S. Korea’s Recovery Exposes Vulnerable Spot

A year after the launch of South Korea’s corporate reform program and even as the nation strides impressively toward recovery, its major conglomerates continue to resist change, according to political and economic analysts.

Indeed, as the power of these so-called chaebol is increasingly threatened, several display amazing flexibility and creativity in side-stepping government pressure, despite their reputation as huge, clumsy dinosaurs.

“They take advantage of every opportunity,” says Cho Dong-Sung, chaebol expert and director of international studies at Seoul National University. “They’re like acrobats.”

These corporate acrobats complain that they can’t be expected to turn themselves around overnight, especially when the government--acting to protect union jobs--restricts their ability to lay people off.

And now there is growing concern that South Korea’s economic recovery will take the heat off the chaebol, leaving them to pursue their old ways.

Meanwhile, grand consolidating plans of the chaebol continue to falter. Last week, two proposed inter-chaebol mega-mergers--the auto and electronic units of Samsung and Daewoo--were abandoned after protracted resistance from the conglomerates.

But the latest high-wire confrontation between the nation’s top five chaebol--Hyundai, Samsung, Daewoo, LG and SK--and the reformist government of President Kim Dae Jung has opened in a somewhat unlikely place: the balance sheet.

Although it’s difficult to imagine anything more dull, these pointy-pencil duels carry enormous stakes. Any major misstep in the government’s bid to restructure the huge family-run groups could derail the nascent recovery and leave Asia’s second-largest economy crippled anew as it enters the 21st century.

Much of the chaebol’s energy seems directed at salvaging a hallmark of their traditional power: the practice of protecting their weak subsidiaries, even when economic logic dictates they should close down.

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The government recently sued the top five chaebol, seeking to eliminate the cross-subsidies they use to help prop up troubled operations. The top five chaebol’s response? They countersued.

South Korea’s top 300 chaebol whitewashed their 1998 balance-sheet losses to the tune of about 30% by using in-house subsidies and other accounting sleight-of-hand, according to a report by Shinhan Securities.

Top chaebol also are accused of devising new ways to bolster those weak units using South Korea’s sharply rising stock market.

In one case, Hyundai Investment Trust allegedly used $1.1 billion in private investors’ funds to finance a weak Hyundai subsidiary in violation of South Korean securities laws. In another, Hyundai and Samsung employed $1.28 billion in incorrectly priced corporate bonds to help their respective weak sister companies. The government is investigating these and other cases. Chaebol executives, meanwhile, deny any wrongdoing.

Over the last several months, Kim’s government has earned high marks for hammering on the chaebol to reduce debt, focus far-flung operations and concentrate on profit, not just market share.

“Restructuring is not going to be delayed or slowed down,” Kim vowed at a recent meeting with foreign correspondents at the Blue House, South Korea’s White House. “Creditor banks have the right to recall loans to debtors, and they will do what they have to.”

Seoul has even had some success. New legislation, regulations and reform-minded agencies are in place, and the chaebol’s access to cheap capital has been contained. A few parts of their empires have been combined and some debt levels reduced.

But the government still is in a tough position against a worthy adversary, analysts say. Recent improvements in South Korea’s economy blunt popular support for painful restructuring even as the chaebol employ a strategy of attrition.

“Most newly elected heads of government try to push through a lot of reforms the first year, but then the drive weakens,” said Kim Joongi, an assistant law professor at Yonsei University who is on a citizens committee monitoring the conglomerates. “The chaebol are waiting for that.”

Furthermore, corporate restructuring--with its focus on employees, factories and business strategies--can take years to yield results, unlike the quick turnaround seen in South Korea’s stock market, foreign exchange reserves and other strictly financial indicators. That point is sometimes lost on today’s impatient investors.

“It’s taken Korea’s chaebol 40 years to get into this mess,” said Han Il Suk, senior analyst with ING Barings. “It’s going to take a few years to work it out.”

Another major battle, meanwhile, rages over chaebol debt. In a bid to make the giants more productive and responsive to shareholders, Seoul wants chaebol to issue a maximum of $2 in debt for every $1 in stock.

At the end of 1998, the top 30 chaebol had nearly twice that level of debt, and second-tier Ssangyong had a whopping $80 in debt for each dollar in stock. Well-run U.S. companies, in comparison, often have less than 50 cents in debt per dollar of stock.

