Seoul push to end ‘the Korean discount’ hits a snag

From London to New York to Singapore, South Korean financial regulators have spent much of this year travelling the world to drum up enthusiasm among global investors for the country’s latest round of capital market reforms.

The changes are Seoul’s latest attempt to address its listed companies’ chronic undervaluations, long attributed to corporate governance weaknesses and poor treatment of minority shareholders — often the result of the dominance of the country’s big conglomerates known as the chaebol.

The “corporate value-up programme” includes a new index to highlight companies that have improved capital efficiency, as well as tax incentives for businesses that prioritise shareholder returns. While far from the first attempt to address “the Korea discount”, this latest push appears to have new political tailwinds behind it.

A surge in the number of local retail investors, the country’s demographic crisis and anxiety about slowing future growth have all helped push capital market reform towards the top of the country’s political agenda. Tokyo’s recent success in unlocking more shareholder value has given the Korean authorities a model to emulate — while also depriving them of excuses for inaction.

So far, however, the “value-up” campaign has disappointed local reform advocates who argue the proposals fail to address the root cause of the Korea discount.

“Most Korea listed companies have controlling shareholders who prioritise their own power and interests at the expense of minority shareholders,” says Kim Joo-young, managing partner at Seoul-based Hannuri Law and a board member of the Korea Corporate Governance Forum. “This often occurs through mergers, exclusive swaps, delistings and corporate divisions, but the authorities are hesitant to regulate these activities due to strong opposition from the business community.”

To illustrate the scale of the challenge, reform advocates point to a current test case — a controversial restructuring proposed by the Doosan conglomerate that has provoked strong opposition from minority shareholders.

Under the proposed restructuring, Doosan Bobcat, a producer of industrial equipment that generates the majority of its revenues in the US, will be merged with group affiliate Doosan Robotics. Korean law stipulates that, when two publicly traded entities are combined, the enterprise value of the companies used in merger terms — the equity value plus net debt — must be calculated using the average share price from the previous month. This is regardless of whether the share price reflects the intrinsic value of either entity.

In this case, however, critics argue the merger is being pushed through at a time when Doosan Bobcat — which made an operating profit of more than $1bn last year — is grossly undervalued by the market and lossmaking Doosan Robotics grossly overvalued. “Based on peer valuation and M&A precedent, we estimate Doosan Bobcat’s intrinsic value at about $10-14bn, but Bobcat’s board has just agreed to a merger that values its equity at $3.7bn,” says Changhwan Lee, chief executive of Seoul-based activist fund Align Partners, which does not have any investments in any of the Doosan affiliates.

Sean Brown of Texas-based Teton Capital, which holds a stake in Doosan Bobcat, notes the deal values Robotics at 86 times its trailing 12-month revenues, while valuing Bobcat at 0.4 times revenues on the same basis.

“The result is that shareholders in Bobcat will see their interest in the company reduced by more than half, while Doosan’s holding company, controlled by family shareholders, will see its interest in Bobcat triple from 14 to 42 per cent,” argues Brown.

In a statement to the Financial Times, Doosan Bobcat’s CFO Duckje Cho rejects the criticisms as “misguided and in some cases based on groundless assertions”, and that “the respective prices have been determined in compliance with the Financial Investment Services and Capital Markets Act”.

“We believe that the proposed transaction is not inconsistent with the government’s corporate value-up programme,” says Cho. “We believe that the ratio calculated in the manner prescribed by applicable laws and regulations is not unfavourable to the company’s shareholders.”

But Park Yoo-kyung, head of emerging market equities at APG Asset Management, describes the proposed restructuring as a “slap in the face” for regulators and Yoon Suk Yeol, the country’s conservative president who has promised voters better shareholder returns.

However, some reform advocates draw reasons for optimism from the episode, arguing that it will add weight to calls for the country to amend its commercial code to incorporate a fiduciary duty towards shareholders for the first time. On Tuesday, lawmakers gathered with pro-reform academics, investors and lawyers for a seminar at the National Assembly to debate the change.

“A fiduciary duty to shareholders would not fix all the problems in the Korean market, but it would help the directors of listed companies to resist pressure from controlling shareholders to do things that undermine the interests of other shareholders,” says Lee of Align Partners.

christian.davies@ft.com