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Chaebol under pressure

The Fair Trade Commission has been cracking the whip on South Korea’s family-run conglomerates, installing ownership limits in a bid to unravel their complicated shareholdings. The efforts are slowly starting to pay off, with the restructuring paving the way for better transparency and corporate governance. Rashmi Kumar reports.

South Korea's chaebol are having to face up to change. From the 1950s until quite recently, there was more or less a blanket view among the country’s politicians and economists that chaebol needed to succeed. The families backing the groups were given carte blanche to run their companies in whatever way would make them profitable.

And the conglomerates certainly made waves. Samsung Electronics, for instance, grew from sales of W18.47tr ($16.5bn) in 1997 to W228.7tr in 2013. Net income meanwhile rose to W30.5tr from W123.5bn in the same period.

Their success is impressive, but it has nonetheless caused angst among locals, lawmakers and politicians. The cross-shareholding structures common to such groups have come in for criticism. Families are being blamed for stifling competition and preventing growth of smaller entrepreneurs, while amassing great wealth but reluctant to hand out handsome dividends to minority shareholders.

Cross-shareholdings, through which the families behind the chaebol ensure their businesses own stakes in each other, allow the retention of control over an assortment of subsidiaries, despite each business only owning minimum stakes and even after the entities have been listed on the Korea Exchange.

But under the leadership of president Park Geun-hye, who came into power in 2013, things are changing. One big reason she was elected was her campaign focus on the chaebol, their control over the country’s economy, and their significance when it came to gross domestic product.

As part of that stern approach to some of South Korea’s most powerful business dynasties, the Fair Trade Commission (FTC) has demanded that the chaebol consolidate their ownership in company affiliates to 30% or less. Otherwise they risk being fined by the body.

Companies have slowly but steadily started paying heed. This February, the Chung family behind the Hyundai Group divested some of their shares in Hyundai Glovis in a W1.16tr block trade — a deal that stemmed from the FTC’s pressure to consolidate ownership. Two months later, an announcement was made about a potential merger of Hyundai Steel Company with Hyundai Hysco, which is expected to help the business become more vertically integrated.

“Many of the chaebol are restructuring their ownership structures, partly to comply with regulatory requirements and partly driven by generational transition from the second to the third generation,” says South Korea-based Dong Chul Kim, a partner at Paul Hastings law firm.

Kim, Paul Hastings

“The [30% ownership restriction] will enable conglomerates to focus on the core business of the company. If the core business grows, the company is able to position itself to acquire other companies in that sector, or the business can become ripe for an IPO or other capital markets transactions.”

Rising next-gens

As Kim suggests, it’s not just the FTC that’s proving to be a driver of change. Family owners are also looking for ways to pass on their businesses to the next generation, restructuring their ownerships in an attempt to do so. Marketwatchers point to the Samsung conglomerate, whose flagship business is Samsung Electronics.

The company is chaired by Lee Kun-Hee, who promoted his son Jay Y Lee to the position of vice-chairman at the end of 2012. Lee senior, who also has two daughters, suffered a heart attack last year and has been in hospital for months.

Analysts saying the listings in 2014 of Samsung SDS and Cheil Industries, both parts of the conglomerate, were held to manage the transition of the group to the control of the next generation.

“Lee effectively has to split his wealth and business between his son and daughters, even if Jay Y Lee is the next chairman,” said a South Korea equity research head, who preferred to remain anonymous. “So the Samsung SDS and Cheil IPOs were conducted in that context. Samsung also sold its chemical and defence unit to Hanwha [Group] because the restructuring comes down to focusing on the core of the business.”

As part of that, Samsung said in May that Cheil would acquire Samsung C&T through an all-stock deal. The move is being seen by those in the market as a way for the next generation to have greater control over the conglomerate.

Whether the merger will actually see the light of day is still a question. In early June, hedge fund Elliott Associates started legal proceedings for an injunction against C&T and its directors to prevent the takeover.

“Elliott continues to believe that the proposed takeover is clearly neither fair to nor in the best interests of Samsung C&T's shareholders, and that it is unlawful,” it said in a press release explaining the decision. The fund owns around 7% of C&T.

Simplification

Over the past couple of years, Korea's chaebol have been using different mechanisms to simplify their complicated shareholding structures. One way has been to set up holding companies and operating companies.

Dongwook Suh, a managing director for South Korea at management consultant Alvarez & Marsal, cites the examples of SK Group and Hanjin Group, both of which transformed their organisations into holding companies.

SK Group, the country’s third-largest conglomerate, said this year that it would merge its holding company with IT services provider SK C&C through an all-stock deal. The transaction removes multiple layers of complications as SK C&C owns around one third of SK Holdings, which in turn holds stakes in other SK Group units.

Suh

Meanwhile, Korean Airlines (KAL) in 2013 decided to spin itself off into Hanjin KAL Holdings and KAL, a move that led to a circular shareholding structure. Two years later, the company said it was merging Hanjin KAL and Jungseok Enterprise — its property investment and management firm — to create a straightforward holding company structure.

“Such transformation into the holding company structure would have a few significant —  planned and unplanned — impacts on chaebol,” said Suh. “First, it would definitely add transparency. Two, this may end up helping the owner family to further legalise, enhance and solidify their control over their chaebol, facilitating a smoother company inheritance planning among the family members.”

Hot capital markets

According to data provided by the FTC, the number of restructurings of Korean companies declined by 2.4% in 2014 compared to the previous year. But the value of companies that underwent the re-organisations went up by an impressive 27.3%.

