The market that never closes

2009 may have been characterised by a slowdown in private equity in most parts of Asia, but South Korea seemed to emerge relatively unscathed from the effects of the global financial crisis.

In the process, the country gave the region its largest private equity buyout deal of 2009 when Anheuser-Busch InBev, the world’s largest beer company, agreed to sell South Korea’s Oriental Brewery to Kohlberg Kravis Roberts (KKR) for a consideration of $1.8 billion in May (see page 19 for a special focus on the Oriental Brewery deal).

While this deal grabbed many of the headlines emanating from South Korea in 2009, the country also saw several large growth and expansion capital deals in 2009.

In September, Vogo Fund, a Seoul-headquartered buyout firm, invested W194.4 billion ($171.6 million) to acquire a 30.7 percent stake in BC Card, Korea's biggest credit card company. Two months earlier, Standard Chartered Private Equity invested $40 million for a 40 percent stake in Environmental Facilities Management, a water treatment company.

Jason Shin, managing partner at Seoul-based buyout firm Vogo Capital Advisors, which has fully invested its maiden fund comprising of a W500 billion ($430 million) domestically raised fund and Korea Global, a $120 million fund raised from foreign investors, says as in other Asian markets, the global financial crisis and overall slowdown in the global economy was felt most keenly in Korea’s export industry, while other sectors bore up well.

Peter Ko, senior managing director, H&Q Asia Pacific, currently investing out of its second fund which closed on W372.5 billion in September 2008, says another reason Korea kept up momentum in 2009 was because things were so bad in 2008 that anyone who wanted to either attract capital or divest ownership preferred to wait. As such, in 2009, as the Korean economy began to fare better, activity began to pick up.

Ko adds that the market for expansion capital investments in Korea is an active one. A lot of generational change is happening in mid-cap private companies with second and third generation owners often looking to cash out of businesses. For example, in 2009, H&Q acquired a 100 percent stake in Esquire, a private company owned by a family for the last 50 years, for an undisclosed amount.

Korean financial institutions also have relatively more liquidity than institutions in other countries and retain capital for new investments, says In-Young Lee, president and chief executive officer of Seoul-based Woori Private Equity. This is largely because Korea made the quickest recovery from the subprime crisis among the OECD countries, he says.

As such, he is of the view that while investing conservatively was the main theme in 2008 owing to liquidity pressures, as signs of recovery became more evident, investment demand increased as compared to 2008 and corporates became more eager to raise capital for business expansion.

Korean banks, too, were not as affected by the crisis as their counterparts elsewhere, and remained willing to provide funding for deals. Shin says in the first half of 2009, Korean banks were much more conservative with lending than in the years gone by, while in the second half of 2009, “appetite came back and is now back to pre-crisis levels”.

However, he is quick to point out that even during the bubble years, Korean banks as senior lenders were not very aggressive. They were conservative even then and typically only 50 percent to 60 percent of a transaction would be funded through senior acquisition financing.

Ko points out that the availability of debt varies depending on the origin of the sponsor. “If you are a foreign general partner and you’re bringing in foreign money, you can structure whatever is commercially feasible for banks. In Korea, if you are registered domestically and you have a fund registered in Korea at the acquisition holding level, your debt equity ratio can only be as high as 2:1,” he says.

Exits wide open

Korea’s ability to obtain leverage locally has led to increased exit opportunities as well, according to Charles Huh, director and head of Korea at Standard Chartered Private Equity. Mid-sized companies are being sold at multiples to revenues to strategic buyers and other private equity firms.

“Financial buyers are interested in such deals as they can avail of debt to enhance return and some strategic buyers are interested in such acquisitions because they have healthy balance sheets,” he says.

The return of favourable market conditions to Korea also meant that capital markets and the M&A market stayed fairly active over the course of 2009, resulting in further exit routes for private equity firms.

“The beauty of the Korean market is the availability of exit options,” says Huh. Whilst a majority of exits are made through IPOs, trade sales and strategic sales are also possible in Korea, he says. In his view, this is primarily because of transparency, good governance and the availability of leverage.

Huh expects to see secondary and trade sales as preferred exit options because there are still a few Korean strategic buyers with healthy balance sheets, who instead of building something on their own are open to control transactions and acquiring businesses that are generating cash flows.

One successful example of an exit through a trade sale was Affinity Equity Partners’ agreed sale of its 70.2 percent stake in Korean cosmetics company TheFaceShop to LG Household & Health Care for W278.5 billion. The exit is expected to fetch Affinity a 3.5 times return on its October 2005 investment.

Unitas Capital put portfolio company Buy The Way, a Korean retailer, up for sale in the second half of 2009. By the end of the year, the Hong Kong-headquartered private equity firm had received nine bids for the company, most of which were worth more than W300 billion, a source told PEI Asia. The interested parties were said to include private equity firms as well as strategic buyers from Korea and Japan.

