Chaebol cross-shareholding: David and Goliath

The jewels in the Samsung Group empire are Samsung Electronics, the world's largest IT company; Samsung Heavy Industries, the world's second-largest shipbuilder; Samsung Life, the world's 14th largest life insurer; Samsung Engineering and Samsung C&T, two of the world's largest construction companies; and leading advertising agency Cheil Worldwide.

There are many more subsidiaries, but at the heart of the web sits Samsung Everland, a small zoo and theme park company with equity capital of around $10 million. This entity, controlled by the founding Lee family, is in turn the genesis of the many threads of ownership through which the crown jewels are held in place. It is a delicate balance but one that is responsible for collective annual revenues of $250 billion. And it may imminently be torn apart.

The check-box term in South Korea's presidential election last year was "economic democratization" - shorthand for boosting employment, reducing income inequality and spreading wealth by cultivating small- and medium-sized enterprises. This would come at the expense of the conglomerates, or chaebols, that dominate the economy. Sales at the 10 largest chaebols amount to more than three quarters of GDP, with Samsung Electronics alone accounting for nearly one fifth.

"The current political mood here in South Korea reflects the economic mood - that it is not the best of times, except for a privileged few, and so it's only fair for the large conglomerates to give some of what they gained back to the public," says Jasper Kim, founder of the Korea-based Asia Pacific Global Research Group (APGRG). "But the issue is whether any cross-shareholding policy will actually have a real connection and impact on the general public."

Walking the talk

Putting to one side arguments for and against reining in the chaebols, what remains to be seen is how newly elected President Guen-Hye Park implements this policy. Will there be comprehensive action on cross-shareholding or will she work with, rather than direclty against, the chaebols in order to find common ground.

Some private equity investors say a robust policy could stimulate rich deal flow. "Korea has decided to cut the chaebols down to size. They dominate the economy and the government wants to them to divest non-core assets so that smaller businesses can survive," the head of a regional buyout fund tells AVCJ. "A lot of deals are coming but they won't come in one year."

Cross-shareholding is the means by which the Lee family retains leadership of Samsung's businesses despite not holding controlling stakes in them. As of mid-2012, Everland directly owned 19.3% of Samsung Life, which held 7.5% of Samsung Electronics and 5.2% of Samsung C&T. Samsung Electronics owned 17.6% of Samsung Heavy, 2.6% of Cheil Worldwide and 35.3% of Samsung Card. Samsung Card, which was also 26.4%-owned by Samsung Life, held 5% of Everland. Samsung C&T controlled 4.1% of Samsung Electronics, 2.4% of Samsung Card and 1.5% of Everland.

The web stretches on and on, in numerous directions and incorporating numerous subsidiaries, but with the common goal of tying the crown jewels so intricately and intimately to the founders that no amount of public market trading could threaten their hegemony. It is the same in many chaebols, stretching from the likes of Samsung, Hyundai and SK Group all the way down to the second- and third-tier conglomerates.

Samsung makes for a useful example because it is so large and its ownership is reasonably well-documented, through a combination of public market filings and disclosures made in legal disputes. But it is unlikely to start offloading assets to private equity investors.

"Samsung is a poor example because it is so well capitalized everywhere that it probably doesn't need to sell some of the companies," says Jason Shin, managing partner at Vogo Investment. "The problem is second- and third-tier chaebols where the founding families don't have as much capital. These are families that own 30 different companies with the slimmest shareholdings possible. Without cross-shareholding they would end up owning less than 10%, and that's where you start getting worried about potential lack of control."

The implication is that, in order to generate the capital required to beef up their shareholdings to 30-40% in core businesses, the families will have to sell off non-core assets.

Modus operandi

It isn't clear how the government would structure any alteration to cross-shareholding agreements - the tax implications and capital reallocation costs would be substantial. Last year the ruling Saenuri Party suggested reducing the cap on industrial conglomerate ownership of banks from 9% to 4%, and banning financial companies from having voting rights in non-financial affiliates as opposed to the current ceiling of 15%.

A removal of voting rights equates to a loss of control, so financial companies would have to sell their assets to other non-financial affiliates so that the founders of the parent group retain existing levels of influence. Not all chaebols would have to act, but those without cash-rich affiliates might require additional capital to the support the transition and put other assets on the block.

Not everyone is optimistic, though. APGRG's Kim notes that, while a chance exists for assets to be purchased by third parties in the event that shares are forced to be sold off, the family founders would find a way to retain majority ownership, which might not appeal to buyers.

Taigon Kim, senior partner and head of South Korea at Headland Capital Partners, expects to see some divestments by chaebols - there is a wider government initiative to prevent companies from straying from their core businesses - but not driven by cross-shareholding reforms.

"Cross-shareholding has been in practice for more than 50 years. The impact of a ban would be huge and it couldn't be executed without granting tax exemptions, so I don't think it's possible," he says. "The government is promoting holding company structures and many chaebols have already moved in this direction."

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• Topics
• North Asia
• Buyouts
• South Korea
• buyout
• Vogo Investment
• Headland Capital Partners