LG Takes the Plunge

RESTRUCTURING -- September 11, 2003 Page 1 of 8

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• Home Search feer.com's LG Takes the Plunge new archive and • Issue Index LG Group was typical of South Korea's family- access articles • This Week owned conglomerates till five years ago, when it published in Far - The Region Eastern Economic Review from the past - China began reorganizing its businesses with a view to 56 years. Free to - Innovation improving efficiency. Its success has been rewarded Review subscribers. - Money by investors and holds a lesson for other big - Currents • Top Interviews business groups

• Special Reports By Kimberly Song/SEOUL Search feer.com • Site Map Issue cover-dated September 11, 2003 • About Us Type in keywords • Contact Us WHEN IN MARCH LG Group unveiled its new corporate structure, it was akin to bulldozing a

sprawling maze of dark corridors, secret Search Regular Features passageways and trapdoors and building a modern Advanced Search Tips • Intelligence complex with an efficient floor plan and light-filled • Regional Briefs rooms in its place. In a word, LG's restructuring • China Briefing marked a sharp break with tradition--and could • The 5th Column come to redefine the future of big business in South • Shroff Korea. • Economic Monitor • Loose Wire LG Group, the country's second-largest family- • Travellers' Tales owned conglomerate, or chaebol, is trying to • CEO Call streamline its business operations to focus on core Other Features areas and enable its affiliates to act more • Editorials independently. The new structure also helps to • Letters differentiate the roles of the owner and • Prices & Trends management. • Corrections The move is unique in Korean big business. LG Group, with total assets worth 58.57 trillion won To Subscribe ($49.7 billion) and business interests ranging from

electronics and energy to telecommunications and Far Eastern • Economic Review financial services, has dismantled its complex web • Feer.com Archive of cross-shareholdings and reorganized the majority • Review E-Newsletter of its affiliates under a holding company, called LG Corp.

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Other Dow Jones "The greatest corporate action in Korea so far is LG Products: The Asian Wall Group's restructuring to a holding company," says • Street Journal Wonki Lee, head of equity research at Merrill • WSJ.com Lynch in Seoul. Investors also appear to approve: Dow Jones LG Group companies have seen their stock prices • Conferences jump since the March announcement of the new structure.

LG's ambitious plans to improve its corporate governance and transparency are providing a test case for one of the country's biggest challenges: restructuring its chaebol system.

For decades, while the economy was still in its formative stages, Korean entrepreneurs built conglomerates whose affiliates could share financial and business resources--profiting together, but also bailing each other out in times of trouble. On the back of this chaebol system Korea skyrocketed from the devastation of the Korean War to become the 12th-largest economy in the world today.

Unfortunately this system also brought the country to its knees during the Asian financial crisis of 1997. The crisis exposed the mismanagement and corruption thriving in the belly of the chaebol system. Today, Korea's conglomerates want to be globally competitive, and they want international investors as business partners and buyers of their stocks and bonds. Indeed, the chaebols are struggling to polish up their tarnished image.

A government-led campaign to overhaul big business dissolved bankrupt Daewoo in 1999 and split Hyundai into three parts in 2000. Hyundai Motor is prospering, while sister group Hyundai Asan remains mired in corporate scandals. SK Group seemed to be doing fine until a massive accounting fraud was unearthed in March at its trading arm, SK Global, which now threatens the survival of the whole group. While the country's largest conglomerate, Samsung, continues to thrive under its traditional structure, LG is shedding its chaebol skin altogether.

"We knew that times had changed and LG had to change too," says Suk-Jeh Cho, chief financial officer of LG Corp., who in 1998 was working in the executive office for corporate restructuring.

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That year, LG Group embarked on a five-year journey to transform itself into a holding company which, by law, is required to own 30% of listed and 50% of unlisted subsidiaries, and to maintain a debt-to-equity ratio of less than 100%.

