In this briefing:
- Why Is South Korea Testing So Many More People for COVID-19 Versus Japan and the U.S.?
- Samsung, Hyundai, and SK – Restructuring Scenarios, Holdco Regulations, Less Risky Stocks
- Korea Stock Market Monthly Recap #45 (February 2020)
- Revised Trading Approach for Samsung C/1P
- Samsung C&T & Electronics Price Coupling Issue Amid New 3-Yr Shareholder Return Policy
In this insight, we delve into some of the overlooked factors as to why there has been a much higher spike in COVID-19 confirmed cases in South Korea, as compared to other countries such as Japan and China in the past month. Amajor reason why South Korea has recorded much higher figures for COVID-19 cases is that it has been testing so many more people for COVID-19 as compared to other countries.
As of February 28th, there were 85,693 people that have been tested for COVID-19 in South Korea. Out of this total, 2,931 have tested positive, 53,608 have tested negative, and 29,154 people are still under inspection (waiting for their results/undergoing further tests).
In comparison, according to the Japanese Health Minister Katsunobu Kato, he stated that “6,300 tests were conducted from February 18th to 24th for an average of 900 per day, while up to 3,800 tests could be done daily [in Japan].” In the United States, it has been reported that just 445 people have been tested for COVID-19 as of February 26th.
Although more than 85,000 people have already been tested for COVID-19 in South Korea, it still has 200,000+ members of the Shincheonji that need to be tested. Plus, there are many thousands of other people with symptoms of flu and pneumonia that will be getting this test in the next several weeks. It is fair to say that South Korea is likely to test at least 400,000 or more people in the coming weeks for COVID-19.
This is a follow-up insight to answer some questions I have received during the webinar. We want to discuss key holding company regulations that are imposed upon Korean conglomerates when envisioning restructuring scenarios. In this insight, we focus on Samsung, Hyundai, and SK. We also look into which affiliates within the group would face the lowest risks upon the restructuring.
The overall objective of South Korea’s holding company regulations is to prevent operating companies from being taken advantage of to finance the group’s aggressive expansion. The relevant rules include:
- If the total value of the subsidiaries that a company owns exceeds 50% of its total assets, the company is automatically converted into a holding company and becomes subject to the regulations.
- When the company is the largest equity investor in an affiliate, this affiliate is legally perceived as a subsidiary.
- In principle, the value of the subsidiary is implied by fair value. The fair value corresponds to the market price for listed subsidiaries and the estimated fair value for unlisted subsidiaries. However, there are some companies that recognize the value of unlisted subsidiaries as the acquisition costs, not the estimated fair value, on their unconsolidated balance sheet. In this case, the cost of acquisition is perceived as the value of the unlisted subsidiaries to calculate the ratio.
- Subsidiaries (operating companies) are not allowed to participate in a capital increase of holding companies and thereby create a cross-shareholding link.
- Subsidiaries and holding companies are not allowed to make joint investments to acquire other firms. This regulation, along with the #2 regulation, aims to prevent subsidiaries (operating companies) from being deployed to finance the holdco’s acquisition activities.
- A 2-tier subsidiary should hold a 100% stake in a 3-tier subsidiary. On the other hand, a holding company is required to hold more than a 20% stake in a publicly listed 1-tier subsidiary. If it is unlisted, a holding company should hold more than a 30% stake. The same rule also applies to a 1-tier subsidiary holding a stake in a 2-tier subsidiary.
- Under the general holding company structure, the holding company and affiliates are not allowed to hold a stake in financial affiliates. The amendment to allow the creation of the “intermediate” financial holding company structure had been under review but was put on hold.
The most likely restructuring scenario for Samsung Group is to split Samsung Electronics (005930 KS) into a holding company and an operating company and to merge SamE Holdco with Samsung C&T (028260 KS). Upon the holdco conversion, Samsung C&T should buy off SamE shares from Samsung Life Insurance (032830 KS). Thus, those three affiliates face uncertainty, albeit in varying degrees. Meanwhile, Samsung Sdi (006400 KS) and Samsung Electro Mechanics Co, Ltd. (009150 KS) have the least exposure to such uncertainty. In particular, Samsung SDI would expect a cash influx by selling off its subsidiary shares to SamE Holdco due to the #3 regulation.
Hyundai Group may or may not adopt the holding company structure. In either case, the restructuring would inevitably involve Hyundai Mobis (012330 KS) and Hyundai Glovis (086280 KS). However, Hyundai Motor Co (005380 KS) is rather a place of relative calm, making it scenario-neutral. Still, there would be one risk facing Hyundai Motor in case of the holdco conversion; according to the #5 regulation, Hyundai Motor should sell off its majority stakes in Hyundai Card and Hyundai Capital. However, Hyundai Motor’s vertical integration with those financial affiliates that provide consumers with car loan services is one of the company’s important differentiating strategies. Thus, the Group would find a way to deliberately avoid being automatically converted into a holding company, though it forms a de facto holdco structure.
SK Group is working on its governance restructuring such that SK Hynix (000660 KS) becomes a 1-tier subsidiary. Currently, SK Hynix, a subsidiary of SK Telecom, is a 2-tier subsidiary of SK Holdings (034730 KS). Because of that, SK Hynix had to comply with the #4 regulation, which forces the company to wholly own the acquired firms. This must have been very costly for SK Hynix to seek business expansion in an active manner. The most likely scenario for SK Group is to split SK Telecom (017670 KS) into an investment company and an operating company and then merge the investment company with SK Holdings. Upon the split, SK Hynix would be moved to the investment company of SK Telecom. After the merger, SK Hynix would become a 1-tier subsidiary of SK Holdings, and thus, can be more active in JVs and acquisitions.
The top 10 events impacting the Korean stock market, economy, & politics in February 2020 were as follows:
2) M&A FIGHT FOR HANJIN KAL
3) 30% CAP RULE FOR SAMSUNG ELECTRONICS/KOSPI 200
4) LOTTE SHOPPING RESTRUCTURING
5) DOOSAN HEAVY INDUSTRIES RESTRUCTURING
6) OCI DISCONTINUES SOLAR POLYSILICON PRODUCTION IN KOREA
8) STRONG OUTPERFORMANCE OF EV RECHARGEABLE BATTERY RELATED COMPANIES
10) SURGE IN E-COMMERCE DUE TO CORONAVIRUS
Our model portfolio was up 0.7% on a net basis in February 2020 (cash was 60% of our model portfolio), outperforming KOSPI which was down 6.2% in the same period. We are increasing cash to 70% of the total model portfolio starting in March so we are very defensive in our portfolio.
Samsung’s 30% cap got pushed back to June. Even if imposed in June, the KRX now has a comfortable buffer as the local ETFs do not need to cap Samsung at 30%. Nonetheless, the Samsung 1P is still going quite strong. The pref discount currently sits at 15.61%, which is still pretty close to the all-time low. Then, the question is why 1P is still going this strong despite the waning 30% cap factor.
Samsung C&T unveiled a new shareholder return policy for the next three years, FY20~FY22. It said that it would give out 60~70% of the dividend income from the affiliated companies in dividends to its shareholders with a minimum DPS of ₩2,000. Also, it will cancel a total of 2,802,962 common shares (with 15 1PB shares). Over the last two years, C&T gave virtually 60% of the dividend income from the affiliated companies in dividends to its shareholders.
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