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PE-backed privatisations: Will Korea’s reform agenda deliver Japan-style deal flow?

  • Korea may see more take-privates, but not necessarily for the same reasons as Japan
  • Inheritance tax, which forces families to divest assets, is the biggest deal driver for PE
  • Value-Up reforms could contribute to more fundamental change in corporate Korea

The Tokyo Stock Exchange’s (TSE) drive to clean up the markets and usher out underperforming players has prompted a surge in take-private activity as PE investors help companies move out of the public spotlight. With divestments of non-core assets ongoing, as corporates are encouraged to pursue efficiency rather than scale, buyout managers claim their Japan pipelines have never been so full.

Is South Korea poised to replicate elements of its neighbour’s reform agenda? The Corporate Value-Up Program, unveiled in February, covers similar territory to the TSE, asking companies to draw up value creation plans. Its immediate goal is to eliminate the “Korea discount” phenomenon whereby listed companies trade below global peers, but some GPs spy a second-order investment opportunity.

John Kim, a managing director and head of Korea at The Carlyle Group, believes inheritance tax – 50%, or 60% for controlling stakes in listed companies – will remain the biggest enabler of buyouts. Second and third-generation members of family-owned business groups recognise they cannot hope to maintain control, so they are more inclined to sell assets. Value-Up could help smooth the path to exit.

“In the past, when you talked to companies about take-privates, they would ask what public sentiment would be like and what the government might think. A big positive of Value-Up is it takes that concern off the table. I think the trend in Japan will come to Korea. We’ve seen take-privates by some smaller founder-owned companies. Once a larger group does one, many more will likely pile in,” said Kim.

Value-Up is also regarded as tacit government endorsement of shareholder activism where it benefits minority investors. Earlier opportunistic campaigns by foreign activists seemingly less interested in driving improvement are not the model. Kim envisages something “more like Japan – where it is not so much event-driven as it is activists going after companies that aren’t doing things to help shareholders.”

While the inheritance tax effect is universally acknowledged, not everyone is so bullish about Value-Up. Assessments of the likely impact of the programme on private equity deal flow range from tentative optimism – “It could, in theory, contribute” – to resolutely non-committal – “we don’t yet know enough about these measures or how they will be implemented” – to outright scepticism.

“With anything initiated by the Korean government, the success rate is very low,” said Steve Lim, chairman and managing partner of SJL Partners and formerly head of Korea at CVC Capital Partners. “Initiatives start under political agendas and then the agendas get dropped. In Japan, the TSE chairman is market-driven and commercially oriented in trying to push for global practices in governance.”

From policy to action

The TSE guidelines specifically target companies trading below book value, instructing them to publish plans to improve performance or consider whether they should remain listed. Approximately half of the companies on the Prime Market and 60% of those on the Standard Market – nearly 1,800 in total – fell below the 1.0 price-to-book ratio threshold when the guidelines were issued in March 2023.

AVCJ Research has records of 34 PE-backed take-private transactions in Japan since the start of 2022, the year TSE launched its clean-up efforts by reorganising the market segments and introducing more stringent qualification criteria for each one. That compares to 39 deals between 2014 and 2021.

More are likely to come. Eiji Yatagawa, a partner and head of Japan private equity at KKR, told AVCJ last month that the firm’s pipeline, once 100% corporate carve-out, now includes an assortment of public-to-private deals. He observed that these transactions “take time, maybe six months or more,” with the added impact of new M&A guidelines only starting to filter through towards the end of last year.

Korea Exchange hosts fewer companies than the Tokyo Stock Exchange – 2,702 vs 3,946 – but Jason Thomas, Carlyle’s head of global research and investment strategy, described the valuation problem as worse: almost two-thirds of KOSPI constituents trade below book value.

In terms of take-privates, however, Korea is starting from a much lower base. AVCJ Research has no records of any PE-backed transactions involving locally listed companies for 2014 through 2022. The common observation among industry participants is that these deals are incredibly hard to pull off. Structural and cultural reasons are largely to blame.

