Still Not the Place to Be

South Korea was once admired as one of Asia’s most dynamic, can’t-miss stock markets, but it is now merely a paper tiger in the eyes of many investors.

In the midst of a steep slowdown in economic growth and sharp deterioration in its trade balance, Korea’s market tumbled more than 40% from its peak three years ago to year-end 1996. This year it has staged a modest rally, but the buying has lacked real conviction.

Korean stocks, like the economy, have been dragged down by a stubborn resistance to free-market reform, especially among the chaebol, the manufacturing giants that dominate the economy--names such as Hyundai, Daewoo, Hanjin, Doosan and LG Group.

After years of being cosseted by protectionist governments, the chaebol labor under excessive debt, a critical dependence on cyclical industries, and in a business culture that values size above profit.

“They never run out of ambitious expansion plans,” said Shahreza Yusof, who manages Asian portfolios for Abtrust Fund Managers in Singapore. “The chaebol are in all sorts of businesses. The main complaint we would have with Korea is that companies expand without fully considering profitability; they focus on sales and market share. When they make money, shareholders never see a cent of it.”

Consider giant Samsung Corp. Its Samsung Electronics subsidiary is one of the best semiconductor companies in the world, Yusof said. But many other Samsung units are mediocre, so the return to holding-company investors from the semiconductor unit is diluted.

What’s more, even though Samsung Electronics is a separately listed minority stock, its profits “are used to subsidize bad businesses [of the holding company], not shareholders in Samsung Electronics. They have a very cavalier attitude to minority shareholders; that’s the main bugbear with Korea,” Yusof said.

Worse, Samsung Corp. soon will have a new subsidiary to digest: It recently agreed to acquire AST Research Inc. of Irvine, the money-losing personal computer maker.

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It would seem that the last thing Korean companies would want is another troubled business. Weaker exports from many of the cyclical businesses that the chaebol favor--semiconductors, cars, ships, chemicals and steel--are expected to slow real economic growth to 5.8% this year, compared with 6.9% last year and 9% in 1995, according to a consensus of major banks.

In such industries anywhere, when things go bad, they go very bad. In Korea, the situation has been worsened by the extraordinary debt many companies carry, a remnant of the days of guaranteed cheap credit.

“As a result of government policy to support big business, the ministries of finance and industry had a concerted effort to divert the savings of the people to government-run banks and then to the chaebol,” explained Mark Mobius, global fund manager at Templeton Investment Management. “That helped them to spend on capital equipment and expand in a big way.

“Now they have to pay the price. Some companies have three to seven times [as much debt as equity]. It’s amazing. It’s great while the party lasts, but now we’re in a global marketplace. When you liberalize an economy, it’s difficult to keep that under control.”

Indeed, the Bank of Korea recently reported that corporate insolvencies are at a record high. Korea’s trade commission said that 13 of the 30 largest chaebol companies lost money in 1996.

The government has belatedly begun a series of reforms. The stock market received a modest lift in March when authorities nudged the maximum allowed foreign ownership of corporate equity to 23% from 20%, hoping to attract new investment.

The government also has been trying to dismantle the system of easy corporate credit, to make the labor market more flexible and to limit the scope of activities the once-favored chaebol can enter.

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But as a report by the Asian Development Bank primly points out: “Although various measures have already been implemented, additional steps are required to achieve full financial and trade liberalization.”

That’s easier said than done in a country with a long history of coziness between state and industry--one that has led to numerous scandals that have rocked the government and markets in recent years.

Earlier this year, after Hanbo Steel & General Construction Co. collapsed under the weight of nearly $6 billion in debt, the company’s founder was charged with siphoning millions of dollars in loan money to buy assistance from politicians and bankers in securing yet more loans for the doomed firm.

He and an assortment of colleagues and politicians are on trial.

“The government is in a dilemma,” observed Ken Lee, analyst in Seoul at investment bank ING Barings. “One day they announce an anticonglomerate policy, then the next day they invite leaders of the chaebol to lunch and say, ‘Look, guys, don’t worry.’ ”

With hopes dim for true reform--and with the constant threat of conflict between South Korea and bankrupt but militarily powerful North Korea--many global investors continue to avoid Korean stocks, despite their depressed levels.

Templeton’s Mobius has only 2% of the company’s emerging-market assets in Korean shares, about half the expected amount based on the market’s size.

Foreign & Colonial Emerging Markets, a large London-based management company, has just 0.5% of its portfolio in Korea.

“Everyone’s in such a negative mind-set,” said Simon Nicholson, head of Far East investing for London-based fund manager Gartmore. “They can’t even conceive of looking for a potential silver lining.”

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Of course, that is often the time to buy into a market. Even Yusof of Abtrust shows a grudging respect for Korean industry’s long-term potential.

“Korean companies are coming to the world stage,” he said.

Yusof owns shares of Korea Electric Power, Pohang Iron & Steel, Korean Long-Term Credit Bank and Samsung Electronics.

For American investors interested in Korean securities, there are a few easy options. Korea Electric Power, Pohang Iron and Steel and SK Telecomm all have shares that trade on the New York Stock Exchange.

There also are several closed-end mutual funds that own Korean stocks exclusively, including Korea Fund and Korea Equity Fund. The funds also trade on the NYSE.

As depressed as Korean shares appear, analysts warn that there’s no assurance that prices won’t get significantly more depressed, if corporate profitability doesn’t improve soon and structural reform of the economy doesn’t take root.

“A little capitalism would help Korea out of its current jam, but don’t hold your breath,” said Jeff Uscher, editor of Grant’s Asia Observer newsletter. “There are far too many vested interests to make that transition an easy one.”