Korea / Special Situations, Clepsydra Capital

Sanghyun Park

I investigate special situations in Korea.

Korea / Special Situations

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Hanwha Group is determined to build a highly-advanced defense development and production business, which will be the first of its kind in the history of Korean defense industry, and Hanwha Techwin appears to be at the heart of Hanwha Group's ambitious plan. They set the goal of becoming one of the few elite engine producers in the world. Yes, they want to focus on the advancement of Hanwha Techwin's engine business. They feel that this is the only way that can increase overseas sales and boost profits at the same time. Hanwha Techwin is aiming to acquire one of those engine component makers that belong to the supply value chain of the three major engine producers. Specifically, Hanwha Techwin is planning to buy an engine component maker with annual sales of USD500mil to 1bil. The company is said to be currently mulling over 5 companies that fall in this category. Now the question is whether Hanwha Techwin has enough money for another M&amp;A worth about USD1bil. In this regard, we now have to pay attention to Hanwha Techwin's recent deal with KAI (Korea Aerospace Industries) for the KF-X research &amp; development project. Hanwha Techwin recently signed a parts supply deal worth KRW241bil (USD204mil) with KAI, the country's sole aircraft manufacturer.On the surface, this is not a glamarous deal. In this research project, Hanwha Techwin's role is to localize parts of the engine for South Korea's next-generation fighter jets. General Electric will supply engines for the KF-X project. Basically, Hanwha Techwin will import GE engines and localize and assemble them before delivering them to the Korean government for this research &amp; development project. So, given the nature of this project, actual profits for Hanwha Techwin from this project will not be significant. But the important aspect of this deal is that this KRW241bil deal is mainly for funding the development of Korea's own engine technology.This KF-X project calls for building 120 locally made twin-engine combat jets. South Korea plans to deploy the new planes starting in the mid-2020s to replace its aging jet fleet of F-4s and F-5s. This means that the entire production project for Hanhwa Techwin will amount to about KRW1.8tril to 2.0tril if Hanwha Techwin successfully develops its own engine technology from this project either through the partnership with GE or the acquisition of a world-class engine component maker.Apparently, this is how Hanwha's top management plans to finance another mega M&amp;A deal. Hanwha Techwin will have to get further leveraged (its debt ratio is 87.1% as of 1Q16) or do another round of paid-in capital increase. But with its deal for the KF-X project, Hanwha Techwin can now argue to its creditors and shareholders that acquiring world-class engine technology can greatly enhance its chance of getting KRW1.8tril engine production deal in the future. Furthermore, this KRW2.0tril engine production deal will serve as an important reference case for developing new clients of Hanhwa Techwin's engine production business. That is, Hanhwa Group is planning to fund another mega M&amp;A deal by capitalizing on the high expectations built on the favorable market sentiments toward Korea's defense industry. The Korean government's recent decision for THAAD deployment is also raising the market expectations for Korean defense industry.Hanwha Techwin's stock price has jumped as much as 60 percent during the past year since June 29 in 2015 when the company changed its named from Samsung Techwin to Hanwha Techwin, compared with a 5.2 percent loss by the broader KOSPI. This indicates that the market has so far responded positively to Hanwha Group's aggressive expansion plan including a possible mega M&amp;A deal worth KRW1tril. It looks like Hanwha Techwin is becoming the biggest winner amid the escalating military tension fueled by the THAAD deployment.Nonetheless, still cautions are still required. Hanwha Techwin is currently trading at a 12M forward P/E multiple of 14.04x with less than 5% OPM. Moreover, given the nature of defense business, Hanwha Techwin's profitability will not be improved substantially any time soon. Even after three years, Hanwha Techwin's OPM will likely hover around 5%. But at the same time, we cannot deny the fact that Hanwha Techwin's current external market conditions are better than ever for its ambitious expansion plan.

Hanwha Group is determined to build a highly-advanced defense development and production business, which will be the first of its kind in the history of Korean defense industry, and Hanwha Techwin appears to be at the heart of Hanwha Group's ambitious plan. They set the goal of becoming one of the few elite engine producers in the world. Yes, they want to focus on the advancement of Hanwha Techwin's engine business. They feel that this is the only way that can increase overseas sales and boost profits at the same time. Hanwha Techwin is aiming to acquire one of those engine component makers that belong to the supply value chain of the three major engine producers. Specifically, Hanwha Techwin is planning to buy an engine component maker with annual sales of USD500mil to 1bil. The company is said to be currently mulling over 5 companies that fall in this category. Now the question is whether Hanwha Techwin has enough money for another M&amp;A worth about USD1bil. In this regard, we now have to pay attention to Hanwha Techwin's recent deal with KAI (Korea Aerospace Industries) for the KF-X research &amp; development project. Hanwha Techwin recently signed a parts supply deal worth KRW241bil (USD204mil) with KAI, the country's sole aircraft manufacturer.On the surface, this is not a glamarous deal. In this research project, Hanwha Techwin's role is to localize parts of the engine for South Korea's next-generation fighter jets. General Electric will supply engines for the KF-X project. Basically, Hanwha Techwin will import GE engines and localize and assemble them before delivering them to the Korean government for this research &amp; development project. So, given the nature of this project, actual profits for Hanwha Techwin from this project will not be significant. But the important aspect of this deal is that this KRW241bil deal is mainly for funding the development of Korea's own engine technology.This KF-X project calls for building 120 locally made twin-engine combat jets. South Korea plans to deploy the new planes starting in the mid-2020s to replace its aging jet fleet of F-4s and F-5s. This means that the entire production project for Hanhwa Techwin will amount to about KRW1.8tril to 2.0tril if Hanwha Techwin successfully develops its own engine technology from this project either through the partnership with GE or the acquisition of a world-class engine component maker.Apparently, this is how Hanwha's top management plans to finance another mega M&amp;A deal. Hanwha Techwin will have to get further leveraged (its debt ratio is 87.1% as of 1Q16) or do another round of paid-in capital increase. But with its deal for the KF-X project, Hanwha Techwin can now argue to its creditors and shareholders that acquiring world-class engine technology can greatly enhance its chance of getting KRW1.8tril engine production deal in the future. Furthermore, this KRW2.0tril engine production deal will serve as an important reference case for developing new clients of Hanhwa Techwin's engine production business. That is, Hanhwa Group is planning to fund another mega M&amp;A deal by capitalizing on the high expectations built on the favorable market sentiments toward Korea's defense industry. The Korean government's recent decision for THAAD deployment is also raising the market expectations for Korean defense industry.Hanwha Techwin's stock price has jumped as much as 60 percent during the past year since June 29 in 2015 when the company changed its named from Samsung Techwin to Hanwha Techwin, compared with a 5.2 percent loss by the broader KOSPI. This indicates that the market has so far responded positively to Hanwha Group's aggressive expansion plan including a possible mega M&amp;A deal worth KRW1tril. It looks like Hanwha Techwin is becoming the biggest winner amid the escalating military tension fueled by the THAAD deployment.Nonetheless, still cautions are still required. Hanwha Techwin is currently trading at a 12M forward P/E multiple of 14.04x with less than 5% OPM. Moreover, given the nature of defense business, Hanwha Techwin's profitability will not be improved substantially any time soon. Even after three years, Hanwha Techwin's OPM will likely hover around 5%. But at the same time, we cannot deny the fact that Hanwha Techwin's current external market conditions are better than ever for its ambitious expansion plan.

Hanwha Techwin's Another Mega M&A Deal: Capitalizing on Escalating Military Tension

Hanwha Aerospace

Hanwha Techwin's Another Mega M&A Deal: Capitalizing on Escalating Military Tension