The Great Unwind and its Impact May 1, 2009

James Zukin
祖金

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The Great Unwind
and its Impact The U.S. and the Roman Empire

Introduction
„ There are striking similarities between the current situation in the United States. and the factors that
brought down the Roman Empire, including
z declining moral values and political civility at home,

z overconfident and overextended military in foreign lands, and

z fiscal irresponsibility by the central government.

„ A metaphor for Wall Street is the Colosseum. In the Colosseum, Romans fought not just individual
duels, but a much deeper battle for the heart and soul of the republic – and lost.
„ The Colosseum was symbolic of their obsession with wealth and material excesses, destroying its values
and exposing its vulnerability, until eventually Rome was overrun by outsiders.
„ The difference between the United States and the Roman Empire is the innovation machine manned by
millions of American entrepreneurs.

Source: Economist, David Walker

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The Great Unwind
and its Impact The Great Unwind

„ Financial complexity is at a tipping point.

z Today the marginal utility of financial innovation may be negative.

„ Financial institutions established to manage risk, instead, have created risk.

„ The think tanks and universities of America did little.
z have stood by as the crisis ravaged their endowments and destroyed the credibility of the market thesis,

z the “market we trust” school of market idolatry has ended.

„ Market mistrust is increased by a dramatic rise in the number and size of Ponzi schemes that have grown
from local to global and cumulatively will soon be crossing the $80,000,000,000 threshold.
„ A market without effective regulation is a “school for scoundrels”.
„ Taxes drive too many transactions. The Internal Revenue Code needs simplification and a focus on
integrating a much more rules-based approach into the system of the major CPA firms, the banks, and
other financial institutions.

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The Great Unwind
and its Impact On the Great Unwind

„ In 1980, bank indebtedness was equivalent to 21% of U.S. gross domestic product. In 2007 the figure
was 116%.
„ In 2004, the Securities and Exchange Commission changed a rule and exempted the five largest
investment banks from regulations that capped their debt-to-capital ratio at 12 to 1. Soon it approached
30 to 1.
„ Since first coined in February 2007, the credit market phenomenon known as the “Great Unwind” has
had a profoundly disruptive effect on U.S. and international financial markets.
„ Disorderly trading and cascading forced selling—coupled with unprecedented levels of illiquidity—has
placed the U.S. banking system into a cycle of distress.
„ As the Federal Reserve/Treasury/FDIC plan attempts to rescue the United States from this crisis, the
banking system’s movement through the cycle will define the duration of the current recession.
„ Reasonable disclosure of investment bank and hedge fund model inputs and assumptions and marks
would help to rebuild investor trust. Fundamental information on the assets being traded in illiquid
markets including cash flow projections, credit/duration risk, prior sales, asset valuations and projections
with base case and deep recession with increased tariffs case would be quite helpful. Supplemental
information of markets utilized by others. The big four CPA firms can spearhead this to show the
number of holders, range and median of marks on specific bonds, stocks or other financial assets.

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The Great Unwind
and its Impact Cycle of Distress

As the U.S. Federal Reserve’s balance sheet swelled from $900B to over $2T almost overnight, the United
States, along with the rest of the G8, went “all-in” with unprecedented levels of government loans and
guarantees in a historic effort to prevent the global financial system from failing.

Cycle of Distress
Stage 4 Stage 1
Good News
Recovery or Obscurity + Less Risk Decline & Challenge
„ Market Exit of Bank to „ Problem Loans Emerge
2010 New Owners 2007
„ Costs Rise
„ New Credit Culture
Implemented „ Governance Issue Emerge

- Decreasing Distress + Increasing Distress

Stage 3 Stage 2
Relief & Recuperation Crisis & Catastrophe
„ Regulators Recapitalize „ Regulatory Intervention
2009 the Banks as Bank Capital Shrinks
2008
„ Non-Performing Loans „ Most Lending Ceases
Transferred to AMC - Greater Risk
„ Many Non-Performing
„ Best Management We are here
Loans
Practices Implemented