Top chaebol recently were accused of eschewing real reform to meet those government targets and instead revaluing assets, understating debts, issuing huge amounts of new stock in a rising stock market and engaging in general window-dressing. The government refused to allow some of the accounting moves, as the battle continues.

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Another fight involves “big deal” plans under which chaebol are supposed to trade subsidiaries and shed money-losing subsidiaries until each is lean, mean and focused instead of trying to do everything under the Korean sun.

Yet here, too, results are mixed at best. In addition to the collapse of the Daewoo-Samsung talks, promises by Daewoo, Hanwha and Hansol to sell companies and property were quietly dropped. Several petrochemical deals have stalled, and the few successful trades in the semiconductor and aerospace industries are modest at best. Nor, critics say, do government-imposed “big deals” address South Korea’s core problem--overcapacity.

“What is accomplished when Daewoo, already debt-ridden, acquires Ssangyong Motors, or when over-leveraged Hyundai acquires the debts of Kia Motors?” The Los Angeles-based Milken Institute asked in a recent report. The group’s conclusion: not much.

Indeed, the end of the Daewoo-Samsung automotive talks--which will result in the bankruptcy of Samsung Motors--may ultimately help South Korea by removing production capacity from its overbuilt market.

If anything, chaebol still seem fixated on expansion where they can get away with it. All five companies are in a headlong battle over credit card operations even as they eye new opportunities in telecommunications, heavy industry, gas, steel and financial services. LG, for instance, recently waged a struggle to take over Korea Life Insurance before ultimately bowing out.

“That’s not the sort of thing a struggling company should try and take over,” said Damien Wood, research director with Barclays Capital Asia. “They just don’t get it.”

That’s not to say there isn’t progress. A number of chaebol operations show promise and are globally competitive. And though Samsung, LG and SK’s latest restructuring plans don’t go much beyond earlier outlines, Daewoo and Hyundai have both released more significant restructuring plans--but they’ll need to show results to reduce public cynicism.

In their defense, chaebol officials point out that debt-reduction can’t happen overnight, especially given South Korea’s underdeveloped capital markets.

“I’m aware there’s public skepticism about the depth of chaebol restructuring,” said B.D. Sohn, executive deputy chairman of the Federation of Korean Industries, which represents major Korean companies. “[But] in Japan, it took 20 years to reduce the trading company debts from 900%. In Korea it’s been less than a year’s time.”

Chaebol executives also say they’re expected to cut costs but that the government restricts their ability to carry out layoffs. Analysts agree that although South Korea has seen many layoffs, Seoul has tried to shield union jobs.

In an interview, Hyundai Senior Executive Vice President Lee Young Il said his company’s restructuring plan is far more than a series of empty promises. “We’re not doing it merely because the government is pressuring us,” he said. “We fully realize restructuring is essential for survival.”

In practice, though, analysts say chaebol are still reacting far too much to the South Korean government and far too little to global competition, especially given the growing clout of foreign investors in the nation.

“The chaebol think they need more time to change their systems,” Lee Hun-Jai, chairman of the Financial Supervisory Commission, said in an interview. “Even if the government wanted, though, the market may not give them more time.”

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Chi Jung Nam in the Seoul bureau contributed to this report.

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Under Water

The debt of South Korea’s top five conglomerates, or chaebol, as a percentage of stock shares outstanding at year-end:

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Name 1997 1998 1999 target Hyundai 572.3% 449.3% 199.7% Daewoo 473.6 526.6 199.5 Samsung 365.5 275.7 193.5 LG 507.8 341.0 199.8 SK 466.2 354.9 199.7 Average 470.2 386.0 198.3

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Note: Typical U.S. corporate ratio is 50%

Source: South Korean Financial Supervisory Commission

Holding Their Ground

South Korea’s top chaebol have avoided drastic restructurings so far. By and large, rankings by size, number of subsidiaries and value of assets have shown little change:

Ranking

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Name ’98 ’99 Hyundai 1 1 Daewoo 2 3 Samsung 3 2 LG 4 4 SK 5 5

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Subsidiaries

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Name ’98 ’99 Hyundai 62 62 Daewoo 34 37 Samsung 49 61 LG 48 52 SK 41 45

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Assets, U.S. billions

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Name ’98 ’99 Hyundai $77 $63 Daewoo 67 46 Samsung 53 56 LG 43 45 SK 28 25

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Note: Asset values translated at $1 = 1,160 won

Source: South Korean Fair Trade Commission