Orchestra Private Equity invests in Korea and Japan, currently on a deal-by-deal basis. In 2017, the firm acquired a 32% interest in JASDAQ-listed golf equipment manufacturer Majesty Golf. Three years later, it took full ownership on completing two successful tender offers.

“We got to 51% and then 82%. I thought we would need to do one more tender, but we went straight to squeeze-out. In Korea, if there were a similar situation, we would need to get to 95%,” said Jay Kim, a partner at Orchestra. “We are contemplating a couple of targets in Korea, but it’s tough there. Given the choice, we would prefer to do more public-to-private deals in Japan.”

Several other private equity firms claim to have avoided take-privates for similar reasons, citing restrictive mandatory tender offer rules and the 95% post-tender offer squeeze-out threshold – seen by many as nearly impossible to achieve. Some GPs have previously acquired controlling stakes in listed companies and decided against pushing for full ownership.

“There have been instances where we did and instances where we did not. It depends on the chances of a take private,” said one manager. “If shares trade thinly, it might take 10 years to get there. Or if you can get control with 60% of an attractive company and you don’t need the other 40%, that’s not bad from a capital deployment perspective. And those interests are sold as blocks for a control premium.”

Nevertheless, Korea has seen five PE-backed tender offers, involving four companies, since the start of 2023. Osstem Implant leads the way, with MBK Partners and UCK Partners using two tenders to complete a KRW 3.64trn (USD 2.6bn) deal. MBK followed up with Connectwave, while Hahn & Company moved for Lutronic and Ssangyong C&EAffinity Equity Partners is looking to do the same with Lock & Lock.

Several reforms have helped, notably a cash for share swap mechanism introduced a few years ago. Once the largest shareholder secures a more than two-thirds stake – achieved by a private equity investor working in tandem with an existing shareholder, typically a founder-owner – it can push for full ownership and a delisting through a share swap instead of making a tender offer to all shareholders.

Moreover, a bill was put before parliament in June proposing that any shareholder surpassing 25% ownership must submit a tender offer for at least 50% plus one share. The objective is to protect the interests of minority shareholders – they can sell alongside a controlling shareholder at the same price rather than get left out of deals – but it also potentially facilitates PE-backed take-privates.

“We’ve never done a take-private, historically it’s been a cumbersome and treacherous process. But with the rule changes we think there will be more interest from buyout players in exploring the take-private options,” said Jason Shin, a senior partner at VIG Partners.

Kim of Orchestra is still circumspect, suggesting that he wouldn’t be interested in situations where the founder-owner holds less than a one-third stake. There is also the matter of pricing, with Kim of Carlyle suggesting that a premium of at least 20% is probably necessary to appease shareholders and regulators. “A lowball take-private would probably run into difficulties,” he added.

Governance gambit

It remains to be seen whether Value-Up indirectly contributes to this activity. Early guidance from the Financial Services Commission (FSC) comprised three pillars: Companies will receive assistance in devising and communicating value creation plans; indices and exchange-traded funds will be introduced to track performance; and a support system will be established to aid disclosure and monitoring.

Since then, a trickle of additional details has been released, some of them regarding the incentives – including tax breaks – for those participating in what remains a voluntary programme.

In a paper published last month, the Asian Corporate Governance Association (AGCA) struck a cautious tone. While noting that Value-Up could help address the Korea discount, it stressed that the country needs a multi-year roadmap for corporate governance reform that coherently sets strategy. “A mishmash of piecemeal policy measures and the Value-Up Program is not enough,” AGCA said.

However, Korea did advance in the organisation’s rankings for the first time in a decade, claiming eighth place. This was largely due to rising shareholder activism and regulatory responsiveness to longstanding corporate governance issues. Increased retail investor participation in the market is seen as having helped elevate governance on the political agenda, as demonstrated in the recent legislative election.

The activist trend is widely observed. Wellington Management flagged an increase in shareholder proposals from 10 in 2020 to a record 77 last year, while law firm Kim & Chang suggested in a note that Value-Up may encourage activists to “express their opinions on companies’ measures to tackle undervaluation and increase advisory shareholder proposals related to shareholder return policy and re-capitalisation.”

