Opening gambit

Korea can be a hard place to make investments. Chaebols – the large family-owned conglomerates that dominate the economy – are tough to compete with on deals. Deal flow is slower than expected given the maturity of the market. Foreign firms need well-connected locals on board to compete. Foreign private equity firms have stirred outrage among the public, politicians and trade unions. More than one investor has felt the push as well as the pull to other regional markets.

 Quietly emerging on this landscape is Hahn & Co, a two-year old spin-out from Morgan Stanley Private Equity Asia (MSPEA) in Korea. Led by Scott Hahn, the Seoul-based firm believes there is deal flow and attractive investment returns to be made in Korea, despite the fact that China, India and Southeast Asia are the favoured regional destinations for capital. Korea, it seems, has been overlooked.

“I do think about this,” Hahn says. “From 2006, no one talked about China, only Japan. As a regional fund, your view was how to attack opportunities in Japan. Three years later, there was a complete reversal where people get up to leave when you talk about Japan but it’s standing room only for China. The level of attractiveness comes and goes. From our perspective, we just need to look at every investment on its own, away from geography. It’s okay if our market isn’t the flavour of the year.”
 
THE NEW OLD TEAM

Hahn, the driving force of the firm, is something of a whiz kid. A Korean national with degrees from Yale and Harvard, he was only in his late 20s when he founded Morgan Stanley’s Asia private equity practice in 2000. Five years later, he became chief investment officer with responsibility for Asia, managing assets of $2.3 billion, at the same time serving as head of Korea investments.

While there, he racked up some points. Over an 11-year period at MSPEA, Hahn made eight investments with realised return “close to 4x and 41 percent IRR”, he says. His figures correspond with those of other industry sources who spoke to PE Asia on background.

The Korea part of the last fund that Hahn worked on before the spin-out was just over half of the fund’s invested capital, according to one source who did not want to be named. “He must have done relatively well in Morgan Stanley to attract that from the investment committee to push through the Korean deals.”

The spin-out had no trigger, but was influenced by timing. In 2005, Hahn felt Korea wasn’t ready for a dedicated country fund. But over the next five years, Korea matured in terms of the available opportunities and well-capitalised country funds began appearing in Asia, a trend led by China that Hahn studiously watched. He aimed to replicate that in Korea. “It’s a highly-localised investment environment and we have dedicated domestic resources. A singular focus on a country does have its advantages.”

The spin-out would be better described as a carve-out, judging by the people who left with Hahn. Four of the six-person investment team at the bank joined the new entity, including the chief financial officer Pratish Patel, a 16-year veteran of MSPEA. Added to that mix is co-founder and chairman of the firm, Yeo-Eul Yoon, previously chief executive of Sony Group Korea, one of the largest multinationals in the country with $1.5 billion in domestic revenues.

LPs no doubt find comfort in a team they sense has been working together a long time. And indeed this is Hahn & Co’s key selling point: the experience and prior performance of the team.

“There’s certainly a difference between spinning out and starting up,” Hahn says. “For spin-outs to be fluid, things need to be more familiar than unfamiliar with the team composition. Everybody worked together before or knew each other in some personal capacity. Getting that team dynamic right is quite important.”

Hahn’s maiden fund, which closed on $750 million in July 2011 (oversubscribed by about $150 million), was anchored by several big name LPs. PE Asia revealed Singaporean sovereign wealth fund Temasek Holdings as a cornerstone investor, committing $250 million and fund of funds Asia Alternatives with an undisclosed commitment. Hahn would only say that LPs are “very large sovereign wealth funds and pension funds, predominantly foreign” (Morgan Stanley is not an investor in the fund).

Given the team’s previous track record, Hahn & Co’s investment strategy should not come as a surprise. The firm intends to continue with the strategy that is consistent with what the team did inside Morgan Stanley: Controlling stake activity, mid-market, with a bit of preference for highend manufacturing that is linked to Korea’s globally competitive industries.
 
WHERE ARE THE DEALS?

Private equity deal flow as a percentage of overall M&A activity is still very low in Korea, less than 10 percent, Hahn estimates. In fact, Korea and Japan are expected to have the least active deal flow in Asia in 2012, according to a 2011 Ernst & Young study.

More than one LP told PE Asia that deal flow was slow because opportunities result from working a web of strong personal relationships within Korea; family names are a factor as well as reputation and connections in domestic business circles. “Sourcing deals you need to do at a more individual level,” one LP says.

 Hahn doesn’t entirely disagree. To succeed in Korea, local relationships and fully dedicated domestic resources are critical, particularly when vying for mid-market buyout opportunities – which is where he sees his firm’s advantage over pan-regional funds. “Korea isn’t a top priority for these regional funds.”

But he is coy about deal sourcing specifics, perhaps understandably so, since tactics and procedures could be a secret sauce in Korea. Deal sourcing starts with his firm’s internal network. “Ideas we have in sectors we like. In Korea it’s not a wait-and-read-the-book type of environment. You need to be proactive in looking at specific industries where you think trends will be and find the best risk-adjusted investment in that space. That’s primarily my role.”

Indeed, deal sourcing is something Hahn seems to have a knack for. At Morgan Stanley, the eight investments he and his team made were not originated by the bank. All those deals he sourced by himself, he says.

