China's fastest growing investment bank

What's CITIC Capital's strategy and history?

Zhang Yichen: The entity dates back to the mid-1980s when it was a retail brokerage. Two years ago, CITIC Group decided it wanted to form an international investment banking arm, under a new brand. They created CITIC Capital from the retail brokerage, which was basically executing trades for CITIC Ka Wah Bank customers. It was very small, with less than 60 people - with most being back office clerks. Since then - with the new mandate to build this into a leading China-focused investment bank, we have experienced rapid growth. We have over 200 people now, and it is now a full service investment bank with businesses that include brokerage, investment banking and asset management.

On the brokerage side, we began as a bit player in the market ranking around number 70. We've improved our market position to 25th in Hong Kong. Our customer base is more retail-oriented (and now targets the higher end of the retail spectrum), plus some corporate clients and small institutional clients. That business has done very well, particularly since the second half of last year, thanks to the fairly buoyant market conditions.

Our investment banking business has expanded from debt finance into corporate finance, M&A and the team has been significantly upgraded. We have had bankers come to us mostly from bulge bracket firms. Our investment banking business is starting to gain traction. The deal that has boosted our profile the most is the Weichai Power IPO. From the investor community's perspective, we've gained a lot of recognition through that deal. It is up roughly 30% and is the best performing major IPOs of the year so far. We've also done a successful block trade for Jiangxi Copper, as well as a placement for Chaoda Modern Agriculture.

The third business is asset management and we started this from scratch. We decided early on that we wanted to put our own capital to productive use and deploy it wisely to grow the business. Part of our capital is being used as seed money to back our funds. We focus on higher margin funds, i.e. alternative asset management classes. We believed that if we could put the CITIC name together with a group of individuals with very strong investment capabilities, we should be able attract smart money and build our track record. At this point we are focusing on private equity and hedge funds. On the private equity side, we took the non-Japan Asia team from Whitney & Co, including the former partner, Brian Doyle. We combined that with some of our own professionals, and based it in Shanghai. On the hedge fund side, we have a team under Zhang Haitao, who used to manage China's external reserves at SAFE as CIO. He joined us a year and a half ago. On both private equity and hedge funds, the rate of development has far exceeded our expectations. On the private equity side, we have already raised a total of $250 million for three funds. The investors include Shinsei Bank, Sumitomo Trust Bank, Marubeni, Rothschild and so forth.

The mandate of these funds is to do private equity in China?

That's right. There are two types of investment we are focusing on. One is purely into China, to basically invest in mature businesses that are ready for IPO, or to invest in medium-sized enterprises that are being privatized, which we could eventually take public. The second investment theme is to capitalize on the relocation of manufacturing into China. A lot of suppliers have not followed multinationals into China, particularly the mid-sized ones - because they don't have the know-how. So we are focusing on opportunities in Japan and the US to invest in these companies and help them relocate their manufacturing opportunities to China so as to lower their cost, as well as to expand their China business.

Are you doing venture capital as well?

No. We're only focusing on late stage types of opportunities. That fits into our overall strategy as it feeds deals into our investment banking pipeline. Early stage investment requires an entirely different set of skills, and takes a long time for the investment to come to fruition.

So the strategy is to use private equity to build an IPO pipeline?

Yes, once we're ready to harvest these investments, we will generate deals. But even at the investment stage, we have our banking team looking at the companies. That way we can use our resources more efficiently.

With private equity, the investment cycle is slightly longer. With our hedge fund business, we've seen results quickly. The China Capital Plus Fund was launched last August and is up 49.46% as of March 31. It is a long-short fund. The other is a global macro-fund, and since inception in December is up 11.54%. These are both star performers in the market and a lot of smart money is being attracted into the funds.

So that's almost the scope of our business. The other thing is that we have built a research team under CY Ho. He was the former head of research at BOCI and gained some notoriety at BOCI for research he wrote on the Hong Kong dollar peg.

How has the firm performed so far?

The firm has done extremely well financially, and in fact, has far exceeded our shareholders' expectations. We started making money from day one.

Last year was our first full year of operation and we generated a 28% return on equity, which obviously made the shareholders very happy.

Is that from fee income or an aggressive prop book?

