subprime fiasco following the collapse of two hedge funds this past summer. In response to that black eye, Bear seems to have tried desperately to land a big-name investor stateside. At one point Warren Buffett's name even surfaced in press reports.

But in the end, it was a Chinese bank that rode to Bear's rescue in a $1 billion deal forming a new operation to sell stocks in Hong Kong.

So far, most investments from the petrodollar region and from China have come in the form of minority investments in companies. But the Bear Stearns deal shows partnerships can work, and Post says it's only reasonable to expect cross-border deals to take various shapes and reach across the financial sector.

This year's credit crunch, he says, is "transforming the financial services industry" around the globe by giving capital-rich, state-backed entities in China and the Middle East an opportunity to buy into high-quality U.S. banks at lower prices. The so-called sovereign wealth funds have built up a multitrillion-dollar war chest on the back of rising oil prices and, in the case of China, hefty exports into U.S. consumer markets.

The lesson, Post adds, is that "there's going to be no return to normalcy" for the financial services companies. He expects Middle Eastern control of global institutions to rise in coming years as the U.S., with the dollar in decline and the economy possibly heading for a recession, is forced into what he calls a "fire sale" of financial assets.

DON'T buy anything with national security implications, like a port -- or, if you're shopping in France, a yogurt company. The Dubai Ports deal of early 2006 -- in which a United Arab Emirates company tried to buy a British corporation that served U.S. ports -- is but a memory now, and the buyers have learned their lessons.

Peter Morici, an economics professor at the University of Maryland, says the Middle Eastern oil dynasties have been increasingly shrewd in their investments. They're making purchases that don't raise national security questions, he says, and doing so at a time when it might be difficult to stir political opposition. After all, he points out, Citi "is in distress" after having spent years making "reckless, profligate" decisions with its shareholders' capital. So who's to object to it getting a fresh injection of capital? What, after all, is the alternative?

Given the massive trade and current account deficits plaguing the U.S. economy, Morici suggests more sovereign wealth deals are coming soon to a company near you. "We have to pay our way in the world," he says.

He says foreign governments are able to buy into America in great volume now because President Bush and his predecessor, former President Bill Clinton, "lacked the political courage" to make hard choices -- such as confronting China over the artificially low value of its currency -- that would have helped give the U.S. more sustainable economic growth.

DON'T forget that the world is watching. Edwin Truman, a senior fellow at the Peterson Institute for International Economics in Washington, recently testified before Congress that the rise of sovereign wealth funds means "a dramatic increase in the role of governments in the ownership and management of international assets."

Given American's faith in a market-based economic system that calls for limited government involvement, he added, "this characteristic is unnerving and disquieting."

Even so, Truman rejects the notion that the sovereign wealth funds are inherently insidious. He notes in his testimony that while there are risks that foreign governments will manage their investments to promote their own economic or political goals, he said in an interview Tuesday that he has seen "no evidence that the sovereign wealth funds have done anything nefarious."

Indeed, Truman believes the biggest threat posed by sovereign wealth funds is to their own economies' health, he told the Senate Committee on Banking, Housing, and Urban Affairs back on Nov. 14. He said the investing nations' efforts to deploy their funds domestically can result in policy shifts that "are likely to boost inflation, create wasteful distortions in domestic economies, and contribute to slower, not faster, growth and development."

In response, Truman calls on the sovereign wealth funds to adopt best practices covering their structure, governance, transparency and behavior. He says that according to his ratings methods, the Abu Dhabi Investment Authority, author of Monday's big investment in Citi, is the least transparent big sovereign wealth fund -- a shortfall that he calls "a bit of a problem."

But it's far from the only problem confronting Americans surveying the economic landscape. "We have made choices that have consequences," Post says of the nation's deficit spending habit. "Denial is not an option." To top of page