Korean outbound M&A: Satisfied partners?

Overseas acquisition activity by Korean companies came to $2.24 billion this year, with 69 deals transacted. But more than half of the capital invested came from just six large players - SK Group, Public Officials Benefit Association (POBA), LG Group, Mirae Asset Group, Samsung Group and Korea National Oil Corporation (KNOC) - seeking assets in oil and gas, real estate, telecommunications and semiconductors.

Korean outbound M&A activity has slowed over the past five years. The $5.6 billion transacted across 102 deals in 2013 was the lowest annual total since the post-global financial crisis frugality of 2009. In 2012 nearly twice as much was invested, according to Thomson Reuters.

Yet in addition to the continued appetite for energy assets, there is an increasing desire for exposure to overseas markets in a broad range of sectors, from consumer to technology. Anecdotal evidence suggests new geographies are coming on to the radar as well, with the US and Southeast Asia prominent - the former offers established brands, the latter fast-growing consumer markets.

And then the nature of the prospective buyers is changing. The large conglomerates may still dominate deal flow but their mid-cap counterparts want to participate as well. Less experienced in outbound M&A, private equity potentially has a role to play in helping them lockdown acquisitions.

"When Korean companies go abroad to acquire minority stakes in natural resources and energy sector companies, investments are relatively straightforward in terms of managing post-deal issues," says Jaewoo Lee, an M&A partner in the corporate department of Ropes & Gray. "But when they go abroad to acquire controlling stakes in other sectors, oftentimes they face greater challenges in terms of post-deal integration and operations."

The National Pension Service of Korea (NPS), the country's most active LP, wants to harness private equity investors' transaction expertise to help realize the outbound expansion ambitions of mid-tier domestic corporations. Several initiatives have been launched to this end, but the most prominent is the Corporate Partnership Fund (COPA Fund), which launched 2011. Three years on, is the initiative working out as planned for these companies and their PE partners?

An evolving model

Since the COPA Fund's inception, at least 17 corporate vehicles have been announced. NPS has agreed to put in KRW6 trillion with the local conglomerates - including GS Group, SK Group, KT Corp, Posco and Hanwha Group - contributing the rest. Each fund is dedicated to one corporation, and it matches NPS' capital commitment on a 1:1 basis. On this basis there should be about $10 billion in dry powder held by the COPA Funds.

As the NPS doesn't have skill sets or bandwidth to manage these vehicles, it initially invited about 13 domestic GPs to join the program, including the likes of IMM Private Equity, EQ Partners and Mirae Asset Private Equity. More recently, the scheme has broadened to allow participation from foreign GPs. The traditional COPA Fund LP structure has also evolved.

Two months ago, CLSA Capital Partners, plus local GP Calix Investments, launched a KRW300 billion ($295 million) global co-investment fund in partnership with South Korean tire manufacturer Nexen. The vast majority of the capital will come from NPS. Nexen is not an LP but will invest alongside the fund, which will only target assets that are of interest to the corporate.

Asia-focused private equity firm Excelsior Capital Asia also recently won approval from NPS to join the COPA Fund program and help Korean corporates invest offshore.

"The role of the GP is to ensure that proper investment processes - structuring, due diligence, risk management, and so on - are carried out. To become a qualified GP, you have to show that you have a successful track record involving a minimum amount of invested capital and that the management team responsible for the track record is still in place," says Michael Kent, a partner at Excelsior.

The two new funds formed with offshore GPs have yet to make any investments, although Excelsior is looking for acquisition targets in China that are a good match for Korean corporates' global expansion strategies. However, industry participants are generally skeptical as to how far the COPA Fund can reach given relatively few deals have been forthcoming.

Lee of Ropes & Gray estimates that less than 10% of the COPA Fund has actually been utilized to make overseas investments. One recent transaction executed through a corporate partnership structure saw IMM invest in a water desalinization business in Spain with GS Group. But the deal was completed two years ago. During the old days, the NPS had never been made clear exactly what function private equity will serve in the program.

"The COPA Fund was a very hot topic two years ago, but now it has been eased off a little bit. The scheme is an interesting concept but it's difficult to put into practice. Pension funds and conglomerates have different views on what a good investment should be. Private equity investors, meanwhile, have become very passive in the transaction process," says a local GP who joined the COPA Fund.

From a broader standpoint, most of the larger Korean conglomerates have high credit ratings, which means they have easy to access to bank financing. They also have strong balance sheet cash flows. In this context, even if these companies are active in overseas markets, they don't necessarily need to ask NPS for financial support. This is particularly the case when NPS sets terms the corporates regard as unduly harsh.

"The cooperation funds are a valuable and helpful funding source, but they come with various conditions attached including on when and how different investors will realize their returns. So depending on the deal type, even when a cooperation fund has been set up, a Korean company may not always go through such fund to do an overseas acquisition," says Ropes & Gray's Lee.

Misallocation of resources?

Under the COPA Fund scheme, NPS targeted large-scale conglomerates that rank among the country's top 30 by market capitalization. Moreover, the pension fund's commitment to each corporation was based on credit rating. For example, a company with an "AA" to "AAA" grade rating received KRW300-400 million. This leaves smaller players at a disadvantage.

"If you're a small- to medium-sized enterprise (SME) and you don't have an ‘A' credit rating, but ‘BB+' grade, you might not be even qualified to set up a corporate funds with the NPS," a fund manager tells AVCJ.

However, smaller companies are arguably those most in need of support from the COPA Fund program. Emboldened by NPS' financing backing, they are able to target larger deals overseas, without worrying about the burdens that might be placed on their own balance sheets. Peter Whang, managing partner at Joshua Tree Asia Investments, blames the situation on a misalignment of interest.