The odyssey began with LG Group improving its financial profile. At the end of 1997, LG was weighed down by a mountain of debt to the tune of 42.9 trillion won and a debt-to-equity ratio of 507.8%. LG merged 15 group companies into other affiliates, shed five noncore businesses like automation systems-maker LG Honeywell and advertising agency LG Ad, and listed 20 more on the Korea Stock Exchange and Kosdaq, such as cable-television shopping channel LG Home Shopping and mobile-phone service-provider LG Telecom. According to the Korea Stock Exchange, LG engaged in the largest-scale restructuring effort of any conglomerate, raising some 7.32 trillion won in 2000 and 11 trillion won in 2001 through market transactions.

LG also set out to woo foreign direct investors. Between 1998 and 2001, United States-based Dow Chemical signed on to create LG Dow Polycarbonate, Nippon Mining & Metals of Japan established LG-Nikko Copper and Philips Electronics of the Netherlands collaborated to launch LG.Philips LCD and LG.Philips Displays-- Philips is investing a whopping $1.6 billion in the liquid-crystal display-making venture alone.

Meanwhile, LG Group flagship companies LG Chemical and LG Electronics went under the knife. In 2001, LG Chemical was split into three companies: LG Chem, LG Household & Health Care, and LG Chem Investment; the latter was set up as the holding company for the first two. Corporate transparency was enhanced with each unit now reporting their respective financial statements.

The next year, LG Electronics was similarly divided between its operating and investing businesses into LG Electronics and LG Electronics Investment. Again, the latter became a holding company for the former. Last March, both the chemicals- and electronics-related holding units were married to put 34 of LG Group's 51 affiliates, excluding financial businesses, under one big

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umbrella, LG Corp.

Through a combination of sales, equity swaps and other transactions, the minority stakes that LG's founding families, the Koo and Huh clans, held in various affiliates were moved to the holding company, of which they now own 59%. This clearly defines their role as shareholders, not managers of the businesses, says Byungnam Lee, executive vice-president of LG Corp. The Koo and Huh families, however, continue to own shares in LG companies outside the holding company, such as financial affiliates LG Card and LG Investment & Securities.

LG Corp. is currently manned by 63 employees in five divisions: new business development, business management, management support, finance, and human resources. The holding company--whose earnings come solely from dividends but which, starting in 2005, will be augmented by LG brand usage fees--is in charge of making group-level investment decisions including expansion of the conglomerate into new business areas, overseeing the performance of the subsidiaries' management and promoting the LG brand globally. That should free up affiliates to concentrate on their individual businesses.

"LG Corp. is a lean, active investment company," says Lee. "We are interested in the subsidiaries' business strategy, their financial status, cash flow, and what kind of job the CEO is doing." In addition to keeping tabs on the affiliates' financial health, LG Corp. meets with all the chief executive officers once a month in a seminar that lasts several hours to discuss topics such as the current business environment, global trends and the economic outlook.

The road to restructuring has been long and hard. There were many difficulties involved, such as finding a fair price for shares of unlisted companies and getting employees of merged companies to get along, says Y.S. Kwon, chief financial officer of LG Electronics.

But the pain has been worth it. Shareholder value has certainly increased. LG Group affiliates, such as LG Electronics and LG Chemical have seen their

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stock prices rise 61% and 30% respectively, outperforming the Korea Stock Price Composite Index, or Kospi, since the March launch of the new structure. Aggregate market capitalization of the group has increased by a third.

Investors applaud the affiliates' new autonomy. "You don't have to worry about unrelated investment burdens," says Lee of Merrill Lynch, referring to the traditional penchant for chaebol companies to be heavily invested in each other. "LG Electronics and LG Chem are showing that they really are independent."

