Sunshine after the rain

CHAEBOLS FEEL THE PRESSURE
Another reason for optimism might be that the crisis has thrown up new potential sources of deal flow, not least of which are the country's chaebols, large business conglomerates which have traditionally dominated the economic landscape.

Many chaebols made acquisitions when debt funding for deals was easily available, as was the case in the years leading up to the crisis. As economic conditions globally have deteriorated, some chaebols have found themselves cash-strapped and needing to divest stakes in some of their businesses.

Jason Shi is a managing partner at Seoul-based buyout firm Vogo Capital Advisors, which has made four investments and currently manages assets of 650 billion won ($503 million) across two funds – a 500 billion won domestically raised fund and a 150 billion won fund raised from overseas investors. He says that until recently, the biggest problem in South Korea was that chaebols were reluctant to sell, restructure or rationalise any of their non-core assets.

“They are into scale and size, so getting a control position in non-core businesses of chaebols was not easy for private equity funds.”

Not only were they unwilling to sell their non-core businesses, they were also acquiring assets aggressively, Shin adds.

However, many of the businesses of the chaebols are export-driven, and they are now realising that a global recession is coming, he says. As a result, they are increasingly seeking to restructure by selling their non-core assets, or even minority stakes in their core businesses.

Doosan Corporation, for example, sold its packaging business Doosan Techpack to MBK Partners for 400 billion won in late 2008. Doosan then sold its liquor business to retail giant Lotte Group. While the reason given for selling these businesses is that the group wants to focus on select businesses, a number of observers are of the view the sales were made in response to worsening economic circumstances.

For the chaebols that have been active in the M&A market in the recent past, the difficulties may be even more pronounced, according to one fund manager, since many of their acquisitions included heavy use of leverage which today they cannot sustain.

Reports of South Korean corporate groups looking to divest assets in a bid to increase liquidity are rife, with the following a snapshot: The Kumho Asiana Group is reportedly seeking a buyer for insurer Kumho Life Insurance; Hanwha Group is apparently having trouble financing its bid for Daewoo Shipbuilding and will possibly have to sell some assets to obtain capital for the deal; the Eugene Group, which acquired electronics retailer Hi-mart from an Affinity Equity Partners-led consortium, may allegedly have to sell some of its assets as its acquisition of the retailer was highly leveraged.

Whether or not the above transactions happen, any sign of the chaebols starting to relinquish their vice-like grip on South Korean business is good for domestic private equity firms.

Up until now, local private equity firms have tended to participate in consortia for mega deals as mezzanine investors or minority stakeholders, rather than acquiring controlling stakes as the single largest stakeholders, says In-Young Lee, president and chief executive officer of Seoul-based Woori Private Equity. Corporate buyers trumped private equity buyers by being more aggressive, in a better position to create value and more flexible in planning exits.

However, when selling a business, conglomerates prefer to sell to private investors rather than their peers, says Lee. This is because conglomerates are reluctant to reveal confidential information to competing conglomerates, especially considering a deal may not go ahead after talks are held.

PRIVATE EQUITY-FRIENDLY ADMINISTRATION
Good news for both foreign and domestic private equity firms in South Korea has come in the form of the new administration led by President Lee Myung-bak, which assumed office in February 2008. The new government is more foreign capital-friendly than its predecessors, say managers.

“Capital has certainly become more scarce, and more expensive. I think that the government has made a concerted effort to promote foreign investment and we'll see over time whether that will convert into more investments,” says Hahn.

Shin is of the view that regulations have not overly impeded private equity investments in the country, even for foreign private equity players, as he explains: “The obstacles were more structural – most companies are not very focused on rationalising their business portfolio. There simply weren't too many attractive and sizable businesses up for sale, so it was more cultural and more structural. I don't believe regulatory changes were a major issue.”.

However, he does agree that South Korea now has a much more “business-friendly, private equity-friendly and foreign capital-friendly government”, putting this down to a combination of current global conditions and the government being market-friendly.

A case in point is the floundering Korean banks. The administration is looking to divest part of its stake in Korea Development Bank to private investors. Though the plans have not materialised yet, the very acknowledgement by the Korean government that its national financial institutions are not running as they ought to and that private capital is required to bolster the domestic financial system is a development many private equity players, foreign and domestic alike, will be watching keenly.

Lee says restrictions surrounding investment type and investment holding periods for local private equity funds whose major LPs include Korean companies are likely to be eased in the coming months. Furthermore, restrictions prohibiting investments into private equity funds by a financial subsidiary of conglomerate companies will be eased to promote such investments. Such developments will be positive for the industry.

However, one potential blip, says Lee, is the newly promulgated ‘taxation on partnership company’, which prohibits the deduction of dividends from private equity funds from taxable income and could deter investments in local funds.

NEW ERA FOR PRIVATE EQUITY
With the government looking more kindly on private equity investors, whether it be local or foreign GPs, and the stranglehold of the chaebols on South Korean business being called into question by the crisis, it is no wonder some in the industry are seeing this moment as a potential turning point for private equity in South Korea.

One such person is Vogo Capital's Shin, who says there is likely to be a realisation “there will always be a need for an investor class such as private equity firms to help rationalise and restructure an economy”.

Another fund manager put it more strongly, saying current circumstances represent the opportunity for private equity firms – whose motives have often been doubted in Korea – to establish their position as a key component of the Korean corporate landscape by ensuring that the damage inflicted from the global financial crisis is limited. STIC's Lim focused on the opportunity for private equity firms themselves being created by the crisis. He said: “I think the next six to 12 months is the investment opportunity of a lifetime. We believe Korea brings an exceptional arbitrage opportunity to the private equity world.”

SIDEBAR: LOCAL LPS WATCH AND WAIT
South Korean regulators allowed for the formation of domestic private equity funds as recently as 2004. Since then, domestic institutional investors including pension funds, banks and insurance companies have increasingly invested in the asset class and seeded South Korea-focused funds managed by local firms.

WEAK WON IMPACTS ON PORTFOLIO COMPANIES
The South Korean won was the worst performing Asian currency in 2008, seeing its value against the dollar slide 38 percent.

“The irony is, many SMEs in Korea are sound and financially healthy, but they have found it nearly impossible to get new funding as equity and debt markets slammed shut late last year. The demand for private equity capital from these SMEs will be sizeable over the next six months or so.”

SOUTH KOREA FINANCIAL SPONSOR M&A BUYOUT FINANCIAL SPONSOR RANKING – 1998 TO 2008 YTD

Source: Dealogic