4
The Great Unwind
and its Impact The Valuation Issue

The U.S. Valuation Debate Continues

„ Accounting rule-makers have come under unprecedented pressure to ease their rules on “fair value
accounting,” the practice of marking assets to market prices.
„ All of the major models and theories in broad use on Wall Street and in finance, such as the capital asset
pricing model, Black-Scholes option pricing model, and modern financial theory in application, often
produces miss pricing based on assumptions based on historical observations with a bias towards the
upside.
z Assumptions regarding volatility and duration that are overly optimistic (i.e., “compound optimism”)
were routinely utilized.
„ Business schools need to rethink how they teach modern financial theory for the theory in application has
serious flaws due to the estimation of variables.

5
The Great Unwind
and its Impact The Valuation Issue (cont.)

The U.S. Valuation Debate Continues

„ An enduring area of option research is the fundamental financial model assumption that future returns
will follow a log-normal distribution, the famous “bell shaped curve.” However, this assumption may
overprice assets in today’s crisis driven market.
„ In analyzing the applicability of market inputs, it is important to look at market volatility. Forced selling
is inconsistent with the concept of “freely and actively traded.”
„ The mark to market valuation information provided from qualified third parties is important information
for investors. Its use in accounting sometimes creates inadvertent events of trading procyclicality causing
downward pricing spirals.

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The Great Unwind
and its Impact Global Lessons: Conclusion

The Great Unwind Begins

„ The “Great Unwind” is now underway. As the financial sector grew to extraordinary size, it did so with
great leverage.
„ The “Great Unwind” does not just describe the eventual liquidation and dismemberment of a generation
of Wall Street creations, including the 30x leveraged investment bank business model that spawned these
now distressed entities. It also has a note of optimism as the markets will eventually rewind in an orderly
fashion under greater regulatory scrutiny.
„ The major long-term issue will be managing the inflationary effect and corruption potential of the
massive expansion of government capital creation moving at full speed across the globe.

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The Great Unwind
and its Impact News From China

„ 36 of the 100 firms anointed by the Boston Consulting Group in January 2009 are “contending for global
leadership” are Chinese. No other country can boast so many.
„ China has become the world’s largest exporter of information and communications technology.
„ China’s banking system is awash with liquidity. Chinese bank lending surged by 21% in the year April
‘08 to January ’09, up 30% in March.
„ Some shovel-ready projects are already under-way. Transport infrastructure spending in December 2008
was already 61% higher than the year earlier.
„ China’s outbound M&A is booming, but only in natural resources.
„ Inbound private equity into China is down along with prices but FDI is still $6-$8 billion per month.

Source: Caijing

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The Great Unwind
and its Impact Challenges in China

„ “What to expect in the Year of the Ox”

z Risk of doing business in China was a much higher cost of insuring Chinese receivable plus 30%

z More anti-trust surprises

– Coca Cola and Mitsubishi Rayon

„ Chinese GAAP and obsolete inventory
z The one knuckle rule; moving to international accounting standards

„ Into adverse selection – why are you in the deal?

„ Retrading
„ One bed, two dreams
„ Any deal with a book
„ If value rises post-agreement, approval may be withheld
„ In JV, pick the CFO
„ Learn Chinese, become Chinese
„ Create relationships based on mutual trust – creating the trust of obligation
„ Comrade Zukin “I am ready” – so is China
„ What are the limiting ingredients for China’s next leap?
z Management and management training