Take the troubles at LG Card, the country's top credit-card issuer now facing massive defaults by cardholders. "Ten years ago, we were shareholders of LG Card," says Kwon of LG Electronics. "Then, we would have needed to spend money to help them." But LG Electronics sold most of its 6.7% stake in LG Card during the restructuring process and today Kwon says he feels no pressure to bail out LG Card. LG Electronics still holds 0.5% of LG Card, which it plans on divesting before March 2004. In contrast, to the chagrin of its shareholders, Samsung Electronics was called in to support its distressed affiliate, Samsung Card.

LG Electronics also divested its 35.6% holding in LG Telecom, another 30% in fixed-line telecoms service provider Dacom Corp. and 4.23% in Internet-service-provider Hanaro Telecom. LG Group's ambitions in the telecoms business are now the domain of LG Corp., not LG Electronics.

"Investor-relations activities used to be very difficult for me," says Kwon of LG Electronics, who often found himself fielding questions about LG Telecom and Dacom. "But now, [investors] only ask about LG Electronics and I can very clearly convey my own company's strategy. That's a big change." Foreign investors now hold 29.4% of LG Electronics shares, up from 19.9% in March.

While markets seem to be enthusiastic about the increased autonomy of the operating units, they are lukewarm about the holding company itself. LG Corp. currently trades at a deep discount of about 70% to the net asset value of its holdings, says J.D. Song, Seoul-based research analyst at Samsung

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Securities. Investors appear to be taking a wait-and- see approach to LG Corp.

"It takes time, but the holding company may become a good proxy for the companies they own," says Henry M. Seggerman, president of International Investment Advisers, a Korea-focused investment-management company in New York.

Still, some investors and shareholder rights activists are less enthusiastic. They remain uneasy about LG's overall restructuring because of what they perceive to be the holding company's uncanny resemblance to the now defunct "chairman's office"--the pulpit from which founders would exercise despotic control over the entire conglomerate.

"Coordination of the group's direction, investment decisions, and people development--these functions are still valid," says Lee of LG Corp., addressing such concerns. But, "unlike the chairman's office, the holding company has legal legitimacy and must act in a rational, accountable way."

The Seoul-based Centre for Good Corporate Governance plans to keep a watchful eye on just how much influence the holding company exerts on its affiliates, says Jooyoung Kim, executive director of the centre.

Indeed, all eyes are on LG. Last month, a 12- member team from the Vietnamese National Steering Committee for Enterprise Reform and Development and other agencies visited LG executives to learn more about the group's restructuring.

LG's new holding-company structure may provide a new way of managing big business in Korea. But Samsung, so far, appears to be successfully barrelling along under its traditional structure of intricate business and financial relationships between its affiliates and the owner family exerting control over the entire group through small direct stakes in a few key companies. What remains to be seen is whether in fact both models can work in Korea.

"The chaebol structure itself is not the critical

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problem," says Lee of Merrill Lynch, provided that the conglomerate produces reliable financial reports and makes proper disclosure of transactions conducted between affiliates. The combined forces of increased foreign shareholdings in Korean companies, more vigilant shareholder activism and government monitoring could help to keep the former abuses of big business in South Korea in check.

Nevertheless, some investors are asking if Samsung Group will follow LG's lead. A simple and transparent ownership structure could enhance Samsung's market valuation, not to mention investor confidence in the conglomerate.

"We have considered the holding-company model," says S.J. Choi, senior manager at Samsung group information headquarters. "But it is not possible for us under the current laws, where we should have more than 30% of shares in listed companies."

Indeed, for Samsung Electronics alone, the Lee family, which directly and indirectly controls about 22% of the company's shares, would have to purchase 8% more from the market. This could cost as much as 5.38 trillion won.

"All chaebols are not the same," says Lee of LG Corp. "Each has its own history and character."

LG Group is showing its talent for making compromise work. Some shareholder activists want to see the chaebol system dismantled and affiliates established as independent companies. The Korea Fair Trade Commission calls the holding company structure a "middle stage" of corporate reform in Korea. For LG, making it successfully to this "middle stage" may be just enough to secure it a place on the global stage.

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