A recent move to sell a controlling stake in Kumho Industrial has drawn a lot of attention, and not just because the winner gets a controlling stake in Asiana Airlines’ parent firm. What is interesting is that quite a few Korean private equity funds seem to be aggressively pursuing the bid.
The company came under creditors’ control in 2010 when its parent Kumho Group ran into financial trouble after paying some 10 trillion won on acquisitions in 2006 and 2008. Its creditors, led by Korea Development Bank, now want to sell 57.5 percent of the construction firm whose market value is about 515 billion won ($469 million).
According to news reports, private equity firms MBK Partners and IMM and a fund led by securities brokerage IBK Securities Co. have expressed interest in bidding.
This development by itself symbolizes the growth of domestic PEFs in Korea. The market has come a long way since 2004, when domestic private equity business was first introduced.
Over the past decade, the PEF market has experienced rapid growth and transformed from a market dominated by offshore sponsors to one that is highly competitive between both foreign and domestic players.
Offshore PEFs initially dominated Korea following the Asian financial crisis in 1997 as overseas sponsors made significant investments in distressed Korean assets and companies. This was largely due to a limited number of experienced domestic sponsors and the lack of local regulations.
The first such legislation was introduced in 1999 allowing for the management and operation of special-purpose vehicles such as corporate restructuring and asset-backed securities companies. This resulted in domestic fund managers forming “special” funds focused on the financial and operational restructuring of small distressed companies. This was given a further boost with the introduction of the Indirect Investment Asset Management Business Act in 2004, which allowed domestic financial institutions to form Korean PEFs.
In the first year, there were only two funds with aggregate committed capital of 400 billion won. The figure has since grown to 277 funds with committed capital of 51.2 trillion won by end-2014.
Today, the top 10 PEF general partners are: MBK Partners with committed investment of 6.37 trillion won, Korea Development Bank (5.92 trillion won), Mirae Asset Financial Group (2.03 trillion won), Vogo Investment Group (1.78 trillion won), Macquarie Korea Opportunities Management Limited (1.76 trillion won), UAMCO Ltd. (1.66 trillion won), Industrial Bank of Korea (1.41 trillion won), Shinhan Private Equity (1.28 trillion won), KTB Investment & Securities (1.17 trillion won) and IMM Private Equity (1.16 trillion won).
The top five PEF limited partners are the National Pension Service (436 billion won), Korea Post Office (103 billion won), Korea Finance Corporation (70 billion won), Korea Investment Corporation (65 billion won) and Korean Teachers’ Credit Union (23 billion won).
As noted by the Financial Supervisory Service in its recent assessment of the PEF industry, the industry has undergone three distinct stages of development and growth over the past 10 years: the early stage (2004-2007), the pre-growth stage (2008-2011) and the growth stage (2012-present).
After the institutional framework took shape and initial investments were made during the early stage, the PEF industry advanced to the pre-growth stage, during which the number and the size of PEFs and GPs began to grow rapidly. Finally, the growth stage emerged as Korea’s risk-averse pension funds began to lead PEF investment in 2010.
As for the PEF GPs, during the early years, most PEFs were managed by investment firms founded by managers from abroad. With the broader participation of institutional investors, the number of funds grew, and demand for deregulation intensified. Although some GPs lacked the necessary expertise and management experience because of the low entry barrier, others began to build track records during the growth stage, and the more successful GPs are now raising more funds for investment.
If we look at the PEFs’ fund-raising activities, the inflow of new capital last year was 9.8 trillion won, the largest ever for the PEF industry.
Institutional investors, including major pension funds, are anchor investors in Korea’s PEF market, taking up 51 percent of the total committed capital at the end of 2014.
During the early stage, managers from overseas focused on strategic investment, while PEFs managed by financial firms focused on financial investment. In the pre-growth stage, PEFs sought diversification strategies such as supporting growth of small and medium enterprises and creating synergy through joint investments. Finally, during the growth stage, PEFs are emerging as investors play an active role in the acquisition and restructuring of large companies. Over the 2004-2014 period, PEFs invested in 690 companies.
The Finance Ministry is rightly gung-ho about this rapid expansion of the PEF industry, especially since it has been taking measures to ease the regulations. However, it should also bear in mind that this growth is being largely driven by the fact that due to the economic downturn, the conglomerates have been holding back their investments, even as they pile up huge cash reserves, giving the PEFs an opportunity to aggressively pursue buyouts.
Moreover, it is still not clear whether over the past decade the Korean PEFs have had a demonstrable effect on three key components of economic growth ― greater innovation, increased productivity and enhanced competitiveness.
As many economists have noted, a positive outcome of private equity activity derives from the influence that improved management has on promoting greater innovation. Also, to the extent that private equity can increase the productivity of companies with improved management and better resource utilization, it contributes to an increase in business productivity and thus economic growth. Likewise, private equity activity can create employment by promoting new business creation. New employment that is sustainable contributes to economic growth through standard expenditure multiplier effects.
Finally, private equity activity can contribute to economic growth through enhanced competitiveness by making companies they invest in more productive. They can also contribute to economic growth through external trade by supporting export-oriented businesses or supporting the expansion of established local businesses into foreign markets.
In today’s challenging environment for the Korean economy, it is therefore pertinent to investigate the impact that private equity investment has, and could have, on sustainable growth and recovery.
By Ram Garikipati
Ram Garikipati is a business writer at The Korea Herald. He can be reached at ram@heraldcorp.com. ― Ed.