More good news expected

The relative strength of the Korean economy compared to other regional economies is something fund managers investing in Korea are banking on for the coming year. Lee expects active corporate restructuring to take place in 2010 and says M&A transactions that were delayed are now being completed.

Furthermore, Ko asserts Korea is well-positioned for private equity investment as it offers both growth and buyout opportunities to investors. That said, the anticipation is that within the overall context of increased deal opportunities in 2010, there are likely to be more control-based potential deals coming to the fore.

Standard Chartered itself completed two transactions in 2009 and going forward, Huh expects the bank to deploy anywhere between $100 million and $200 million in the country each year. It may not see the capital inflows that nearby China will see, but Huh predicts the Korean private equity market will continue to grow at a steady and measured pace. “It won’t be explosive growth but it will grow at 25 percent every year,” he says.

Chaebols: private equity’s best friend and worst enemy

Korean conglomerates, or chaebols, are key to the success – or failure – of Korea’s private equity market.

The fortunes of the two types of investor are closely tied, but run at opposites to each other. When things are looking good for the chaebols, it is normally bad news for the private equity industry; and when things are looking grim for these giants of industry, it normally indicates good news and rich pickings for private equity firms.

At this point in time, the private equity funds should, in theory, be enjoying a period at the top of the see-saw, due to the debt-induced woes of many of the country’s chaebols.

“During the bubble years preceding the global financial crisis, a lot of the acquisitions that were made by Korean chaebols were made when prices were at their highest and with heavy leverage, and a lot of them had problems digesting these acquisitions,” says Jason Shin, managing partner at Seoul-based buyout firm Vogo Capital Advisors.

Many of these conglomerates are now looking to divest their non-core assets to meet debt obligations. For instance, the Kumho Asiana Group recently finalized plans with a private equity fund backed by the Korean Development Bank to sell a controlling stake in Daewoo Engineering and Construction, in which it acquired a 72 percent stake for W6.43 trillion in 2006.

In December, the same group selected homegrown North Asia-focused buyout firm MBK Partners and telecom company KT as the preferred bidders for Kumho Rent-A-Car, a Korean car rental company, a source close to the deal confirmed with PEI Asia. The deal, when completed, is estimated to be worth about W300 billion.

Private equity firms active in Korea expect the chaebol-originated opportunity to continue into 2010. Vogo itself plans to start raising capital for its second private equity fund by the middle of 2010 to tap opportunities the market is likely to present.

And the problems faced by chaebols are benefitting private equity in another way as well. Not only are they now looking to sell stakes in non-core assets, they are also now less aggressive when it comes to acquiring assets. During the bubble years preceding the collapse of Lehman, “any and all” auctions were heavily crowded by chaebols who were coming in as strategic buyers and heavily out-paying private equity firms, says Shin.

The same companies were wiped out as buyers in 2009. “Lessons were learnt and Korean chaebols either did not seek to buy assets, or when they did, they were far more conservative with the prices they offered,” Shin adds.

Government comes to the fore

Korean institutions have been a key source of capital for domestic managers since 2005, when the Korean National Assembly passed an act promoting financial and non-financial institutional participation as limited partners in domestically registered private equity funds. Since then, the government has put in place several further initiatives to back the growth of the private equity industry domestically.

2009 saw the South Korean government and government-backed entities make several forays into private equity. Amongst them was the launch of a W1 trillion restructuring fund by the Korea Development Bank. The fund has been set up to acquire companies that have growth potential but have been hit by financial problems. It invests capital in distressed small- and medium-sized enterprises in exchange for a controlling stake in them. In June, this fund acquired an 80 percent stake in sewing machine manufacturer Sunstar Precision for W40 billion.

The government also launched a $60 million initiative called “New Growth Momentum”, through which the Korean Ministry of Knowledge and Economy committed $20 million each to three private equity funds focused on the environment, information technology and biotech respectively.

Initiatives were taken not only to spur private equity activity domestically in Korea, but to allow for the outflow of capital from Korea as well. For instance, Korea Investment Corporation (KIC), the country’s $25 billion sovereign wealth fund, launched into private equity investments for the first time in 2009, disclosing in June that it is to invest $1 billion in private equity, real estate and infrastructure overseas.

Soon after, KIC signed separate memorandums of understanding with Queensland government-owned QIC, an institutional investment manager, and Malaysian sovereign wealth fund Khazanah Nasional, to expand cooperation and jointly pursue investment opportunities.

Also in June, the Abu Dhabi Investment Company, Korea Development Bank and Korea Trade Promotion Agency signed an agreement to increase the flow of investment between South Korea and the Middle East and North Africa. That agreement encompasses private equity, cross-border M&A and infrastructure.

It is evident from these examples that the powers to be in Korea have growing confidence in an asset class that has often been viewed with suspicion in years gone by.  Such steps by the government can only be a good sign for both foreign private equity firms seeking to tap the Korean market and domestic Korean private equity houses alike.