z Resource, Environmental and water supply issues including healthcare

z Regulatory deal review may take 1-3 years, how to do it in 2-4 months

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The Great Unwind
and its Impact M&A Considerations for Chinese Buyers
„ Cross-border M&A transactions are often precedents for Chinese and U.S. companies, therefore, it is
critical to address the additional complexities.
Pre-Closing Considerations
„ Language difference and cultural differences
„ Time zone difference
„ Managing U.S. and PRC deal teams
„ Parent company objectives
„ Lack of complete information
„ Expectation gap
„ Greater detailed due diligence
„ Conversion of financial statements
„ Complex tax structures
„ Cash vs. stock consideration
„ New PRC M&A rules – 2 approvals
z SOE’s can jump the cue
„ U.S. regulatory approvals
z SEC, HSR, CFIUS, as applicable
„ Extended time frame to closing
Post-Closing Considerations
„ Managing new management teams
„ Keeping employees motivated
„ Reporting to new board of directors
„ Maintaining vendor relationships
„ Integrating operations
„ Achieving synergies
„ Managing cultural differences
„ Communicating to public
„ Dealing with the financial crisis
„ Political dimension of partnering with the
state (SOE JV’s)
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The Great Unwind
and its Impact Panda Bonds to the Rescue?

„ Amid a dearth of liquidity in global capital markets, sovereign Panda bonds are now on the agenda.
They could redirect excess liquidity in the Chinese money system to a global financial system badly in
need of capital, and it would raise China’s profile in international capital markets.
„ Should China allow foreign governments, particularly the United States, to issue renminbi bonds in the
domestic market? China has seen only three domestic bonds by foreigners: two by the International
Finance Corp in 2005 and 2006, and one by the Asia Development Bank in 2005.
„ China is also sitting on US$1.9T of foreign reserves. Currency risk has become a major concern.
„ The Panda bonds could siphon liquidity out of the mainland money supply, which has surged on
consecutive record trade surpluses. That would save the government the expense of having to issue
money-supply-sterilizing government bonds, which carry an interest cost.
„ Use of the instrument could also help develop the domestic capital market and help to establish the
renminbi as a major currency in global finance. This could happen in a controlled manner over several
years with tight coordination with NDRC, MOFCOM, PBOC and CSRC.

Source: Ifre.com

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The Great Unwind
and its Impact

Dow Jones Industrials

Asia Borrowing
(2/1/2008 – 4/2/2009) - Datastream
(billion dollars)
14,000 5,000

12,000 4,000
100
Bond Equity Loan

10,000 3,000 80

8,000 2,000 60

6,000 1,000 40

4,000 0 20
Feb- Mar- Apr- May- Jul- Aug- Sep- Oct- Dec- Jan- Feb- Mar- Apr-
08 08 08 08 08 08 08 08 08 09 09 09 09

DJ Industrials SHANGHAI SE COMPOSIT PriceClose 0

Source: Datastream Source: Bond, equity and loan database of the IMF through Dealogic

Spreads on Credit Default Swaps Initial Public Offerings Volumes in China & Hong Kong
(basis points) (HK$B)

900
800 100
700 Shanghai & Shenzen Hong Kong

600 80
500 60
400 Asia excluding Japan
300 40
200
20
100 Japan
0 0
July Sept Nov Jan Mar May July Sept Nov
2008 2003 04 05 06 07 08
2007 2008

Sources: Bloomberg and IMF staff calculations Source: Dealogic

Notes: Measured by iTraxx Indices. Spreads are the annual amount that
an entity seeking protection must pay, expressed as a percentage of the
value of the debt being protected. A basis point is 1/100th of a
percentage point.
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The Great Unwind
and its Impact

Greater China M&A Quarterly Trend Asia-Pacific M&A Quarterly Trend

70,000 Value 400 160,000 Value 1,000
Number of Deals Number of Deals
900
350 140,000
60,000
800
300 120,000
50,000
700
250 100,000
600
40,000
Value ($M)

Value ($M)
Volume

Volume
200 80,000 500
30,000
150 400
60,000

20,000 300
100
40,000
200
10,000
50
20,000
100

0 0
0 0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
03 03 03 03 04 04 04 04 05 05 05 05 06 06 06 06 07 07 07 07 08 08 08 08 09 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
03 03 03 03 04 04 04 04 05 05 05 05 06 06 06 06 07 07 07 07 08 08 08 08 09