There remains some scepticism as to how far it can go. According to a second private equity manager, the government wouldn’t countenance a large-scale attack on a chaebol group. The manager pointed to MBK’s unsuccessful hostile takeover bid for Hankook & Company last year, observing that it “prompted officials to consider poison pills and added protection for family-owned conglomerates.”

Yet there is a sense that Korea’s corporate hierarchy is being eroded at the edges – and this is where activism, inheritance tax, and private equity buyouts potentially collide.

MBK took aim at Hankook by siding with the chairman’s eldest son who had been passed over in favour of his younger brother. As assets are handed down to the next generation, disputes have broken out within several family groups about who should get what or how they should settle inheritance tax bills. Food ingredients supplier Ourhome and Hanmi Pharmaceutical are frequently cited examples.

Inheritance tax features in corporate governance discourse are perceived as a cause of the Korean discount. AGCA makes the case that it dislocates the interests of majority and minority shareholders because the former is not incentivised to boost returns when low market value is the optimal tax outcome. AGCA would like to see an inheritance tax cut and the separation of dividends from income for tax purposes.

Others, however, regard inheritance tax as a powerful change agent. “As long as the larger publicly listed companies are in the hands of chaebol groups controlled by families, you will not have the level of transparent corporate governance you see in the US and Western Europe” said Shin of VIG. “We need these groups to break up and inheritance tax is the only factor pushing some families to act.”

Divestment dynamics

When asked whether the second part of Japan’s reforms – divestments of non-core assets by bloated conglomerates – could also be replicated in Korea, several investors highlighted different ownership dynamics. Japanese conglomerates must satisfy multiple stakeholders, but they are ultimately controlled by corporate boards, whereas in Korea boards answer to family groups.

Inheritance tax that, in the space of two generations, might reduce a 100% interest in a listed company to 16% could help redress the balance. The focus on maintaining family control, often through convoluted cross-shareholding arrangements, has ended, according to Kim of Carlyle.

“Those discussions don’t really happen anymore. For any second or third-generation family owner, their ability and legitimacy in maintaining leadership is increasingly based on how well they can perform. If non-core businesses are dragging the share price down, people will ask questions,” he said.

Connections are readily drawn between this and the steady rise in Korean buyouts, with AVCJ Research recording an average of 62 per year between 2019 and 2023 compared to 48 for the five years before that. Kim of Orchestra added that he would look at 10 carve-out opportunities per year before COVID-19; it has since risen to 15-17 per year.

But the emphasis on performance – for the hypothetical family member who wants to keep activist shareholders at bay and retain the top job – isn’t just about casting off laggard subsidiaries or alleviating balance sheet weaknesses. Chaebol groups must respond to competitive pressures globally and reposition portfolios to take advantage of technology. Selling the old often pays for the new.

SK Group is arguably the best example, having made an aggressive push into electric vehicle batteries. Hahn & Company alone has bought six businesses from the conglomerate in the space of six years. Carve-out specialist Glenwood Private Equity claims its deal pipeline is full of similar cases.

“Chaebols have added more core businesses on top of their traditional core businesses, and the new additions require a lot more capital a lot sooner than they expected,” said Michael Chung, co-founder and CIO at Glenwood. “If EV batteries is the new core, there are still other businesses that support EV batteries and need capital to grow, and they can’t hold on to everything.”

Lim of JSL has observed the same trends. His firm pursues cross-regional buyouts, targeting assets in Europe and North America that have some relevance to Korea. Chaebol groups are typically brought in as strategic partners, and interest tends to track portfolio rebalancing.

When parallels are drawn between the TSE reforms and Value-Up, private equity is not the starting point. The Nikkei 225 Index hitting a record high on the back of a 60% gain since the start of 2023 is invariably referenced. And when the KOSPI recently surpassed 2,800 points for the first time since January 2022, local media linked it to announced incentives for companies participating in Value-Up.

As a third Korea-based PE manager observed, the programme is primarily “a good way to get money into the hands of voters.” But the second-order effects cannot be ignored. Provided it doesn’t fizzle like other policy initiatives, Value-Up might become emblematic of – and could be a contributor to – more fundamental changes that influence the development of corporate Korea.