House of Cards (81 page)

At first, Lewis did not look so smart. On September 20, Bear Stearns reported third-quarter earnings of $171.3 million, down 62 percent from the $438 million the firm had earned a year before. Net revenues had fallen 38 percent. The results also included approximately $200 million in losses and expenses related to the High-Grade Fund. Not surprisingly, given the markets, the firm's main problems were to be found in the fixed-income division, where revenue fell to $118 million, down 88 percent from the $945 million of revenues in that business a year earlier.

A week later, Joe Lewis looked like a genius. On September 26, the
New York Times
reported that Warren Buffett, the legendary investor, appeared close to buying a 20 percent stake in Bear Stearns and that Buffett had contacted Cayne, his old bridge friend, about the potential investment. The paper also reported that Bank of America, Wachovia, China Construction Bank, and Citic were considering investments in Bear Stearns. Bear's stock leapt $8.76 on the news, closing at $123 per share. By October 2, the stock was back to $129. Nothing about the potential
Buffett bid, of course, was certain (or even accurate, Buffett said later). “But the decline in Bear's share price and its relative value—it trades slightly above its book value—has stoked the interest of outside investors,” wrote Landon Thomas Jr. “Previously, Mr. Cayne negotiated from a position of strength, always reserving the right to walk away if a deal did not meet his standards. The firm seems to have survived the worst of the summer crisis, but its continuing exposure to a moribund mortgage market and its need to expand its presence in faster-growing overseas markets have made the prospect of a capital infusion, matched with the expertise and prestige of an outside partner, more compelling.”

In an interview with the
Financial Times,
Cayne reiterated Thomas's view that the worst had passed for the firm. “Most of our businesses are beginning to rebound,” he said. “I'm confident that Bear Stearns will weather the storm and come out a stronger, more diversified and greater organization.” He also said that many of the firm's prime brokerage clients who had pulled money out of the firm in August had since “moved all their money back.” Tom Marano, the firm's global head of mortgages, told the
FT
that the market had started to rebound. “It definitely feels better,” he said. “Volatility has come down and we have seen siginificant purchases from investors all the way down through the non-investment-grade tranches of deals.” Even in the early October press about an investigation by the U.S. Attorney's Office in the Eastern District of New York into the collapse of Bear's hedge funds, Cayne found reason for optimism. He said he was “confident in our future and our business, and we see compelling value in our own stock.” Indeed, such was the optimism at the firm that, as part of the firm's third-quarter earnings announcement, the board authorized an increase to $2.5 billion in the firm's stock buyback program, from $2 billion.

The optimism continued at the October 4 investor day. Schwartz, Molinaro, Marano, Jeff Mayer, and Jeff Lane spoke of the great opportunities that lay ahead for Bear Stearns. Schwartz spoke about the growth in Bear's international business and of the “dynamic growth in Europe and Asia”—where Bear Stearns had never before spent much time or money—and noted that the firm's overseas year-to-date revenues of $1.4 billion had already surpassed the 2006 annual total. Understandably, he spoke about Bear's bright spots, not its problem areas, such as fixed income (the home of its increasingly toxic assets) and asset management (the home of its problem hedge funds). In his presentation, Molinaro focused on the progress the firm had made in shifting its funding mix from short-term unsecured borrowings to longer-term secured borrowings. He compared the firm's performance in the third quarter of 2007 to
the firm's quarterly performance during other market “dislocations” in 1994 and 1998. In some ways, he pointed out, the prior two hiccups had been even worse. The key issue, he mused, “was the length and severity of the market correction.” As part of the investor day, Lane, Mayer, and Marano also spoke about how well positioned their businesses were for the difficult market ahead. Inside the firm, this improvement seemed real. “Actually, September and October were pretty good,” Friedman said. “Right after Labor Day, things got better again.”

Cayne's return to 383 Madison, in improving health, meant that the man pushing the Citic deal forward was also back in the saddle. He drove his subordinates hard to get the deal signed up and announced, even though the $1 billion in cash the firm would receive from the Chinese would go right out the door again when Bear Stearns bought $1 billion worth of convertible debt in Citic. Above all, Cayne thought the strategic importance of the deal trumped the detail about whether or not the firm would actually raise badly needed capital. “We're undersized in Asia,” one senior Bear executive explained, “and the short of it was Citic was probably the best entity—not just Citic Securities but the whole Citic Group—for us to align ourselves with. They were really the mother lode. It was quite a coup for us to have this opportunity.”

Citic's one requirement was that Bear Stearns agree to sell them half of its non-China Asia business so Citic could begin to grow outside of China. Citic had spoken to Lehman and Citigroup about a similar deal, but these firms had declined. The problem for Bear was that it didn't really have half of an Asian business to sell Citic. “It's not like we can say, ‘Here's the income statement and balance sheet,’” this executive said. “Our revenues in Asia were booked in dozens of different legal entities. Capital comes from somewhere. Derivative trades are booked somewhere else. Different departments allocate costs and revenues amongst regions differently.” To actually put together a financial statement for the business was “really hard; it doesn't exist,” he said. Additionally, he observed, “It's the fastest-growing region in the world and it's going very quickly for us, so why would we want to give up half the upside? Especially since we had gone from not making money to just making a little bit of money but we had big expectations. We were selling it at the wrong time. What we thought we needed to get from it was … an opportunity in China. It's very hard to know how to get an opportunity in China. What I argued for was, ‘Well, why don't we get a revenue share on Citic securities?' because then you can just account for one number. We can work with them to grow new businesses. Anyway that they win, we know we're getting paid. If we're giving up half of our growth in non-China Asia
and non-Japan Asia, we need to get something in China. The revenue share is the lowest-risk, the easiest to keep track of, and the best alignment of our interests. I eventually persuaded Jimmy and Alan to allow us to ask for that in the term sheet.”

