“Chung’s Tails”, a Cantabrian magnum opus of genetically modified engineering and construction
Posted on 8 September 2010
Authors: KR Min, Senior Research Analyst and Adrian Cowell, Director and Fund Manager
Despite the seemingly inexorable rise of the “BRICS”, Korea is still the second largest emerging market. The market, as we are sure all readers of this will know, is dominated by the large chaebol (conglomerate) groups such as Hyundai. Their structure is not at all simple, but this was a story we felt should be told…
The report below was written by Kyung-Rae Min, Head of the Rexiter Korean Office, to help explain the implications of the impending sale by the creditor banks of a stake in Hyundai Engineering and Construction. The article relates to the ownership structure and control of the entire Hyundai Group or Groups… depending on who wins…
The Cast
The Patriarch
Chung, Bong-Sik (deceased), farmer in what is now North Korea. Of 8 children, there were 5 significant sons.
The First
Chung, Ju-Young (1915~2001), the founder of the Hyundai Group. Of 9 children, 5 significant sons.
The Second
Chung, In-Young (1920~2006), Honorary Chairman of Halla Group.
The Third
Chung, Soon-Young (1922~2005), Honorary Chairman of Hyundai Sungwoo Group.
The Fifth
Chung, Se-Young (1928~2005), Honorary Chairman of Hyundai Development.
The Sixth
Chung, Sang-Young (1936~ ), Honorary Chairman of KCC Group.
General Prologue
As a teenager in the early 1930’s, Chung Ju-Young ran away from the farm in what is now North Korea, sold a cow and stole the proceeds. Such were the first rapid steps towards the establishment of the Hyundai Group, which by the early 1990’s had become Korea’s largest family controlled industrial conglomerate (Chaebol); the advertising claimed, “from chips to ships”. The establishment in 1947 of Hyundai Engineering & Construction (HE&C) marked the formal founding of the Hyundai Group, whose progress was characterised by risk-taking, discipline and a can-do spirit. HE&C became Korea’s top construction company, along the way building the nation’s first expressway from Seoul to Pusan. Hyundai Motor built the first Korean car, Hyundai Heavy Industries built ships, and Hyundai Electronics produced semi-conductors. Five of founder Chung Ju-Young’s brothers ran related groups and companies.
By the 1990’s with Chung Ju-Yong in his mid 70’s and with so many sons, succession was becoming an issue. The “famous five” were Mong-Koo at Hyundai Motor, Mong-Keun at Hyundai Department Store, Moung-Hun at Hyundai Elevator, Mong-Joon at Hyundai Heavy Industries and Mong-Yoon at Hyundai Marine & Fire.
HE&C had prospered under the leadership of Lee Myung-Bak, the current President of Korea. Lee Myung-Bak had been recruited by Chung Ju-Young out of university, his potential undoubtedly enhanced by Lee’s relationship with Park Chung-Hee, the then President of the country. However, HE&C’s fortunes started to wane during the Iran-Iraq war (from 1980 to 1988) when it lost large amounts of equipment in the war zone as well as accounts receivable. Ten years later, the Asian financial crisis of 1997 finally drove the company into the hands of the creditor banks, led by the Korea Exchanges Bank (KEB), the main bank for the Hyundai Group.
Chung Ju-Yong’s chosen successor was son number five, Mong-Hun who was given responsibility for businesses that his father believed to be core and the future of the Hyundai Group, namely HE&C, Hyundai Electronics, Hyundai Elevator, Hyundai Merchant & Marine and Hyundai Securities. However these core companies did not weather the Asian financial crisis well, thereby undermining Mong-Hun’s inheritance and status.
Feud
Rebellion by the Prince – MH Chung
Mr. MK Chung (left), the late Mr. JY Chung, and the late Mr. MH Chung in March 2000. Source: Database from Chosun Daily
Before the old Hyundai Group was broken into its three constituent parts (new or current Hyundai Group, Hyundai Motor Group and HHI Group) Mong-Hun, with some guidance and tacit support from his father, tried to evict his brother Mong-Koo, from Hyundai Motor. Mong-Hun failed in his attempt, resulting in the complete breakdown in relations between the brothers. The FTC (Fair Trade Commission) had not approved Mong-Hun’s proposed restructuring plan of old Hyundai Group in early 2000. The distressed nature of many of Mong-Hun’s companies wouldn’t have helped his case.