To date, his firm has made one investment, a controlling stake in Cowell, a mobile handset components manufacturer. Hahn & Co’s operational work involves revamping management, diversifying the customer base, and bringing in “a top-class research and engineering team for R&D work”.

In post-acquisition work, co-founder Yoon takes the lead. A local business veteran, he is well-equipped and well-known in the domestic electronics industry. Yoon can bring to bear his connections and experience, establishing contacts with key suppliers and distributors, making the portfolio company attractive to the large strategics he understands well. The portfolio company may also find a certain prestige attached to an operational workout led by the former chief executive of Sony Korea.

Hahn likes Korea’s technology sector – not startups, but manufacturing or fundamental R&D. Corporate Korea, he says, is one of the largest R&D spenders worldwide. “Owning businesses that benefit from that is something we must have.”

 He also likes domestic development plays that could be regulatory-driven such as healthcare. In addition, the firm is studying Korea’s financial sector, but so far is doing only that. Deregulation of the sector is ongoing and regulations are changing. “There are movements in the regulatory space we’re monitoring before we decide to make a commitment.”

Hahn prefers buyouts and corporate restructurings, which draw directly on his past experience. At MSPEA, Hahn’s team acquired struggling Ssangyong Corp, a commodities trading company, and successfully turned it around, he says. Jinbang Steel was another example. Jinbang had filed for a creditor workout following a labor union stoppage. A few months later, Hahn’s team acquired the company and helped it to normalise operations.

“Using leverage, being proactive in making management changes or changes in strategies is what we like. It’s more difficult to do in minority growth investments.”

KOREA’S NEW GPS

Korea’s chaeobls have deep pockets, powerful connections and strong appetites for buyouts, making them formidable competitors. On any deal, “they may have a relationship with the target company”, says one LP. “Korea always has strategics lurking in the background for buyouts.”

Given Hahn & Co’s fund size, the firm doesn’t compete with the big chaebols, Hahn says. He sees a two-tiered market in Korea. The top tier is large, high-profile, highly-valued transactions – typically a byproduct of corporate workouts – with a lot of chaebols as contenders. The other level has many smaller transactions, companies with $500 million in revenues or less where competition is less, which is where his firm operates.

“While we do compete with strategic parties for opportunities, they aren’t super-capitalised chaebols. You can find pretty attractively valued companies. There will be things you must do operationally and strategically, but if you have the confidence and resources to do that, you can find companies at a good value.”

Other domestic competition is limited. Regulations for domestic private equity went into effect only in 2005. In mid-2011, the number of domestic private equity funds reached 167, according to Korea’s Financial Services Commission. But these GPs by definition have a short track record.

Local GPs are much more focused on growth capital, less on buyouts, adds Hahn, emphasising his firm’s differentiation. The domestics have ownership structures that may raise issues for foreign LPs. Many are captives, owned by large financial holding companies. “They focus on structured minority and mezzanine-type deals and they are almost entirely capitalised by domestic limited partners such as government pension funds and institutions”, he says.

From this perspective, the competitive landscape looks appealing. Hahn has surely noted that very few firms have been investing for more than five years, creating a space in which a local player with an impressive track record and operational team could flourish.

But Hahn is taking a slow, careful approach to deals. He emphasises “being selective” as an advantage. It’s hard to dispel the impression of a chess player studying possible moves. He wants to – indeed he has to –  get each investment right.

“We’ve been given a big responsibility for investing on behalf on some very esteemed institutions. They’re very sophisticated, with an understanding of market dynamics in Korea. I’m grateful because I’ve always had the view that the opportunities in Korea were misunderstood. Korea can be a very difficult place to make acquisitions, manage businesses and exit from a business. But difficult doesn’t mean unprofitable.” 

WHEN FOREIGN MEETS LOCAL
It’s hard to talk about private equity in Korea without mentioning Lone Star Funds. The firm’s 2003 investment in Korea Exchange Bank turned political when it became clear that the firm would make billions on exit. Tax authorities raided Lone Star’s Seoul office. The media, trade unions and politicians railed against private equity “vultures”. Lone Star was never found guilty of wrongdoing and was given permission to exit only in December. The long ordeal raised questions about how committed Korean politicians were to welcoming foreign investment.

“Perception [of private equity in Korea] depends on the fund,” says Scott Hahn, co-founder of Hahn & Co. “Distinctions are made. We make a conscious effort to make sure we have a good reputation in the market. We show we are somebody who focuses on being a responsible owner as well as on investment return. That includes appreciation of business, social and political factors. Not only as a shareholder, but also an appreciation of the position of employees, labor unions, management, customers, suppliers. These dynamics are unique in Korea. The focus is on doing the right thing. Certain funds have not been doing that.”

It’s not that non-locals can’t play. But there are tactics and protocols to follow, and the starting point is a dedicated local presence.

“Foreign companies can do fine in Korea,” he says, giving the examples of his former employer Morgan Stanley as well as Macquarie Group, which invests in Korea infrastructure. “It’s not a foreign-domestic thing. Korea requires significant resource commitments. With a team of one or two people, it’s difficult to get things done. Those with a significant amount of capital and resources located in Korea have done very well.”