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Changing moon 20/12/2005. Source: Asia Private Equity Review (APER).
 Korea's private equity scene has certainly been spiced up of late, providing some flavourful events for foreign participants, says the Asia Private Equity Review.
For a country that is also known also as the Land of Morning Calm, South Korea's private equity scene has been far from peaceful in recent months. In the wake of rising concern that the country is increasingly inhospitable to foreign investors, Seoul is making earnest attempts to allay mounting skepticism towards its commitment to foreign capital.
Last month, H&Q Asia Pacific ('H&Q') became the first foreign private equity firm to receive a commitment from the National Pension Corp, as a member of a consortium including Hyundai Securities and Wise Asset Management. The investor group received US$200 million for their buyout investment vehicle and aims to raise a total of US$400 million. In engaging one of the oldest names in the Asian private equity industry, H&Q, Seoul is gesturing to the private equity community outside of its country that it welcomes non-domestic entities in its private equity drive.
H&Q has all the credentials for selection by the National Pension Corp.. It is a pioneer in the South Korean private equity market since the country first opened its doors to foreign investors. H&Q became the first and continues to remain as the only pan-Asia fund management firm that created a dedicated fund for South Korea, which has an approximate US$40 million in funds. The private equity house was also among the first group of foreign investors to provide finance to financially beleaguered companies in South Korea. Among them was Good Morning Securities, which is one of the most successful restructuring stories in the nascent Asian buyout history.
In October 1998, H&Q led a consortium of investors, including the Asian arm of the San Francisco-based Lombard Investments and the Government of Singapore in committing US$30 million to take over Ssangyoung Securities which had fallen prey to the 1997-1998 Asian Financial Crisis. Renamed as Good Morning Securities, it was subsequently acquired by the local Shinhan Group in 2002. H&Q and its fellow investors were far from reserved in publicising a 5-fold return reaped from this divestment. Interestingly, at that time, the successful sale of Good Morning Securities was hailed as an exemplary investment in South Korea and there was no suggestion that the South Korean populace was uncomfortable with the profits raked in by foreign investors.
Times have changed. The recent high profile exits of KorAm Bank by The Carlyle Group and Korea First Bank by Newbridge Capital raised an alarming level of hostility towards foreign investors whom South Korea once welcomed as the conduit to saviour capital for the country. The development underscores a nation that has regained its financial muscle and that is ready and resolute to be in charge of its own destiny. Its vibrant domestic investment industry, once dominated by foreign names, is no longer prepared to take the position of second fiddle.
Preparing for the New Dawn
Late last year, Seoul unveiled its grand scheme to boost its direct equity investment industry, re-directing the focus from early stage technology companies to equity financing for mature companies that are in need of structural overhaul. The ministry of finance planned tax holidays and 1 trillion won (US$968 million) was known to have been earmarked to further invigorate domestic companies. At the same time, a host of local financial institutions and institutions, including Korea Development Bank, Industrial Bank of Korea, Kookmin Bank, The Korea Small Business Corporation and the Korean Military Mutual Aid Associations have or are known to be at the threshold of either setting up their own or making commitments to domestic private equity funds. In this latest announcement in which H&Q was named to co-manage a buyout fund, Shinhan Group's private equity arm was also a recipient, securing a US$150 million commitment from National Pension Corporation. As a result, since 2003, domestic private equity fund pool in South Korea has ballooned and is estimated to be around US$1.5 billion.
During the past seven years of extensive economic overhaul, some of South Korea's conglomerates have assiduously acquired domestic assets that have fallen into foreign hands. Between 1998 to the first quarter of 2005, foreign private equity houses were known to have disposed of 20 investments, 30% of which were sold back into South Korean hands. Among them were Shinhan Financial Group's acquisition of Good Morning Securities from H&Q Asia Pacific, Lotte Group bringing TGI Friday into its umbrella after having purchased the company from HSBC Private Equity (Asia) and the sale of Haitai Confectionery to Crown Confectionary Co by CVC Asia Pacific, JP Morgan Partners Asia and UBS Capital Asia (now known as Affinity Equity Partners).
South Korea Inc. has not been shy in flexing its muscle to regain domestic assets, even as early as three years after the Asian Financial Crisis. In 2002, after a year of negotiations, The Carlyle Group and JP Morgan Partners Asia had to abandon their plan to acquire Kumho Tires, one of the world's largest tire makers. South Korea's Military Mutual Aid Association filled the void left behind by foreign investors and paid US$1.2 billion for Kumho Tires. The recent bid of Jinro, a household name in South Korea's beverage industry was another reminder of the reinvigorated financial health of domestic conglomerates. Hite Brewery outbid all foreign private equity investors in agreeing to pay US$3 billion for Jinro, about 30% more than what its foreign rivals were prepared to pay.
