Saturday, February 25, 2012

Corporate governance explains South Korea’s low stockmarket ratings

IT IS sometimes asserted that low South Korean equity valuations stem from the threat of instability in North Korea. That explanation looked a lot less convincing after the death of Kim Jong Il in December, when the KOSPI 200 index of leading shares and the won, the South Korean currency, both quickly shrugged off the news.

So what is the source of the “Korea discount”, which means that the KOSPI has a forward price-to-earnings ratio of under ten, below most other Asian stockmarkets (see chart)? There are a few possibilities. The national economic model is still built on exports, often in highly cyclical industries such as shipbuilding. The capital structure of South Korean firms has historically been debt-heavy.

But the prime cause of the discount is more likely to be poor corporate governance at the family-run chaebol conglomerates that dominate the economy. Nefarious schemes to pass on control to sons, avoid taxes and exploit company assets for the benefit of family members are widely discussed in private. They are also lambasted abroad: a 2010 survey by CLSA, a broker, placed the country third-from-bottom in Asia on governance, ahead of only Indonesia and the Philippines.

The issue is now also getting more of an airing at home. A recent report by Tongyang Securities, a broker, drew an explicit link between Korea’s low equity valuations and the practices of “tunnelling” and “propping”, which benefit insiders at the expense of smaller investors.

Tunnelling is the awarding of contracts to firms owned by family members. Chaebol heads typically own only a small portion of their firms, but are able to maintain control through complex cross-holdings; tunnelling offers a means of exploiting that control to get richer, quicker. In 2007, for instance, the Fair Trade Commission, an official watchdog, fined Hyundai Motor for, among other things, giving 1.3 trillion won ($1.4 billion) of business to Glovis, a firm owned by the son of Hyundai’s chairman—without any tendering.

Propping is similar to tunnelling, and means that unviable units get financial support from sister companies. But it is no less damaging to small investors. If company insiders are able to misuse shareholders’ funds at will, would-be investors will reduce their expectations of future cash flows and thus attach lower valuations to stocks.

Other allegations are even more serious. On February 3rd Hanwha Group announced in a regulatory filing that its chairman, Kim Seung-yeon, was among several officials being investigated for alleged embezzlement. Chey Tae-won, the chairman of SK Group, was indicted in January over the disappearance of 99 billion won from company coffers, as part of a scheme allegedly planned by his brother to cover futures-trading losses. Mr Chey denies the charges. The Federation of Korean Industries, a chaebol pressure group, has urged prosecutors to go easy on Mr Chey. They say that punishing him would harm “entrepreneurial spirit”.

Mr Chey has had previous scrapes, having been convicted of a billion-dollar accounting fraud in 2003. He eventually received a full pardon from the president and was also chosen to represent the nation during the 2010 G20 summit, leading a meeting of international chief executives. Lee Kun-hee, the chairman of Samsung, received a similar pardon in 2009, having been found guilty of tax evasion, and was picked to front South Korea’s bid for the 2018 Winter Olympics. Yujeon mujwai, mujeon yujwai—an old expression meaning “money = innocence, no money = guilt”—is enjoying a resurgence in popularity.

The irony is that the largest chaebol are models of efficient production and are enjoying a golden period. Their success, say proponents, vindicates the family-run approach to business. Their ownership structure means they have no need to appease short-termist investors or to meet quarterly earnings targets; instead, they can invest for the long run. Smaller shareholders have reason to feel less thrilled. ◦

Mobile phones in North Korea

Some North Koreans get better connected

A NORTH KOREAN professor apparently posted footage on YouTube last year boasting that his country was developing applications for the Android mobile-phone operating system. Ordinary North Koreans are more likely to be pining for a humble mobile phone of any sort, and now their chances of owning one are increasing. Smuggled mobiles have been used on Chinese networks near the border for years, but now business is booming for Koryolink, the North’s only official cellular network, based in the capital, Pyongyang.

The service—75%-owned by Orascom, an Egyptian firm, and 25%-owned by the North Korean state—has gone from 300,000 to 1m subscribers in 18 months. For a hermit kingdom whose rulers resent their subjects keeping closely in touch with each other, this is a remarkable development.

