As Blackstone (BX) Turns To China For Money, Banks Become Less Important For Private Equity

Blackstone (BX) is making a bid for miner Rio Tinto (RTP), at least according to The Telegraph. Rio has a market cap of over $150 billion, and will probably be sold at some kind of premium. That is a lot of money, even by today’s standards. It would appear that one of the funds affiliated with the Chinese government will put up much of the money.

And, money from sovereign funds is showing up everywhere. Singapore’s fund just put close to $8 billion into a bail-out of UBS (UBS). Citigroup (C) and AMD (AMD) have recently received money from funds tied to governments in the Middle East.

The trend may well revive the flagging private equity business. Up until recently leverage-buyout operations like Blackstone, Apollo, and KKR have had to rely on bank loans to close their deals. A private equity firm would put up 10% of a purchase and borrow the other 90% from banks. The banks would syndicate those loans to other institutions. But, that system broke down when credit got tight last summer, and banks were stuck with LBO loans, some of which they are writing down. The trend has hurt big US banks like Citigroup and JP Morgan (JPM). And, those loans could produce more losses in future quarters.

But funds from Singapore, China, and the Middle East do not have the constraints that banks do. They are essentially private investors who can hold loans for long periods of time. The can take risks that banks can no longer afford.

This will lead to a big up-tick in private equity lead deals. Foreign government funds have capital, but they do not have the industry expertise and analytic capacity of the largest buy-out firms. The marriage makes sense, especially in buying attractive assets like mining companies whose sales are being pushed higher by global commodities demand.

Another trend which is likely to emerge is private equity buying back loans on its deals from the banks that made them. The source of funds? Pools of capital controlled by foreign governments. They can buy debt at a fraction of what the banks put up when they made the loans. And, if most of the deals end up being smart investments, they will make a small fortune. To add, that is, to the huge fortunes which they have already amassed.

Private equity has a new banker. The firm of Singapore, China,  Dubai, Abu Dhabi & Company.

Douglas A. McIntyre