Facing a declining number of deals with attractive entry prices, foreign private equity capital has not been able to sustain its momentum in South Korea. Between 1998 and the first quarter of 2005, foreign private equity capital peaked in 2003, at US$2.7 billion.
The inflow was unusually large because it was boosted by two exceptional transactions exceeding US$1 billion each. In terms of the number of deals completed, South Korea has never regained the peak reached in 2000 of 18 transactions. In fact, there were no deals consummated by foreign firms in 2005 thus far.
Tides Turned
For foreign private equity investors, the investment terrain in South Korea will be rugged. The country's central bank, the Bank of Korea, recently advised its policy makers not to sell state-owned interest in banks to private equity funds. The Institute for Monetary and Economic Research, a unit of Bank of Korea, concluded that while domestic banks must be sold, foreign banks are "more suitable" than private equity funds. Its observation is based on the fact that foreign private equity funds have "not contributed to efficiency in the banking sector (in South Korea)".The communiqué is one of the many recent incidents that mirrors how the tides have now turned against foreign private equity.
While the Asian private equity industry hailed the sales of KorAm Bank and Korea First Bank, the South Korean government had no appetite to join the party. Through these two deals, the two private equity houses, namely The Carlyle Group and Newbridge Capital respectively have pocketed more than three times their invested capital. The Financial Times described a "public antagonism towards US funds" is building up in South Korea in view of the hefty profits made by these fund houses.
To appease South Korean authorities, Newbridge Capital is known to have donated US$20 million to assist local small and medium enterprises. But the gesture does not appear to have pacified the swelling fury. Further reports suggesting that South Korean authorities are still reviewing their positions with regard to foreign private equity funds continue to surface. The National Tax Service was known to have paid unannounced visits to five foreign fund houses' offices, including The Carlyle Group, Newbridge Capital, Lone Star and Citigroup. In late May, the metropolitan government of the city of Seoul declared its plans to "investigate the Government of Singapore Investment Corp. for possible tax breaches". This relates to a building that the Singapore government bought from Lone Star back in 2001.
Perhaps the most disturbing revelation in the recent spate of increasingly souring sentiment towards foreign investors is the fact that secret cameras and listening devices were found embedded in the walls of the chief executive's room of the Korea Exchange Bank, which is 51%-owned by Lone Star. It is believed that the impending sale of Korea Exchange Bank which could command a price of tag of US$5 billion is a key reason behind such surveillance. In October 2003, Lone Star committed to a US$1.2 billion deal in becoming the majority shareholder of Korea Exchange Bank. If the speculated sale price is correct, Lone Star is set to achieve an envious gain from the disposal of Korea Exchange Bank.
Observation
Not all foreign institutions are perturbed by the disturbing moves made by South Korean regulators. Singapore's Temasek Holdings and Canada's Ontario Teachers Pension Fund are confident of South Korea's future prospects. The former has committed US$500 million in MBK Partners LP, a US$1 billion buyout fund for South Korea, while the Canadian institution pledged US$250 million. Armed with a handsome pool of capital from its foreign anchor investors, Mr Michael Kim, former president of The Carlyle Group's Asia office, founder of MBK Partners, is on schedule to raise US$1 billion for its maiden fund, according to market sources.
For South Korea, its nascent private equity industry needs foreign participation to introduce best practices to domestic firms, if it is to succeed. Teething problems have already emerged. The newly-formed Woori No.1 Private Equity Fund appears to have acted inappropriately in its recent investment in Woobang Co.. It entered into an agreement with another investor in the transaction providing it with a guaranteed return of between 10% and 20%. Laws governing private equity funds regard this type of transaction as a loan and it is not permitted for private equity funds. Woori No.1 Private Equity took up a 32% stake in Woobang for 42 billion won (US$41.5 million).
Despite a series of unwelcoming events for foreign private equity investors, institutions remain staunchly hopeful that promising opportunities will continue to emerge from South Korea. Foreign private equity might have stirred some unsettling commotions in the Land of the Morning Calm, but it will continue to play a key role in the country's economic progress, as long as both parties are committed to overcome the cultural divide.
Asia Private Equity Review (APER) is the foremost voice on matters related to private equity/venture capital in the region. Well-recognised as being the singular source for accurate and timely news, in-depth analysis and global perspectives, APER is published by the Hong Kong-based Centre for Asia Private Equity Research. For further information please visit their website at www.asiape.com or email them at info@asiape.com
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