Source: Mergermarket Source: Mergermarket

2009 YTD – By Value 2009 YTD – By Volume

Transport Construction Pharma, Medical & Construction
Transport
Pharma, Medical & 13.6% 0.4% Biotech 2.2%
2.3%
Biotech Industrials & 3.6% Industrials &
1.1% Chemicals Leisure Chemicals
23.2% 3.6% 24.8%
Leisure Business Services
2.5% 5.1%

Business Services
2.8%
Real Estate
7.3%
Real Estate
4.1%
Consumer Financial Services
12.6% 8.1%

Financial Services Consumer

17.6% Energy, Mining & 18.9%
TMT Utilities
5.9% 11.0%
Energy, Mining &
Utilities
TMT
16.1%
13.1%

Source: Mergermarket Source: Mergermarket

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The Great Unwind
and its Impact Altered M&A Market

„ Massive global liquidity

Pre- June
„ Liberal lending terms Robust Environment
2007
„ Record M&A activity driven largely by private equity firms

„ Global debt market dislocation

„ Massive reduction in private equity activity and disappearance of large leveraged buyouts
2H 2007 /
„ “Broken” deals with greater focus on MAC clauses and reverse break-up fees Market Disruption
1H 2008
„ Significantly reduced equity valuations
„ Middle market M&A is resilient

„ Failure of major financial institutions leads to near-evaporation of credit markets as interbank

lending tightens Investor Confidence
„ Retreat in investor confidence leads to dramatic decline in equity capital markets Crisis, Offset by
2H 2008 „ Areas of relative strength (middle market, cross-border) tested by credit market collapse Government
„ Consolidation / equity infusions among financial institutions to strengthen capital positions Intervention
„ Unprecedented global coordination of government intervention in financial sector

„ “Mergers of necessity” likely to emerge as prevailing theme

„ Capital constraints continue to limit M&A activity…but encourage attractive divestitures and
sales by cash constrained companies looking to weather the storm
2009 Uncertainty Amid
„ Equity market volatility makes valuations difficult to determine…but depressed valuations
Outlook make returns work, even on over-equitized deals Changed Landscape
„ Conditions point to a buyers' market, with capital rich companies as the key beneficiaries
„ Creative financing structures, PIPEs and stock deals likely more prevalent

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The Great Unwind
and its Impact Historical Context
„ After a sharp downturn from 2000-2002, M&A activity steadily increased from 2003-2007
z Through June 2007, transaction levels rebounded to near all-time historical highs
z The onset of the credit crunch, triggered by problems in the sub-prime market, has effectively shut down financing markets since
the second half of 2007, causing agreed upon transactions to be unwound and the rate of new to deals to fall
„ The outlook for the remainder of 2009 reflects an altered M&A landscape, with a different set of drivers underpinning a more
muted level of activity
z M&A activity likely to consist primarily of defensive mergers, sales of non-core assets and industry restructuring plays
z Opportunities triggered via sellers motivated by short-term liquidity needs, covenant default pressures and focus on core
business

Historical Developments

Credit Crunch/
Mild Recession
Number of transactions

1960s 1970s-1980s 1990- 2000- 2003-

2000 2002 2005
2007

Active
M&A
Conglomerate Consolidation, Market/
Mergers, LBOs, Raiders, Deregulation, Pent-Up
Hostile Takeovers, Divestitures Megadeals Demand
Diversification

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The Great Unwind
and its Impact U.S. M&A Activity ($25MM-$500MM)*

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

January 795 664 500 508 684 729 754 921 919 486
February 863 595 456 494 609 576 696 782 768 425
March 978 588 504 568 709 688 819 817 709 522
April 744 596 554 552 664 676 779 752 743
May 894 653 567 516 612 637 860 957 666

June 893 600 494 554 666 705 855 927 797
July 782 610 538 595 649 672 808 809 871
August 801 537 504 487 657 722 796 845 640

September 779 359 489 622 627 735 848 815 688
October 775 536 544 653 593 702 809 945 592
November 635 464 440 519 587 691 741 786 510

December 697 469 479 656 672 647 833 736 588
Annual Total 9,636 6,671 6,069 6,724 7,729 8,180 9,598 10,092 8,491 1,433