The legacy of the rebellion
In his latter years, Chung Ju-Yong became increasingly preoccupied with North Korea. He made a number of visits to the country, looking to advance tourism and latterly delivering cows and vehicles. Upon his death, Mong-Hun continued with his father long-cherished desire to develop business with North Korea. He became deeply involved in the Mt. Kumgang tourism project (a mountain in North Korea with a near mystical attraction) and Kaesong Free Economic Zone, the heart of the “Sunshine Policy” of Nobel Peace Prize winner, President Kim Dae-Jung. Illegal money transfers of around $500m to North Korea were made through Mong-Hun’s companies. He committed suicide in 2003, giving his widow, Ms. Hyun, control over the new Hyundai Group. A Hyun in control rattled the Chungs.
In 2003, Ms. Hyun’s control over the new Hyundai Group was challenged by Chung Sang-Young, the only surviving brother of Ju-Yong. Convinced that Hyundai companies should be Chung controlled, he attempted to takeover Hyundai Elevator, Ms. Hyun’s new Hyundai Group holding company. Along with Hyundai Heavy, run by his nephew, he purchased a 40% stake. However much of this stake was held through mutual funds and private equity funds which breached rules of proper disclosure (the 5% rule). The attempt failed, but Ms. Hyun’s position was not safe, especially as the relationship with North Korea had deteriorated and her new Hyundai Group balance sheet structure had been weakened. Despite 2 million visitors, the cumulative loss at the Mt. Kumgang tourism project has been approximately W302bn ($250m) over the period November 1998 to July 2008.
Two other sons and the uncle
Hyundai Heavy Industries (HHI) is run by Chung Mong-Joon (the sixth son), who has had a varied career, having been groomed by his father for a career in politics, with the ultimate goal of becoming President of South Korea. The Chairmanship of Hyundai Heavy, the largest shipbuilder in the world, funded his political aspirations, which were largely based upon his Presidency of the Korean Football Association, Vice-Presidency of FIFA and the securing of the joint-hosting for Korea of the 2002 Soccer World Cup. Immediately thereafter, he failed in the Presidential Election of 2002 as an independent; he then became Chairman of the Grand National Party, the current ruling party, a post from which he has recently resigned. Fuelled by the shipbuilding boom, the slump has cramped his style. Global stimuli, Toyota product recalls and “cash for clunkers” have introduced his elder brother at Hyundai Motor into the fray.
Hyundai Motor Group led by Chung Mong-Koo, the second son, is interested in HE&C. HHI, separately preoccupied with taking over Hyundai Oilbank, has withdrawn from the bidding for HE&C.
The HE&C deal now looks to be a competition between the daughter-in-law camp and the motorized son with the help of an aging uncle and the brothers.
Hyundai E&C
HE&C’s main businesses are civil engineering, housing, architecture and plant that includes nuclear power. The company is ranked #1 in terms of construction ability out of c. 57,000 constructors in Korea. Sales and net profit in 2009 were W9.3tn ($7.8bn) and W456bn ($380m) respectively, with a market cap of W6.6tn ($5.6bn, the 35th largest in Korea by market cap) and foreign ownership of 21.2% as of July 13.
Creditor banks hold 38.6% stake in Hyundai E&C
Source: FSS (Financial Supervisory Service) filing and RBS securities
In 2001 HE&C was spun off from the old Hyundai Group into a work-out program led by creditor banks. The creditor owned but independent company graduated from the work-out in 2006 and has been waiting for an opportunity to find new shareholders. The creditor banks are holding 38.6% of HE&C, namely Korea Finance Corporation 11.1%, KEB 8.7%, Woori Bank 7.5%, Kookmin Bank 3.6%, Shinhan Bank 2.9% and others 4.8%. W3-4tn ($2.5-3.3bn) is expected to be the range for the stake which includes management rights.
The linkage between HE&C and Hyundai Group
Whoever purchases the majority of HE&C from the creditor banks will be positioned to get easy access to Hyundai Merchant Marine (HMM, a shipping company, and the de-facto holding company of new Hyundai Group).
Hyundai E&C is an important link to other Hyundai companies
Source: FSS (Financial Supervisory Service) filing and RBS securities
As shown in the chart above, HE&C holds 7.2% of Hyundai Merchant Marine (HMM), the third largest shareholder, following Hyundai Elevator’s 20.6% and HHI’s 17.6% stakes. Total ownership by HHI/KCC is c.31.2% vs. Hyundai Group’s 40.3% including Hyundai Elevator, Hyundai Securities and Cape Fortune Fund’s 5.75%. If HE&C’s stake were added to that of HHI/KCC, the combined stake at HMM would be as big as 38.4%, close to Hyundai’s 40.3% and is big enough to threaten Ms. Hyun’s control. HE&C is the gatekeeper.
HMM is holding significant stakes in affiliates of the Group; from 23.2% at Hyundai Sec to 35.3% at Hyundai Research. The key companies are HMM and Hyundai Sec; both are making money.
What are the participants mulling over?
