Korean ECM faces hurdles after tough year

Stricter financial disclosure rules, a corruption scandal and a global equity market selloff derailed what should have been a big year for South Korean IPOs last year, leading to three of the biggest transactions being postponed. There are reasons for hope, but the country must overcome some serious structural challenges. Aidan Gregory reports

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South Korean equity capital markets had a difficult 2018, as the country’s benchmark Kospi index ended the year in bear market territory and the multi-billion dollar IPOs of Hyundai Oilbank, Lotte Hotels and Kakao Games were all delayed. 

As a major export economy, a close ally of the US and a neighbour of China, South Korea is heavily exposed to trade tensions between China and the US, which led to South Korean equities being hit particularly hard by the selloff last year. 

The country’s Kospi benchmark index finished 2018 down more than 20%, although it has since recaptured some of its losses and is up more than 9% so far this year. 

Volatility in South Korean equities was particularly painful for IPO issuers. The volume of IPOs in Seoul fell 64% from 2017’s total to just $2.5bn, according to Dealogic data. 

“Generally the equity market last year was not favourable for the issuers,” says June Won, head of capital markets origination at Citigroup in Seoul. “That is the main reason for some of the IPOs getting delayed, and in addition the financial disclosure rules are getting stricter, so it takes some more time to complete the finance numbers.

“However, we are starting to see the equity market improving, as you see from the Kospi numbers,” says Won. “We have a good pipeline that we are looking to IPO this year. Some are jumbo deals that we will try to do. I believe that if the jumbo deals are completed, IPO volumes will be 30% to 40% up in South Korea this year.”

Last year, among the largest South Korean listings, the IPOs of Hyundai Oilbank, Lotte Hotels and Kakao Games, were all postponed. Only the gaming arm of Kakao Group is likely to return in 2019. 

Asia 2019Hyundai Oilbank, a subsidiary of shipbuilding group Hyundai Heavy Industries, cancelled its W2tr ($1.8bn) IPO in October during the onset of the global equities sell-off. Besides the market correction, Hyundai Oilbank was also forced to delay because of a financial review by the Korean market regulator. 

This points to a wider risk for listing volumes. Scrutiny of IPO sellers has increased significantly since July, after an investigation into Samsung Biologics found that it had failed to disclose important accounting information before its 2016 IPO. 

“I am not expecting a big uptick in the volume of Korean IPOs this year,” says Robin Kollannur, managing partner for equities at RVX Asset Management in Aventura, Florida. “IPOs are at a multi-year low and there isn’t great visibility for the next year.  If anything we have seen more delays than actual activity.”

Hyundai Oilbank is unlikely to return in 2019. But the IPO is not dead and the company is taking more time to introduce itself to pre-IPO investors, such as Middle Eastern sovereign wealth funds. That process is likely to take more than a year, so it might return in the second half of 2020. 

Lotte Hotels, the hotels business of the Korean-Japanese conglomerate Lotte Group, is also unlikely to relaunch its $4.5bn IPO any time soon. The deal has been shelved for more than two years after the company’s chairman Shin Dong-Bin became embroiled in the corruption scandal that led to the impeachment of former president of South Korea Park Geun-hye. 

Shin was released from jail in October, after his sentence was suspended by an appeal court. The IPO is a key part of Lotte Corp’s plan to adopt a new holding company structure. 

Lotte’s flotation is now earmarked as a 2020 deal, GlobalCapital understands. Lotte Group is taking time to transform itself into a holding company structure to improve the performance of its duty free and hotel businesses to boost its overall valuation. 


Tougher governance

Despite last year’s disappointments, there are several reasons why the prospects for Korean ECM are likely to improve in 2019. 

Historically, the bulk of IPOs and equity block trades in South Korea come from the chaebols, the huge family-led conglomerates such as Samsung and IG that have dominated the economy for decades. 

The chaebols wield tremendous power and influence, but they are also notorious for their opaque nature, and have been embroiled in several scandals that have gone to the very top of government. 

Former president Park was jailed in April 2018 for her involvement in soliciting bribes from top Korean companies such as Samsung and Lotte in exchange for favourable treatment from government. 

Her replacement, Moon Jae-in, is more left-leaning and took office promising to make Korean society more equitable with corporate reforms to curb the chaebols’ power and tackle corruption. 