Koryolink earns a gross margin of 80%, making North Korea by far the most profitable market in which Orascom operates. The company has worked hard to court the regime, its chairman travelling to Pyongyang last year to meet the late supreme leader, Kim Jong Il.

North Korean mobile-phone users spend an average of $13.90 a month on calls and text messages, and they tend to pay in hard currency. According to a foreign diplomat, many customers turn up at Koryolink shops with bundles of euro notes. There are even incentives for paying in euros, such as free off-peak calls. This provides foreign currency for a government that craves it.

Mobile-phone customers obtain the hard currency from the informal private trading on which many North Koreans depend. Such business is forbidden, but the government has failed to feed its people, forcing it to turn a blind eye to some capitalist practices. Many insiders benefit: Pyongyang’s “golden couples” consist of a government-official husband and an entrepreneur wife.

Mobile usage now appears to be spreading beyond Pyongyang. The gadgets are a common sight in other cities such as Nampo, not far from the capital, and increasingly are owned by non-officials. As yet, though, only a sixth of the country has a mobile signal.

The authorities are not naive. Some outside observers believe that North Korea’s first experiment with mobile telephony came to a sudden end in 2004 because a mobile phone was used to detonate a huge bomb at a train station that nearly killed Kim Jong Il.

Koryolink is a walled garden: users are not able to make or receive international calls, and there is no internet access. It would be hard to imagine that calls and text messages are not monitored. As in China, the network is even becoming a means by which the state disseminates propaganda. Rodong Shinmun, the government mouthpiece, sends out text messages that relay the latest news to phone subscribers.

Orascom’s slogan is “Giving the world a voice”. For Koryolink’s users, that may literally be true, as North Korean mobile-phone users enjoy some of the benefits of modernity that other countries take for granted. Their phones are not yet the tools of revolution, but mark an amazing change for all that. ◦

Let them eat cake: A half-baked effort to curb the conglomerates

SOME parents give their children cakes. A few give them cake shops. The hot topic in South Korea is the trend for daughters and grand-daughters of chaebol families to open bakeries and other small food outlets. The chaebol are the conglomerates that dominate the Korean economy, so these plutocratic pâtissières have deeper pockets than any of the little bakers they compete against.

Their baking has provoked outrage. Lee Myung-bak, South Korea’s president, calls it a “hobby” business for rich girls that threatens the livelihood of poor shopkeepers. Lee Ju-young, a member of the national assembly, likens it to Park Ji-sung (Manchester United’s Korean midfielder) lording it over amateurs in a backstreet game of football. A restaurateur in Seoul puts it more plaintively: “These families already control everything else in Korea. Why can’t they leave something for the rest of us?”

The chaebol families have decided that this is not a battle worth picking. Scions of the Samsung, LG and Hyundai dynasties are all hanging up their aprons. Artisée, a chain of swanky pastry shops run by Lee Boo-jin, whose dad is the chairman of Samsung, is to close. So is the Hyundai-affiliated Ozen.

Whether this will help small bakers much is open to question. Artisée has only 27 shops; Ozen a mere two. Both are cupcakes in comparison to SPC Group, which operates more than 3,000 Paris Baguette shops in Korea. Buns have always been SPC’s bread and butter—and its boss is not an heiress.

Some say all this pie-throwing distracts attention from the real problems that overmighty chaebol cause. Entrepreneurs complain that if they have a good idea, the chaebol show up with their chequebooks and poach their staff. Small firms that supply chaebol complain that they are ruthlessly squeezed, though few dare say so publicly.

Consumers also suffer. Korea’s Fair Trade Commission (FTC) detected over 3,500 cases of price-fixing in 2010, but only 66 led to fines. The average penalty amounted to just 2.3% of unfairly earned revenue. Samsung and LG were fined in January for fixing the prices of notebook PCs and flat-screen televisions between June 2008 and September 2009. Samsung was ordered to pay a fine of 25.8 billion won ($23m); LG, 18.8 billion won. LG’s fine is to be waived, in return for co-operation with the FTC. This is the third time the two firms have been caught price-fixing in the past two years.

Politicians follow the same old recipes when dealing with the chaebol. They lean on banks to lend cash to small firms. And they lean on the chaebol to stay out of a few minor businesses, such as baking or tofu-making. However you sugarcoat it, this is not serious reform. ◦