At first, Citic agreed to give Bear the revenue-sharing agreement, albeit at a lower percentage than the firm hoped. But then, after Citic spoke with “some regulator” in China, the revenue-sharing agreement was withdrawn. “This started a process of where the deal got less and less good,” this executive said. “Every time the deal gets less and less good, you're entitled to say, ‘I don't want to do it anymore,' or you're entitled to say, ‘Even though it's less and less good, I want to do it anyway.’” But regardless of how the deal changed—usually for the worse for Bear Stearns—Cayne kept pushing it forward. “There was nothing that could change in the deal where he would not want to do it,” he said. One day in mid-October Cayne called this executive to his office. “Congratulations,” Cayne said. “The deal is done. We're announcing it Monday.”

“What's done?” he said.

“Well, that term sheet,” Cayne said. “They agreed to it.”

“Jimmy, that's not a document,” his partner said. “That's deal points. There's a lot of stuff that's missing from it.”

“Well, they agreed to it and we're announcing it Monday,” Cayne replied.

The deal contained the idea of a cross-investment. “Jimmy, we haven't done any due diligence on the company,” he said. “Can we delay the announcement a week and go visit the company? Other than Donald [Tang], nobody's been there. I have nothing bad to say about Donald— Donald's great at what he does—but he does not like digging through the financial statements of things we put $1 billion into for a living.”

The executive said that “Jimmy almost took my head off. That's one of the few times he yelled at me. He said, ‘We're doing this. I don't know what you are going to learn on the diligence. We're going to do it anyway. It's a great thing for us.’”

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, Bear Stearns announced the deal with Citic. The agreement “in principle”—meaning the deal still needed almost everything, including signed documentation and approval by both boards of directors and various government agencies in the United States and China—could be canceled at any time. The two sides had agreed to work together exclusively to bring the deal Cayne and Tang negotiated in Beijing on September 3 to fruition. If it closed, each firm would make a $1 billion investment in the other—Citic's would be in the form of equity;
Bear's would be in the form of convertible debt—and a new joint venture would be created in Hong Kong comprising each side's non-China Asia businesses. Despite the fact that investment banking joint ventures have a horrendous record of actually succeeding, both Citic and Bear Stearns trumpeted the deal. Wang Dongming, Citic's chairman, said the Bear Stearns partnership was ideal because of its “client-focused culture, sophisticated analytical systems and deep capital markets expertise … We look forward to working effectively with Jimmy Cayne and Bear Stearns' talented management team and employees in the years ahead.” For his part, Cayne called the deal “a groundbreaking alliance” that “would give Bear Stearns a unique footprint in one of the world's fastest growing economies through a strategic partnership with a premier market leader.” The $1 billion investment that each firm planned to make would translate into a roughly 6 percent stake of each firm in the other.

In an interview with the
Financial Times,
Cayne called the Citic deal “the best to cross [my] desk in 40 years” and likened the Chinese investment bank to the New York Yankees. “This could either be just good for us or it could be very good,” he said. He also made crystal-clear that the firm neither needed nor wanted a capital infusion from an outside investor. “We have been very clear that we have zero interest in a capital infusion,” he said, and noted that the firm had close to $20 billion in cash. But the market was underwhelmed by the deal. The stock barely budged on the news, closing around $116 per share for the day, and the research analysts were blasé. Susan Katzke, at Credit Suisse, said the deal “was not the sale some were hoping for,” but thought it was a decent strategic move. Michael Hecht, at Bank of America, worried that “joint ventures look good on paper strategically and are always tough to execute, particularly with a strong culture like [Bear Stearns].” He also wondered what happened to the “capital infusion.” The
New York Times
observed, “The venture does not directly address Bear Stearns' balance sheet. Some investors and analysts have suggested that the firm could require a capital infusion because of its high exposure in the moribund mortgage market. But Bear Stearns has often said such an infusion is not necessary, and its deal with Citic seems to be an expression of confidence in Bear Stearns.”

Behind the scenes and after the public announcement, the real work began of trying to bring the deal together. “We eventually did go and kick tires, and learn about the company,” said a senior executive who worked on the deal. “We learned some stuff we wish we knew beforehand. We got a large team of people working on getting some sort of pro forma financial together. We had dozens of people working on it. What
was very clear was that there was a very opaque approval process in China. And as things started to sour, what was also clear to me was that the Citic money was never coming in if we needed it…. If we didn't need the money, they would put it in. If we needed the money, they weren't putting it in unless maybe somebody else put in the money and they wanted to participate. There was certainly an element in our capital-raising thinking of ‘Well, we got the $1 billion coming in from Citic, and that's something.' But most people, even Jimmy probably, thought there was always some element of conditionality to that money. To the extent anybody thought that the Citic money counted, they were deluding themselves. The market gave us no credit for that. I gave us no credit for that. I think others gave us no credit for that. I don't know if Alan or Sam or Jimmy gave us credit for that. They shouldn't have.”

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