Sellers – creditor banks
Korea Development Bank (KDB) is currently faced with time constraints. One of the big tasks faced by the Korean President, Mr. Lee Myung-Bak (MB Lee), is to privatize KDB within his presidential term - he is halfway through that term. The global financial crisis impeded KDB’s timeline for unwinding their investments before commencing the privatization process. Consequently, in the latter part of MB Lee’s term, there are a large number of tasks for completion, including the sale of HE&C. The ultimate owner of HE&C doesn’t currently seem to be that important to KDB. Advisers have been selected – Merrill Lynch, Woori Investment Sec. and KDB – and creditors reportedly wish to get the deal completed by year-end or early in the new year.
KEB – the main creditor bank of HE&C as well as Hyundai Group
As the second largest shareholder at HE&C, the value of HE&C is important for private equity firm Lonestar’s exit from its investment in Korea Exchange Bank (KEB). KEB is not only a shareholder of HE&C, but was also the main creditor of new Hyundai Group. This is a problem. KEB has been forced by the financial regulator to agree to a financial restructuring of Hyundai Group, as the balance sheet structure is unstable. A high gearing ratio as at end 2009 is due to the loss-making shipping business of HMM. KEB wishes to increase their influence on the financial activities and the restructuring, which may block Hyundai Group from participating in the HE&C bidding process. One reason is that KEB wishes to lock up the value of Hyundai Group stakes before commencing sale of the stakes by Lonestar. On the surface, KEB is in a dilemma because the more Hyundai Group is willing to pay for HE&C, the riskier its own book value becomes due to higher gearing. Hyundai Group cannot bid without raising more debt, which adds uncertainty to Lonestar’s sale of KEB. KEB’s credit line exposure to Hyundai Group was reportedly W160bn ($133m), which is not that significant. Now Hyundai Group is saying “no” to KEB and KEB and the other banks are responding that there will be no more fresh lending to Hyundai Group.
Were Hyundai Group to sign the agreement with KEB for financial restructuring, they may agree to all of the restrictions such as no equity funding, no further debt increase, less aggressive management, sale of assets etc. Relations between KEB and the old Hyundai Group go back more than 40 years when KEB was spun out of the Bank of Korea in 1967. KEB has been the main creditor bank for all four Hyundai Groups – Hyundai, HHI, HMC, and Hynix. Is the relationship now about to be broken?
Hyundai Group
Restoration of the old Hyundai Group is perhaps a realization of one of the wishes of her husband – from Ms. Hyun’s perspective.
However, business circumstances are not helping her. The group’s cash cow used to be HMM, but the company has generated losses after the global crisis, with a gross gearing ratio of 320% and total debt from financial institutions of W2.2tn ($1.8bn) as at end 2009. On a positive note, Hyundai Group’s shipping business has been recovering sharply into this year, making a 1Q10 operating profit of W11.6bn ($9.6m) on sales of W1.7tn ($1.4bn), following five consecutive quarterly losses. This will alleviate the financial burden going forward and allow the Group to defend the management of Hyundai Group against any takeover threat and to participate in bidding for HE&C, via more debt financing.
From Hyundai Group’s perspective, KEB’s strong intention to force the Group into a financial restructuring smells fishy. Hyundai Group wishes to sever the relationship with KEB and change the main credit bank role to another bank. But who will replace KEB is another matter. Recently, Hyundai Group repaid W40bn ($33.3m) to KEB out of W160bn ($133m) borrowings and is looking to repay the remaining debt soon, strongly requesting no financial restructuring and a change of the main bank.
We believe that Hyundai Group is in a desperate situation which will be difficult to overcome.
Source: Korea Times’ database
Hyundai Heavy Industries (HHI) Group
It’s not certain whether HHI Group are looking to restore the old Hyundai Group through ownership of HE&C, but they seem to have a fundamental rationale for acquiring HE&C – the nuclear business and technology. HHI Group has looked to diversify its business from shipbuilding to industrial plants, engine and machinery, construction equipment and renewable energy including exposure to the solar energy business. Nuclear technology could be an attractive business from HHI’s perspective - a synergy with the current business lines.
However, a dispute over Hyundai Oil Bank with IPIC (International Petroleum Investment Company) of Abu Dhabi sets some restriction on cash management. It is a legacy of the Korean financial crisis as well. IPIC bought a 70% stake at Oil Bank (a 50% initial investment + 20% call option for preferred shares) from HHI for $680m both in 1999 and 2003, however HHI has the right of first refusal when IPIC exits from Oil Bank. Seoul District Court judged in favour of HHI Group against IPIC on July 9, which means HHI Group needs to have W2.6tn ($2.2bn, 70% stake at W15K/share) in cash for the transaction soon.