Source: Thomson Reuters

* Includes undisclosed transactions

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The Great Unwind
and its Impact U.S. M&A Activity ($25MM-$1B)*

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

January 816 675 507 513 701 740 764 945 937 491
February 895 607 464 501 629 586 715 811 784 431
March 1,007 595 514 575 722 701 839 837 727 526
April 757 608 566 555 677 694 796 772 763
May 913 659 582 528 628 652 875 992 680

June 909 611 502 560 675 725 870 956 811

July 801 623 545 607 664 686 821 845 888

August 820 542 513 499 670 741 815 871 648
September 792 365 494 630 641 746 858 831 697
October 797 550 551 666 603 723 830 961 600

November 651 470 450 526 596 703 766 803 518
December 710 479 491 669 682 663 856 753 593
Annual Total 9,868 6,784 6,179 6,829 7,888 8,360 9,805 10,377 8,646 1,448

Source: Thomson Reuters

* Includes undisclosed transactions

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The Great Unwind
and its Impact Global M&A Activity ($25MM-$500MM)*

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

January 2,042 1,849 1,534 1,587 1,731 1,901 1,923 2,454 2,408 1,717
February 2,229 1,728 1,315 1,266 1,546 1,506 1,707 2,061 2,146 1,630
March 2,481 1,823 1,440 1,542 1,845 1,952 2,130 2,357 2,074 1800
April 2,006 1,756 1,492 1,356 1,665 1,712 1,820 2,179 2,280
May 2,238 1,931 1,533 1,493 1,492 1,638 2,072 2,511 2,108

June 2,229 1,722 1,273 1,511 1,533 1,902 2,165 2,453 2,261
July 2,076 1,783 1,486 1,606 1,667 1,777 2,082 2,511 2,421
August 1,979 1,459 1,329 1,335 1,527 1,724 2,018 2,247 1,944

September 2,109 1,161 1,374 1,540 1,578 1,808 2,118 2,239 2,299
October 2,000 1,567 1,560 1,774 1,632 1,827 2,123 2,556 2,093
November 1,981 1,526 1,290 1,479 1,619 1,797 2,106 2,169 1,945

December 2,029 1,397 1,346 1,685 1,851 1,922 2,308 2,183 2,146
Annual Total 25,399 19,702 16,972 18,174 19,686 21,466 24,572 27,920 26,125 5,147

Source: Thomson Reuters

* Includes undisclosed transactions

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The Great Unwind
and its Impact Global M&A Activity ($25MM-$1B)*

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

January 2,079 1,877 1,551 1,605 1,757 1,930 1,947 2,497 2,448 1,729
February 2,281 1,757 1,332 1,279 1,577 1,537 1,740 2,125 2,186 1,650
March 2,528 1,853 1,459 1,560 1,881 1,976 2,182 2,412 2,123 1,816
April 2,040 1,783 1,514 1,375 1,688 1,751 1,865 2,226 2,329
May 2,283 1,952 1,562 1,513 1,519 1,672 2,130 2,591 2,155

June 2,269 1,747 1,300 1,527 1,554 1,939 2,215 2,532 2,317
July 2,116 1,810 1,505 1,634 1,706 1,809 2,129 2,592 2,468
August 2,013 1,475 1,350 1,359 1,550 1,770 2,056 2,310 1,964

September 2,143 1,179 1,388 1,557 1,601 1,834 2,152 2,280 2,325
October 2,037 1,604 1,582 1,800 1,655 1,864 2,173 2,612 2,127
November 2,017 1,541 1,314 1,497 1,645 1,831 2,164 2,222 1,968

December 2,072 1,417 1,371 1,711 1,893 1,976 2,371 2,233 2,164
Annual Total 25,878 19,995 17,228 18,417 20,026 21,889 25,124 28,632 26,574 5,195

Source: Thomson Reuters

* Includes undisclosed transactions

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The Great Unwind
and its Impact Disclaimer Statement

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