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Holding Companies New Roles of Holding Companies in Korea

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Holding Companies New Roles of Holding Companies in Korea 2H19 Outlook Holding companies New roles of holding companies in Korea Dae-ro Jeong +822-3774-1634 [email protected] Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT. Contents [Summary] New roles of holding companies in Korea 3 History of holding companies in Korea 4 New roles of holding companies in Korea 5 Isuue: Financial conglomerate supervision regulations 10 (1) Samsung Group’s ownership structure 11 (2) HMG’s ownership structure 15 IV. Top Picks 19 SK (034730 KS/Buy) 19 LG (003550 KS/Buy) 21 [Summary] New roles of holding companies in Korea Holding companies are expected to play new roles as a value creator in Korea Asian Expansion of Ban on additional Corporate Controlling Government financial control over circular restructuring shareholders business crisis in 1999 groups shareholdingsg High Foreign Governance Ownership inheritance/gift capital inflow overhaul succession taxes Holding Need for holding companies Need for cash flow Dividends, brand royalties, to play new roles companies improvements etc. Holding companies 3.0: Establish new roles for In-house businesses holding companies as a value creator could add cash flow Discount rate: Pure Engage in new business investments for future holding companies > growth and in-house businesses holding companies with in-house businesses Compensation disclosure Legitimate way to Dividend requirements; generate expansion regulations on substantial cash related-party flow transactions Source: Mirae Asset Daewoo Research 3| 2H19 Outlook [Holding companies] Mirae Asset Daewoo Research I. History of holding companies in Korea Establishment of and • Ban on holding companies: In 1987, the establishment of holding companies was banned to prevent the concentration of economic power. transition to holding • Holding companies 1.0: With the increased importance of restructuring and governance overall following the Asian financial crisis, the establishment of and transition to holding companies were allowed with certain companies have been conditions in 1999. allowed since 1999 • Holding companies 2.0: Controlling shareholders expanded their control over the conglomerates via legitimate means, as controlling families’ stakes more than doubled via spin-offs and tendering offers after spinning off subsidiaries. • Holding companies 3.0: The functions and roles of holding companies need to be examined. A new holding company model needs to be formulated in Korea. Changes in controlling shareholders’ stakes before and after Regulatory changes related to holding companies conversion to a holding company structure 1986 1999 2000 2001 2004 2007 2013~ Controlling shareholders’ stakes I. Introduction Establishment of holding companies allowed Holding companies in holding companies (%) of MRFTA [conversion year] End of conversion One year after Before Ban on establishment of year conversion holding companies Holding Company Act introduced SK Holdings (2007) 11.01 25.14 30.45 II. Debt-to-equity ratio Debt-to-equity ratio of 100% Debt-to-equity ratio LG Corp. (2001) 7.40 34.03 31.91 (100%→200%) GS Holdings (2004) New 49.41 50.44 Ⅲ. Shareholding Requirements for ownership in listed subsidiaries (50%→30%) Hanjin KAL (2013) New 10.01 23.09 requirements CJ Holdings (2007) 16.59 38.24 38.22 Requirements for ownership in Booyoung (2009) 77.32 77.32 77.32 second-tier subsidiaries introduced (Listed: 30%; unlisted: 50%) LS Holdings (2008) 26.82 26.82 26.64 Requirements for ownership in subsidiaries Kolon (2010) 13.15 47.99 48.16 (Listed: 30%→20%), Hankook Technology Group (2012) 35.27 35.27 73.89 (Unlisted: 50%→40%) Dongwon Enterprise (2001) New 56.59 49.19 IVI. Tax benefits Rise in percentage of dividend Consolidated Halla Holdings (2014) 7.72 22.95 23.32 income that is excluded from tax return introduced gross income SeAh Holdings (2001) New 58.72 71.18 AmorePacific Group (2006) 27.70 55.18 55.11 Ban on ownership of more than 5% in non-affiliates V. Other Celltrion Holdings (2011) New 88.02 97.53 requirements to qualify as HHIC Holdings (2007) 16.89 50.11 50.25 a holding Abolition of requirement for business relationships between company second- and third-tier subsidiaries; ownership in third-tier Hitejinro Holdings (2008) 16.13 16.13 28.93 subsidiary allowed (100%) Hansol Holdings (2015) 6.93 6.67 14.03 HHI Holdings (2017) 10.15 25.80 25.80 Source: FTC, Mirae Asset Daewoo Research Source:: FTC, Mirae Asset Daewoo Research 4| 2H19 Outlook [Holding companies] Mirae Asset Daewoo Research II. New roles of holding companies in Korea Holding companies 3.0: Establish new role for holding companies as value creators • Engage in new business investments for future growth and in-house businesses: Need to create new value beyond existing roles, including subsidiary management and business portfolio adjustment • Holding companies’ existing roles are divided into strategic coordination, strategic control, and financial management. • Most domestic holding companies focus on strategic coordination (with one to two flagship businesses and related businesses). • Leveraging the strengths of the holding company structure, holding companies should play more proactive roles to create synergies in the long term. Typical functions of holding companies Types of holding companies Strategic Strategic control Financial management Functions Detailed roles Characteristics coordination With high discrepancies in With moderate With high similarities in subsidiaries’ businesses, Set a vision and a strategic direction; discrepancies in subsidiaries’ businesses, holding companies decide on subsidiary polices; decide on subsidiaries’ businesses, holding companies Characteristics manage subsidiaries roles are balanced manage subsidiaries based Establish a business the acquisition and sale of businesses; based on a short-term between strategic on a common strategic financial goal; create portfolio decide on resource allocation The scope and extent coordination financial goal; holding companies’ value via the acquisition management intervention is high principles; formulate an organizational of holding companies’ or sale of businesses structure activities can vary Modest revenue growth Rapid revenue growth and Growth Acquisition-driven and margin high margins on flagship depending on the strategy revenue growth improvement businesses Monitor subsidiaries’ performances; definitions of their No decision-making on Intervention in business No decision-making on Decision- evaluate executive directors’ roles subsidiaries; cautious strategies; proactive subsidiaries; final making on Improve business recommendation of a recommendation of a decisions are made by performances; support performance subsidiaries performances business direction business direction subsidiaries improvement programs; make Subsidiaries set a adjustments to create synergies strategic direction, while Holding companies control Subsidiaries make all Interest holding companies only businesses, while decisions, with no Decide on a capital structure and mediation evaluate them; no subsidiaries only make intervention by holding Capital cost and competition among suggestions companies manage stakes in subsidiaries; monitor financial policies business units These functions are subsidiaries’ financials Review the Investment Review the feasibility of Intervene only in holding companies’ strategic/operational management far-reaching investments exceptional cases Communicate with shareholders and feasibility of investments Communication with traditional roles Set short-term goals Set short-term goals that the capital market; improve Holding companies set external stakeholders Goal setting based on subsidiaries’ reflect subsidiaries’ strategic financial goals relationships with regulators strategic decisions direction Source: Mckinsey, Mirae Asset Daewoo Research Source: Goold & Campbell, Mirae Asset Daewoo Research 5| 2H19 Outlook [Holding companies] Mirae Asset Daewoo Research II. New roles of holding companies in Korea SK Holdings establishes an investment-type holding company • In-house businesses: In addition to dividend income and brand royalties, the in-house IT services business adds cash flow, building a stable revenue structure. • Investments: Secure steady growth drivers by identifying/nurturing new businesses based on solid cash generating power: ① Preemptive investments in promising businesses ② Value chain expansion and inclusion of new businesses as subsidiaries, or ③ Recovery of investments via an exit strategy • Prove solid performances as an investment-type holding company: Expand shareholder return policies and the sharing of profits with the society SK Holdings’ net asset value (NAV) to increase and its discount rate to decrease. SK Holdings’ operating revenue by unit SK Holdings has invested W3.8tr to secure new growth drivers (Wtr) Materials (W1.4tr, 36%) Biotech/pharmaceutical 3.0 IT Service (W0.8tr, 22%) Rental income Investments〮 in semiconductor value chain Nurturing〮 the new drug Royalty income - Acquisition of SK Materials development business 2.5 Dividend income (special gases) - Financial support for US NDA SK Siltron (wafer) approval and marketing Materials business Establishment of a global 2.0 diversification pharmaceutical - Investments in Wason, a manufacturing base Chinese copper foil maker New growth - Acquisition of plants from businesses AMPAC and
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