Friday, December 01, 2006

Problems for foreign investors in South Korea

Public Scorn For Private Equity

Spurred by the outcry over huge profits, prosecuters are going after foreign firms Lone Star Funds of Dallas is one of the savviest global investors around. Its managers have put more than $13 billion to work in buyouts and other deals around the globe. A big coup: bagging 51% of Korea Exchange Bank, one of South Korea's largest financial institutions, in 2003 for the low price of $1.5 billion. After cleaning out the bad debt and sprucing up customer service, Lone Star and its local partners were ready this year to sell out to Kookmin Bank (KB ) of Korea for an estimated profit of almost $5 billion.

Lone Star, however, did not count on rising Korean wrath over the huge returns foreign private-equity firms have scored by buying and selling local assets. And Lone Star certainly did not count on aggressive prosecutors in Seoul delving into the Korea Exchange Bank deal for possible criminal wrongdoing. On Nov. 20 prosecutors indicted the Belgian company Lone Star set up to take over the Korean bank. The charge: stock price manipulation. On Nov. 16 a Seoul court even issued warrants for the arrest of Lone Star co-founder Ellis Short and Lone Star's general counsel.

The indictment caps almost a year of street protests, court maneuverings, and blistering newspaper editorials, all on the subject of Lone Star. The Texas firm declined to comment to BusinessWeek, but on Nov. 13, Chairman John Grayken accused the Korean prosecutors of making "slanderous claims against Lone Star and its employees." The ferocity of the Korean investigation has alarmed observers. "I'm worried about this pseudo-nationalist fervor being whipped up," says Kim Sang Jo, a leading shareholder activist. "This could discourage foreign investment." One local private-equity fund manager says he already knows of foreign investors who are steering clear of Korea. Foreign players now have big exposure in Korea. Non-Koreans own some 40% of all shares traded on the Seoul bourse, while foreign direct investment has totaled some $90.8 billion since the Asian crisis in 1997.

Although the Lone Star case has the highest profile, other investment funds have come under intense scrutiny. In April prosecutors charged the local head of U.S.-based Warburg Pincus with insider trading in connection with the 2003 purchase of troubled LG Card Co.: He is still on trial. Another U.S. fund, Newbridge Capital, was investigated last year by the tax office for allegedly making a $1.2 billion tax-free profit from the sale of its interest in Korea First Bank. The tax office has declined comment on the probe's status.

Korean prosecutors accuse Lone Star executives of manipulating the stock price of Korea Exchange Bank's credit-card unit, which once traded separately from the bank. The prosecutors allege that after Lone Star purposely depressed the shares of the credit-card business, it scooped up the subsidiary for a bargain price. A separate investigation is under way into allegations that Lone Star executives bribed regulators into letting the U.S. firm inflate the value of bad loans on Korea Exchange's books. That way, say prosecutors, Lone Star got to pay even less for the bank.


Koreans also think the huge tax-free profits earned by foreign funds in their country are a scandal. Tax authorities have argued that many private-equity funds sheltered their Korean profits from taxes by setting up companies in tax havens to control their Korean assets.Beneath the legal wrangling is a dramatic change in Korean psychology. In 2003, Lone Star was hailed as a savior, the brave outsider willing to invest in financially troubled Korean companies. Now it's depicted as a demon bent on making a quick buck and trampling corporate ethics underfoot. As one local paper, The Herald Business put it, no other tax evader was more "habitual and wicked" than Lone Star. Whatever the validity of the prosecution's case, Korea risks reverting to an earlier suspicion of foreigners that sharply limited outside investment.