Hyundai Heavy Industries Group: Cross shareholding structure
Source: FSS (Financial Supervisory Service) filing and Daiwa Securities
Net cash balance as of 1Q10 end looks c. W1.2tn ($1bn) with Shareholders’ Funds of W10.4tn ($8.7bn). Assuming HHI Group participate in the bidding for HE&C without any financial investors, they would need to secure c. W5-6tn ($4.2-5bn) cash for two transactions in a short period of time, which looks burdensome, but not entirely unrealistic. W7.8tn ($6.5bn) of pre-received (liabilities) from ship-owners for c. 2 years of backlog is another problem for cash burn (working capital for building ships).
The market suspected that HHI is the only plausible acquirer of HE&C until the recent talks amongst the Hyundai family are released. Anyway, the largest shareholder of HHI Group, MJ, ex-leader of GNP (Grand National Party), may find more time focusing on HE&C as the Football World Cup is over. So far HHI Group hasn’t said anything.
Korea Chemical Corporation (KCC) Group
KCC Group and its honorary Chairman were looking for the Chung family to regain control of the old Hyundai Group from its Chairwoman, Ms. Hyun. HHI Group was regarded to be of help to KCC Group when KCC Group was trying to make an earlier acquisition. Two years later, HHI Group has increased their stake in HMM to 17.6%.
KCC Group increased their stake at Hyundai Elevator up to 31.2% at the end of 2003, partly through various funds’ purchasing a 20.6% holding. Actually, KCC and other Hyundai family members started to purchase a Hyundai Elevator stake right after the suicide of Mr. Chung, MH in Aug 2003. The investment through funds were not regarded as voting shares by FSS (Financial Supervisory Service) and KCC’s attempt failed in spite of a big tender offer in the market. Following this failure, KCC sold their stake (25.5%) to a German investor (Schindler Deutschland, an elevator manufacture) in March 2006. The battle between KCC and Ms. Hyun/Hyundai Group finally ended; though tensions remain. KCC Group may support HHI Group or HMC Group when they are asked to do so.
Hyundai Motor Group
Hyundai Motor Company Group: Cross shareholding structure
Source: FSS (Financial Supervisory Service) filing and Daiwa Securities
The biggest victim of the rebellion in 2000 was Mr. MK Chung of HMC Group who was targeted by Mr. MH Chung. After having been spun off from the old Hyundai Group, HMC Group have focused on their main businesses, auto and steel and have achieved outstanding results by generating strong growth and profitability. Now with a superior balance sheet, HMC Group have reasons to participate in the bidding process to acquire the founding company in their Group. The Chung Family seem to agree that MK Chung is quite entitled to get HE&C back as the big brother and it seems that the plan is welcomed by other family member except Hyundai Group (i.e. Ms. Hyun). It is reported that MK, MH, and the uncle (SY) have agreed among themselves to support HMC Group in order to get the deal done. From a seller’s perspective, HMC Group’s participation would be very welcome, given that Ms. Hyun’s Hyundai Group looks financially stretched and there would be no major interested parties except the Chung family.
However, this raises concerns on the corporate governance of HMC Group. Following strong performance during the last few quarters – HMC’s net cash of W4.6tn ($3.8bn), HMC Group could now disappoint investors as their participation in the bidding has not been alerted in the past.
Assuming the deal size is W3-4tn ($2.5-3.3bn) for the entire stake from the creditor banks, it’s only 9-12% of HMC’s market cap. Following a press report regarding the possibility of HMC’s participation, the market cap of HMC fell by more than 9%, equivalent to the estimated bidding amount.
The competition race is about to come to an end…
Thanks to the earlier-than-expected sale announcement by Korea Finance Corporation and KEB, the stock price of HE&C has gained some momentum, having underperformed the market quite substantially YTD. As discussed above, the current Government has little time to complete its privatisations.
The current timing is not helpful to Hyundai Group and to Ms. Hyun. Clearly she will want to keep control of the Group, but is effectively having to do so when financially stretched. Thus, the KEB push to restructure isn’t to her liking.
We could only guess the reaction of the founder (Mr. Chung, JY) should HE&C fall into the hands of either HHI Group or HMC Group. Obviously, giving Hyundai Group to the eldest son (MK) or the sixth son (MJ) was not that appealing a prospect in early 2000 from the founder’s perspective. However, 10 years have now elapsed; Hyundai Group has seen little growth in its core business (shipping and securities) and business with North Korea is poor; compare this with the growth of Hyundai Motor Group and HHI Group over the same period.
Thus, the two sons running HMC and HHI are perhaps now better positioned for taking on the original mantle of the old Hyundai Group? The rebellion by the fifth son will have finally failed if new Hyundai Group and his widow fail to get the control over HE&C – at least for now.
Chungs chasing their tales!
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