South Korean takeovers
Dead deals walking
Feb 7th 2002
>From The Economist print edition
South Korea has plenty of big companies that interest foreign investors. Why are they so difficult to buy?
MICRON, an American semiconductor maker, is a relative greenhorn in South Korea. Two months ago, it started negotiating to buy Hynix, a struggling South Korean rival. Since then, it has already walked away and come back again once. This week it was facing a rival bid from Germany's Infineon, also something of a newcomer. To get an idea of what they are in for, both suitors might ask how other foreigners have fared in Seoul. The answer is: not well at all. In January, after 18 months of negotiations, AIG, an American insurance giant and veteran investor in Asia, pulled out of a consortium bidding for the securities arm of Hyundai, formerly South Korea's biggest and proudest conglomerate (of which Hynix was a part until recently). General Motors has been in talks to buy Daewoo Motor, a bankrupt car maker, since September 2000, when Ford, which had been negotiating for six months, gave up. South Korea's government recently set a deadline (the umpteenth) to sell Daewoo by March. This week GM submitted a revised bid, though there is still much talking to do. HSBC and Deutsche Bank, two global banking groups, retreated after failing, successively, to reach a deal with Seoul Bank, which has been on the block for three years. Newbridge Capital, an American investment firm, stands out as a rare success. It took over Korea First Bank in 2000, after haggling for a mere 15 months. Why is doing deals in South Korea such a nightmare? There are many reasons, most of them to do with South Korea's past. Once known as the "hermit kingdom", the country began engaging with the world economy only a few decades ago-by exporting to it. It was only with the Asian financial crisis of 1997-98 that the country's bankrupt conglomerates, or chaebol, found themselves in need of foreign capital. Both for the South Korean sellers and the foreign bidders, the resulting contact proved a new-and very awkward-experience. The trouble often starts with simple technical issues. In their heyday, the chaebol expanded into industries whose vital technologies were often owned by western or Japanese companies. This forced the South Koreans to license the technology; such deals usually bar any transfer to another company if the licensee is taken over. According to Stephen Schiller, an investment banker at Salomon Smith Barney, the problem of "borrowed technology" has spoiled many deals. Another difficulty is a legacy of the chaebol structure itself. Even after a conglomerate is broken up, links between its members remain. One part of a former chaebol often derives virtually all its sales from another part. To investors, this presents enormous risk. So do the country's labour unions, which are belligerent and can block restructuring plans. Then there is debt. Many companies for sale are insolvent. More troubling, however, are their unknown debts, which often surface late in the due-diligence process and have been a problem in almost all negotiations. Hoping to protect themselves, foreign investors usually bid for specific assets (such as a factory), as opposed to whole companies, but this rarely works. The key sticking-points in the talks for Korea First and Seoul Bank concerned loans that might yet go bad. Lack of good information aggravates the problem. The Enron scandal is a reminder that creative accounting is not solely an Asian speciality. Even so, the scale of number-juggling in South Korea is breathtaking. "All the people we started working with are now in jail," says one long-time adviser to Daewoo, whose former chairman is hiding in exile. The sloppiness also extends to internal management accounts. Several foreign investors have discovered that their target companies never acquired the information-technology systems to collect details about cost structures and margins by product line.
Playing by different rules All this may be off-putting. But risk can still be factored into valuation or the rest of a deal's terms. Why is this not happening? The biggest problem lies in the negotiating process itself. South Korea's negotiators are often new to mergers. Instead of looking for win-win propositions, say their western counterparts, they approach all talks as a zero-sum game. Any agreement, by this logic, means that they have conceded too much. One western negotiator remembers several instances when he struck a deal during the day, only to receive a phone call from the sellers in the evening asking for a higher price. Korean culture does not help. Based on concepts such as "face" and "shame", it offers no rewards for risky decisions that turn out well, but punishes-with jail, in some instances-those that turn out badly. The incentives for negotiators are thus stacked against completing a deal. One who has experienced this personally is Hogen Oh, who chaired Daewoo's restructuring committee. Seen by foreign investors as one of South Korea's bravest and best negotiators, Mr Oh was mauled in the local press last year for being easy on foreigners. "Afterwards, they can always say that you could have done better, and there is no defence," says Mr Oh, who has since resigned and moved to Singapore. Xenophobia plays a part too. South Koreans consider it a scandal that the head of one bank drives a Mercedes, not a domestic car. When Newbridge took control of Korea First Bank and installed a Japanese-American as chief executive, the staff threatened to resign en masse (though they subsequently accepted him). Many South Koreans distrust foreign investors instinctively and feel that the financial meltdown of 1998 shamed their country and made it vulnerable to a modern form of colonial exploitation. This leads to paranoia and posturing by Korean negotiators. They feed leaks to the local press to gain stature-often, in doing so, breaking confidentiality agreements-but fear being criticised for selling the country cheaply. To prove "toughness", they frequently storm out of meetings. "We tell our foreign clients to be prepared that the Koreans will walk at least five times, and that they should walk a few times too," says one investment banker. Another way to complete a deal is to go an extra mile to build trust. Newbridge was close to giving up in its talks to buy Korea First Bank when its negotiators offered one last concession. They promised the Koreans that, even after signing the contract, they could subsequently change items if they could show that these were unfair or illogical. That gesture created enough trust for the deal to go through.
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