It is both. Fee income accounts for roughly 35%. Investment gains from our seed money in funds are roughly a third too. But that is not prop in my view because that seed money is helping us to build a fee base down the road, by attracting more money to our funds. Pure prop trading makes up the other third.

Speaking of your equity capital markets strategy, you are going after mid-caps and small-caps. Does that put you in the same competitive space as BNP Paribas Peregrine, CLSA, HSBC and Core-Pacific Yamaichi?

That's more or less our competition. Our space is basically $50 million and up - basically the mid-cap segment.

The thing is that a lot of the bigger names have started to move into this space as well. There is so much capacity on the investment banking front in Hong Kong, if the major players just focused on the mega-deals they couldn't keep themselves occupied. So we see competition, particularly when the deals get over $100 million in size.

How many of these IPOs would you like to do per year?

Our target is to do four to six per year. We are trying to create a reputation for only doing IPOs for good Chinese companies with high corporate governance standards. Our private equity strategy will help us to achieve this, because we will be working with the companies from an earlier stage.

How does CITIC Capital differentiate itself from CICC and BOCI?

It's simple. The market almost always focuses on the IPO business, as this is where you have the highest profile. But if you look at all the major investment banks, IPOs is only a part of the revenue and in the last two or three years, quite a small part of the revenue. A large part of their revenue comes from proprietary trading, asset management fees, and even equity sales commissions. So what we aim to build is a true, full-service investment bank that is China-focused, and staffed with professionals with global experience.

So if you look at our business, the revenue is more balanced. This year, it will be even more balanced, because our brokerage is doing better. And thanks to deals like Weichai Power and the placement for Chaoda, so is our investment banking fee income.

So we don't see ourselves as a single business-line business. The other two entities clearly have strengths. For example, on the IPO front I don't think anyone can compete with CICC in the near future. They have a good track record and first mover advantage.

Given the amount of restructuring work that is required before these big China privatizations, is that business model profitable?

For CICC I believe it is, but for the other guys it may not be. CICC is almost always the only game in town, so they benefit from economies of scale when it comes to all this complex restructuring work. For Goldman or Merrill or whoever teams up with them there is no scale because they don't do it often enough. CICC have done this so many times and have a lot of people who can do this work. I actually think CICC is very profitable - but is largely dependent on market conditions.

When you are looking for IPO candidates what sectors do you like?

We still focus on the basic manufacturing types of industries because this is where I believe Chinese entities have a core competence. They have a low cost advantage and have a strong competency in terms of deploying engineers and that advantage is going to last for a long long time.

Where do you stand on the debate over whether China is overheating and whether a lot of the GDP growth is actually quite wasteful, inefficient GDP growth?

Both are true. In certain sectors, China is clearly overheating. I am encouraged that the government has realized that and is trying hard to cool it down. However, this time around, I am more confident the cooling-down process will not lead to a hard landing. Traditionally, the Chinese economy would overheat when it was let loose and when it was calmed down, it would go into recession. This time around, I feel the private sector, including foreign direct investment, has increased its participation in the economy and they tend to be more rational, so their investment decisions were made more rationally and with better judgment - therefore it will not be nearly as wasteful as 10 years ago. Overall, I feel the overheating will be contained without a hard landing .

Can you talk a little about your background?

I grew up in China and went to the States when I was 18 on an exchange programme then went to MIT. I started working on Wall Street in 1987, and came back to Asia in 1993 to help a Hong Kong family to build a hedge fund business. I was also advising the Chinese Ministry of Finance on how to establish a government bond market. I joined Merrill in 1996, and was there for four years. I was a managing director in charge of their Greater China debt capital markets business. Then I joined CITIC Pacific as an executive director and president of the telecom unit. Two years ago when the group decided to form CITIC Capital they asked me to lead the effort.

How does CITIC Capital fit into CITIC Group's overall approach to financial services?

CITIC Group has been trying to transform itself into a financial services player. CITIC Group is the most comprehensive financial services provider in China and it realized it wouldn't be complete without an international investment banking arm. CITIC started out as the window company of China to the outside world, to facilitate foreign investment into China. And CITIC's brand name has a lot of credibility with international investors. The brand name is a great asset and CITIC Capital is putting that asset to good use.