What this has fuelled is not just mergers and acquisitions, but also equity-swap deals, overnight stake sales via blocks, straight asset sales and IPOs. There were a total of 137 ECM transactions recorded in the country last year by Dealogic, accounting for volumes of $13.1bn. This was a big uptick from 2013, when there were 114 deals worth $9.3bn, and from 2012, when there were 107 trades for $8.5bn.

From the debt perspective, the chaebol still enjoy very reasonable funding costs — both onshore and offshore.

“Overall funding cost is very attractive for chaebol and many companies took advantage of that last year,” says Chris Park, senior vice president in the corporate finance group of Moody’s. “Bank of Korea continues to cut rates, which means reasonably good credits can issue three or five year bonds at less than 2% yield. This was unthinkable a few years ago, and many companies are using it to reduce their burden.”

The cost of raising debt in the domestic market is also very appealing, added Park, meaning chaebol have little reason to go to the offshore dollar market for their fundraising needs, except for hedging purposes.

The revamp of conglomerates has also had little impact on sentiment among the banking community, where the shrinking of ownership by some big shareholders can often trigger covenants on loans that are guaranteed by the parent.

In the case of the chaebol though, that problem doesn’t exist. Payment guarantees between listed companies onshore have been banned since the financial crisis in 1998, when many chaebol got burnt because of a failure to pay up. Keepwell structures too are uncommon, although a Korean company is allowed to provide a payment guarantee to an international arm, says Park.

The conglomerates, however, venture out very rarely to offshore US dollar loans, thanks to robust appetite among bond investors and ample domestic bank liquidity, say analysts.

Call for transparency

What the push for an ownership re-jig has done is provide more transparency.

“We are seeing more independent directors being appointed to listed companies affiliated with chaebol,” says Alvarez & Marsal’s Suh. “The increase of independent directors in these companies is expected to have a positive impact on the overall governance and transparency of these corporates, especially around their key decision-making criteria and processes.”

There are clear long-term signs that South Korean corporates are changing. It can sometimes appear glacial, but it is progress that marketwatchers reckon will see full-fledged benefits in the long run.

In the short term, though, dissent among minority shareholders and the public against the owners of chaebol has picked up — as witnessed in the case of Cho Hyun-ah, the Korean Air executive and daughter of the company's chairman. In early 2015 she was sentenced to prison after having been found guilty of violating airline safety rules, after having ordered a Korean Air flight to abandon its take-off because she was served nuts in a bag rather than on a plate.

“Facing pressures to be more open and transparent from the government, public opinion, media and creditors, the chaebol are making various efforts to restructure themselves,” reckons Suh. “They need to make more decisive moves, and they know that.”

Another example often cited by disgruntled shareholders is Super AGM Day, where many firms hold their annual general meetings on the same day. According to a report in the Financial Times, on March 13 this year, some 58 companies held their annual general meetings. On March 20, 260 companies did, and on March 27, some 252 listed firms met up. The timing can make it difficult for minority shareholders to attend the AGMs of all the companies they own stock in.

“The underlying reason for the FTC requirement is to boost corporate governance and to make it more independent of the family controlling the company,” reckons Paul Hastings’ Kim. “The FTC wants transactions to be conducted on an arm’s length basis.”

More to come

Analysts admit that president Park is faced with a lofty challenge: to push for legislation distinguishing chaebol and the families that run them, while doing this without being branded as anti-business. On the other end of the spectrum are the families themselves, which boast a privileged position on the business echelon and have accumulated extraordinary wealth over the years.

Park has so far been moderately successful. M&As, sell-offs, IPOs and asset sales have featured pretty heavily in the country’s capital markets landscape over the past year. But there have also been many failed attempts that need revisiting sooner rather than later.

In September 2014, Samsung Heavy Industries said it would merge with Samsung Engineering to simplify its circular and convoluted holding structure, which includes stakes in Samsung Life and Samsung Electronics. But a couple of months later, the merger was pulled because of opposition from shareholders.

Its latest move to merge Cheil and Samsung C&T could also head the same way if shareholders side with hedge fund Elliott, say sources.

Meanwhile, Hyundai Motor Corp is yet to identify steps to unravel its own structure. “Hyundai Motor and Samsung Electronics are the two conglomerates that haven’t taken the holding company structure yet,” says Michael Na, Nomura’s Korea equity strategist. “They have the circular shareholding and the government is critical of this because you can control all the companies without owning a majority in them.”

The re-structuring might be important, but the sheer size of the companies means executing anything concrete will be a herculean task.

“Restructuring the chain between Samsung Electronics and Samsung Life with a holding company structure is not something that’s going to happen right away,” adds Na. “The biggest issue is that Samsung Life will have to completely sell out of Samsung Electronics, which is unthinkable as there’s a regulatory requirement that a financial company cannot have a majority stake in a non-financial holding company.”

Unwinding such cross-shareholding structures is not an easy task, therefore. But it is seen as necessary in the long term to breathe life into South Korea’s economy, particularly if new entrepreneurs are to be encouraged to establish their own businesses.

But change is on the way. Minority shareholders are publicly voicing dissent more than ever, which marks an important shift from the past. Add to that the fact that the government is slowly putting together measures to relax the strong control that chaebol have traditionally wielded on the economy, and there are clear steps in a new direction.

“The hope among investors in Korea is that an increase in transparency and better corporate governance will lead to an increase in the dividend payout ratio, which has been comparatively low in Korea compared to other developed nations, and generally more efficient management of corporates,” says Alvarez & Marsal’s Suh. 

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