Shareholder activism is also on the rise and boards are under pressure to increase their historically low dividends, improve governance and rationalise their portfolios of assets. This may lead to more spin-offs through IPOs or block trades. 

“A very welcome development in our view has been to focus on better corporate governance,” says Amélie Thévenet, fund manager in the Jupiter Emerging Markets team in London. “The National Pension Fund has increased its voting against company resolutions at AGMs from 10% to 20% in 2018. We think many corporations are looking at increasing their dividend payout ratios, which have been historically very low.”

If companies improve governance, more international capital should come to the country’s equity market, which MSCI still classifies as emerging, despite its size and liquidity, and the quality of many Korean firms. 

“According to some of the specialists, there are two [key points],” says Won. “They believe Korean stocks are relatively cheap versus other countries and also we have the transparency [issue], which is getting improved. They like Korean stocks for those reasons. From this year there are changes in mind and companies would like to work with investors. They want to pay more dividends, for the benefit of existing shareholders.”Asia 2019

While the chaebols will remain crucial clients for now, ECM bankers in Seoul are focused on bringing more start-up companies to market. 

Moon’s government has been trying to stimulate the growth of independent private enterprises, particularly in the technology and biotechnology sectors, to boost competition and create jobs. 

“That is the angle we are looking into,” says Won. “We are looking into the biotech and games sectors. We have some advantages compared to others. We are looking to the future.”

Another sector banks are focusing on is property. Korea’s public real estate investment trust (Reit) market is nowhere near as deep as those in Hong Kong and Singapore, but that could change if a Reit listing by discount retailer Homeplus Stores gets back on track.

The company was planning to raise as much as W1.73tr ($1.5bn) from a share sale, a huge increase for a market that has seen few deals above $100m, according to Dealogic data. Homeplus Reit scrapped its deal as this publication went to press but there is likely to be more where that came from.

“[Reit IPOs] will be a big theme for Korea,” says Byungil Lim, UBS’s South Korea country head in Seoul.


Reasons to be long

While investors have been recovering from market falls in 2018, this year is likely to be just as tricky to navigate for South Korean sellers, with higher levels of volatility and a crowded calendar of political risk. 

“Overall volumes will increase but it will be a mix of large trades, equity-linked bonds and IPOs,” says Lim. “Off the back of increased volatility, a variety of equity solutions will be explored. In terms of IPOs, this will not be an easy year with the macro components making a meaningful impact … I think we should take a bit of a cautiously optimistic view.” 

As an exporting economy, Korea is heavily exposed to US-China trade tensions, which is why Korean stocks fared worse than many others last year. There is also the familiar fear of tensions with North Korea, which has weighed on valuations.

“The stock market overall is very cheap by global standards and it is very liquid,” says Kollanur. “They have improved corporate governance at the margin over the last year. All the signs are there for an uptick in the equity market. The overhang though is always the very volatile neighbour in the north. It is still a wildcard, which is why the valuations are still under global peers.”

Despite this, South Korea’s equity market is resilient and investors see its stocks as attractive, due to improving fundamentals. 

“The South Korean economy may be impacted by the uncertainties around the US-China trade war, but the earnings downgrade cycle seems to be ending,” says Jupiter’s Thévenet. “The equity market is trading at 8.8 times 12 month forward earnings, which is relatively cheap, both compared to history and other Asian markets.” It is the only market trading at a single digit earnings multiple, she says.

The Jupiter Asian Fund does not generally make macro calls on how to allocate among countries, but it is overweight South Korea as a result of its bottom-up stock picks. “We think this overweight position will stay on in 2019, but we do not anticipate the fund increasing its exposure to South Korea further,” says Thevenet.

The geopolitical signs are good. US president Donald Trump met North Korean leader Kim Jong-un for the second time in February, and although the talks were cut short there has clearly been a softening in relations between North Korea and its southern neighbour. The US is also widely expected to agree some kind of trade truce with China. 

If progress continues on these fronts, South Korean equities should outperform in 2019, leading to more ECM issuance, especially if corporate governance standards rise further.

“The market expects that the tensions between China and the US will improve,” says Won at Citi.

“That is one of the key reasons why Korea and the general region’s stock prices will improve, in addition to interest rate expectations. I hope that the tension between China and the US will improve and that will be of huge benefit to the Korean economy and corporations.”