Sunshine after the rain

The implications of the global financial meltdown have not dampened the spirits of South Korean private equity fund managers, who now anticipate a friendlier reception and increased dealflow. Siddharth Poddar reports.

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.

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.

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.”

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.

Now, however, according to one fund manager, most South Korean LPs are waiting to see which of the domestic private equity firms will become “winners” and come up with better performances before they allocate more money to the asset class.

“Starting in a couple of years, more of the money is going to be allocated to a few managers that have good track records,” he says.

Fundraising was difficult in 2008, says In-Young Lee, president and chief executive officer of Seoul-based Woori Private Equity. This was due to the fact that financial institutions including commercial banks and pension funds were struggling to beef up their balance sheets to weather the rough economic times that lie ahead.

One local limited partner bucking this trend is the National Pension Scheme (NPS), one of the world's largest pension funds with assets under management of 229 trillion ($169 billion) won. The pension fund currently has an allocation of 3 percent to alternatives, a figure it is looking to increase significantly over the next few years.

According to a source, the pension fund sponsored six domestic funds in 2008 and committed a total of about 900 billion won to these funds, which, when put altogether, closed at a total of about 2 trillion won. These commitments were made to purely domestic funds where the pension fund has committed as a limited partner, and exclude its investments in overseas funds.

The pension fund also entered into separate agreements with Oaktree Capital Management, The Blackstone Group and MBK Partners to invest jointly with them on a deal by deal basis across a variety of asset classes including private equity and real estate.

Following the Oaktree agreement, Daeh-hwan Kwag, the pension fund's head of global investments, told sister publication NPS's contribution to Oaktree's private equity, real estate and special situations opportunities in the country could be pursued by way of co-investments or by via commitments to Oaktree funds.

According to the agreements, Oaktree will invest up to $3 billion, Blackstone $2 billion and MBK $2 billion in South Korea in partnership with NPS. While NPS will invest $2 billion alongside Blackstone, it has not revealed its investment contribution to the other two agreements.

The South Korean won was the worst performing Asian currency in 2008, seeing its value against the dollar slide 38 percent.

Although a weak won is a cause for concern for the Korean government and the economy at large, for the private equity industry it brings pros and cons.

The most obvious plus for foreign investors, of course, is that their dollar goes further when it comes to acquiring assets. However, for those already invested in South Korea, the value of their investment now will very much depend on whether they hedged against the won or not.

Looking at the impact of a depreciating won on the portfolio companies themselves, there is good news and bad news.

Export-driven companies are being helped by the sliding won. “Even assuming revised sales and volume numbers as a result of economic conditions, the depreciation of the local currency is helping soften the blow these companies have felt,” says Scott Hahn, chief investment officer and head of South Korean investments for Morgan Stanley Private Equity Asia.

However, for those that import raw materials and components for goods, the depreciating won has meant import costs have shot up.

For target companies, however, that same macro-economic impediment can be an extra factor helping to pave the way in for private equity firms in current economic conditions, as Kevin Lim, chief executive officer of STIC Investments, points out: “Korea has around something like 100,000+ small and medium companies with enterprise value of US$500 million or more. They are all facing foreign exchange difficulties and because many are suppliers, they're going to get squeezed by the big corporations – not to mention that the tightening of bank credit hasn't helped them.

“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.”


Rank Financial Sponsor Value ($m) No.
1 MBK Partners LLC 1,734 4
2 Lone Star Funds 1,608 4
3 AIG Global Investment Group Inc 1,445 2
4 CVC Capital Partners Ltd 1,420 4
5 H&Q Asia Pacific Ltd 1,180 2
6 Newbridge Capital LLC 1,090 3
7 Morgan Stanley Private Equity 1,051 5
8 Shinhan Private Equity Inc 1,033 4
9 CCMP Capital LLC 1,007 4
10 GIC Special Investments Pte Ltd 950 1
10 Gilbert Global Equity Partners 950 1

Source: Dealogic