July 5, 2012 2H12 Outlook Report Industry Report Holding companies (Overweight) Daewoo Securities Co., Ltd. Dae-ro Jeong +822-768-4160 [email protected] Investment opportunities during transition to holding structure Holding companiesÊ shares significantly outperformed the KOSPI early this year (after displaying sluggishness at end-2011). However, due to the protracted European crisis, they have pulled back once again. As a result, they are trading at the upper end of their historical discount range. However, we believe the current significant discount presents investors with a buying opportunity. Generally speaking, when the stock market is bearish, holding companiesÊ shares tend to significantly underperform the shares of their subsidiaries and the KOSPI. But when the market turns bullish, they tend to rebound quickly, since they are considered deeply undervalued (relative to their asset values). In selecting our top picks for 2H, we took into account valuation merits as well as growth prospects (amid a myriad of economic uncertainties). We recommend SK Holdings (003600 KS) and Doosan Corp. (000150 KS) as our top picks. When a company adopts a holding structure, the management control (i.e. ownership succession) of its controlling shareholder is usually strengthened. Given that politicians are whispering about bringing back a shareholding cap, banning circular shareholding, and placing new restrictions on holding structure conversion process, companies are rushing to adopt holding structures to achieve smooth ownership succession and attain greater management control. Companies that are currently pushing to adopt holding structures are doing so to prepare for ownership succession or to increase the ownership stakes of their respective controlling shareholders. And these companies are opting for the same conversion process: tendering offers after spin-off. As a company switches to a holding structure, we see some opportunities for investors. During the conversion process (announcement of conversion spin-off tender offer), we advise investors to invest in its subsidiary. However, when a holding company acquires its subsidiaryÊs shares via a tender offer, we recommend buying the holding companyÊs shares, as they should rise on their valuation merits (relative to their asset values). Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. I. Investment strategy and valuation.............................................................................................3 1. Deeply undervalued; Poised to rebound...................................................................................3 2. Overweight; Top picks are SK Holdings and Doosan Corp......................................................5 II. 2H12 Outlook .............................................................................................................................11 1. Elections and holding companies ...........................................................................................11 2. Conversion to holding company structure to accelerate.........................................................12 III. Issue analysis: Transition to holding company ...................................................................14 1. Status ......................................................................................................................................14 2. Method of transition: Spin-off and tender offer .......................................................................14 3. Holding company investment strategy....................................................................................16 LG Corp. (003550 KS)................................................................................................................... 18 SK Holdings (003600 KS) ............................................................................................................ 20 Doosan Corp. (000150 KS) .......................................................................................................... 22 Hanwha (000880 KS) .................................................................................................................... 24 2 July 5, 2012 Holding companies I. Investment strategy and valuation 1. Deeply undervalued; Poised to rebound Holding companiesÊ shares significantly outperformed the KOSPI early this year (after displaying sluggishness at end-2011). However, due to the protracted European crisis, they have pulled back once again. As a result, they are trading at the upper end of their historical discount range. We believe that the current deep undervaluation presents investors a compelling buying opportunity. As holding company shares show a tendency toward path dependence, when the stock market is bearish, the shares tend to significantly underperform their subsidiaries and the KOSPI. But when the market turns bullish, they tend to rebound quickly, since they are considered deeply undervalued (relative to their asset values). The shares are also significantly impacted by the market conditions of the holding companiesÊ major businesses. Figure 1. Relative share performances of holding companies in KDB Daewoo Securities Universe (1/1/11=100) 160 LG SK Doosan Hanwha KOSPI 140 120 100 80 60 40 1/11 3/11 5/11 7/11 9/11 11/11 1/12 3/12 5/12 Source: KDB Daewoo Securities Research Figure 2. YTD share price changes of major holding companies and their subsidiaries (%) KOSPI LG LG Electronics LG Chem (%) Doosan Doosan Heavy Doosan Infracore 10 10 1.548413246 2.801120448 0 0 -10 -10 -8.031496063 -9.440559441 -10.42345277 -11.67434716 -20 -18.01075269 -20 (%) SK SK Innovation SK Telecom (%) Hanwha Korea Life Hanwha Chemical 20 20 9.504132231 10 10 0 0 -2.816901408 -10 -10 -11.66077739 -20 -20 -15.08295626 -13.10810811 -14.22764228 Source: KDB Daewoo Securities Research KDB Daewoo Securities Research 3 July 5, 2012 Holding companies Figure 3. Relative share performances of the portfolios of holding companies and major subsidiaries (1/1/08=100) 160 KOSPI Holding companies portfolio 140 Major subsidiaries portfolio 120 100 80 60 40 1/08 7/08 1/09 7/09 1/10 7/10 1/11 7/11 1/12 Source: KDB Daewoo Securities Research Figure 4. LG Corp.Ês NAV discount trend Figure 5. SK HoldingsÊ NAV discount trend (%) (%) 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 06 07 08 09 10 11 12 08 09 10 11 12 Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research Figure 6. Doosan Corp.Ês NAV discount trend Figure 7. Hanwha Corp.Ês NAV discount trend (%) (%) 80 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 1/09 7/09 1/10 7/10 1/11 7/11 1/12 3/10 6/10 9/10 12/10 3/11 6/11 9/11 12/11 3/12 6/12 Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research KDB Daewoo Securities Research 4 July 5, 2012 Holding companies 2. Overweight; Top picks are SK Holdings and Doosan Corp. Recommend SK In selecting our top picks for 2H, we took into account valuation merits as well as growth Holdings and Doosan potential (amid a host of economic uncertainties). We recommend SK Holdings (003600 KS) Corp. as our top picks and Doosan Corp. (000150 KS) as our top picks. for their valuation merits SK HoldingsÊ shares had pulled back alongside those of SK Innovation (a key subsidiary), and growth potential whose shares have been negatively affected by demand contraction and growing uncertainties over oil prices and refining margins amid the economic slump. However, concerns about SK Innovation have already been priced in, in our view. Meanwhile, another subsidiary SK E&S is anticipated to serve as a new growth driver as the company has integrated gas field exploration/development and LNG procurement/distribution businesses through the acquisition of K-Power. SK E&S is also expected to reduce SK HoldingsÊ earnings volatility by complementing oil refining and petrochemical subsidiaries that are highly volatile to the economic cycle. We are also optimistic about Doosan Corp. in light of the growth potential of its in-house businesses, which account for 30% of its total NAV. These businesses have strong potential for growth and margin improvement. Currently, Doosan Corp. is significantly undervalued, trading at a 45% discount to its NAV. Also positive are 1) the companyÊs efforts to enhance shareholdersÊ value, including treasury share buyback and retirement, and 2) a sharp decrease in subsidiary-related risks. Table 1. Ratings and TPs of holding companiesÊ shares in the KDB Daewoo Securities Universe (W, x) Discount Companies Ticker Rating CP TP Upside P/E P/B rate SK 003600KS Buy 130,000 220,000 69.2 3.8 0.8 58.0 Doosan 000150KS Buy 129,000 210,000 62.8 11.2 1.0 46.3 LG 003550KS Buy 53,900 90,000 67.0 9.6 0.8 55.0 Hanwha 000880KS Buy 28,100 42,000 49.5 7.1 0.5 52.9 Note: P/Es and P/Bs are based on 2012F; Share prices are as of June 26, 2012 Source: KDB Daewoo Securities Research KDB Daewoo Securities Research 5 July 5, 2012 Holding companies Table 2. LG Corp.Ês major subsidiaries by business type Type of business Listed Unlisted Holding company LG Corp. (003550 KS) - LG Electronics (003550 KS) LG Siltron, Lusem, Hiteleservice, Hiplaza Electronics LG Display (0034220 KS) Hi Business Logistics, Himsolutek etc LG Innotek (011070 KS) LG Chem (051910 KS) LG MMA, LG Polycarbonate, SeeTec, Coca-Cola Korea LG Life Science (068870 KS) Chemicals Hankook Beverage, Diamond Water, The Face Shop LG H&H (051900 KS) TOSTEM BM, HousysENG etc LG Housys (108670 KS) LG Uplus (032640