"It's really the SMEs that would benefit the most from this program as they have limited resources to seek overseas investment but going overseas is arguably more critical to them for their long-term viability," he says. "But for NPS, as they are a public fund, it would be safer to work with large conglomerates in order to secure a more stable partner."

Just as the large conglomerates have sufficient financing options that they don't need NPS' help, they also have strong in-house investment departments that are experienced in handling M&A issues. The SMEs, by contrast, do not.

According to an investment manager with a large conglomerate, smaller players lack the relevant experience and they don't have the resources to bring in third-party professionals - who come with their own networks - to form captive units that focus on overseas deal-making.

To be fair to NPS, it now appears to be addressing the SME space. While the first batch of partnerships under the COPA Fund focused on large conglomerates, the program is looking at ways to support mid-cap or even small-size companies. Excelsior's participation is an example of this evolution. The private equity firm strategy is to target at SMEs and help them secure partnerships overseas as well as looking at cross-border deals.

"A lot of Korean SMEs are in a growth phase. We like the entrepreneurial spirit in Korea and the high level of R&D spending on technology," Excelsior's Kent says. "For example, recently we had our China team help one of our Korean companies at a trade show in Beijing. We assisted in the research into potential targets and markets offshore. What we're looking to do is provide the company with capital, enabling it to move to the next level of expansion."

Value-add and influence

Foreign GPs like Excelsior and CLSA are expected to leverage their networks and market expertise in different geographies to source deals which will be benefit to the Korean corporates. Local private equity firms, however, may struggle to operate in markets that are less familiar. Under the COPA Fund scheme, the deal flow often comes from strategic investors.

"The corporate investors know the market. At least they have strategic reasons to invest in certain targets in Europe, America, or other places. They would certainly use the NPS funding to be competitive to acquire companies," says Alex Zhang, an attorney in law firm Kim & Chang.

In this context, it could be argued that less experienced domestic GPs are simply getting a free ride and add little value to the negotiation process. One local manager points out that some domestic GPs are not able to communicate effectively in English; they would be of little help to a corporate that wants to close a deal in Russia, for example.

The same criticisms can be made of certain corporates. Without experience and established networks in overseas markets, they are not able to put together a pipeline of deals despite actively looking for targets. This results in the passive participant, NPS, sitting on a pile of capital as the local GP and the corporate flounder.

Lee of Ropes & Gray puts it in more charitable terms: companies are reluctant to pull the trigger. "Even though many Korean companies are actively looking at overseas targets, they have been very selective about which deals to seriously pursue," he says. "For this reason, the high level of deal sourcing and screening activities by Korean companies to identify suitable overseas targets hasn't resulted in a corresponding increase in announced cross-border deals."

Based on the events of the past three years, private equity's role and influence in the COPA Fund program is limited. This is not altogether surprising given the corporates wield much of the decision-making power. In that case, would global private equity firms serve as better candidates? They are likely to have larger networks and generate more deal flow than the corporates might muster - but would a global firm want to get involved?

"In terms of partnering with international private equity funds, Korean corporates ideally could benefit from their global networks, management contacts, and vast experience and credibility in getting deals done," says Paul Kim, a partner at McDermott Will & Emery. "Some of the larger international private equity funds may not, however, necessarily be interested in partnering with local Korean companies to make acquisitions in their original home markets. It may not fit their investment model."

The structure of the COPA Fund is also a turn off for global and domestic GPs alike, according to one local manager. First, the management fees on offer are too low. Second, there are potential conflicts of interest when investing what is effectively NPS' money to best serve the needs of a single conglomerate. Securing exits at the right time and at the right price are a particular concern.

"Most large corporate won't consider IPOs and they don't really want to deal with minority shareholders," says Joshua Tree's Whang. "Meanwhile, over time they don't want to sell the acquired asset to another strategic buyer, especially when they want to integrate the business as part of their long-term corporate development plan. It is a bit difficult for private equity investors to maximize the investment return in such a restricted situation."

Instead of having one strategic relationship per fund, Whang suggests creating a fund that is more akin to an "open platform." Under this structure, the GP would be able to invite the most suitable strategic investors to look at a given opportunity. The governance regime would be better balanced and there would be a clearer path to exit.

However, exits may still not be completely liberalized. Working with a group of corporates rather than just one, would the GP be obliged to give its partners first refusal on any trade sale? And if so, how would these transactions be priced? This could limit the upside and effectively cap carried interest payments.

A more perfect union

The COPA Fund scheme remains a work in progress. It is not a perfect solution but if structured properly it does present an opportunity for domestic corporations to scale up their operations overseas and at the same time fertilizes the local PE community by allowing GPs to build up experience in outbound investments.

Meanwhile, NPS is increasingly willing to engage with foreign private equity firms. Also in 2011, the pension fund entered into a co-investment partnership with Standard Chartered Private Equity (SCPE), which completed at least four outbound deals. They included a $46 million commitment to nutritional beverage brand Smoothies Korea, which had outgrown its US-based franchisor and wanted to take control of the global business.

Another stand-out transaction saw NPS team up with Mirae Asset Private Equity and Korea Development Bank to support Fila Korea's acquisition of US-based Acushnet - owner of the Titleist golf equipment brand - for $1.23 billion in 2011.

Although it remains to be seen whether these partnership arrangements can deliver a high volume of transactions, Excelsior is keen to try. The firm believes that its approach, which resembles that taken by SCPE, will prove to be effective. "We invest in significant minority stakes in Korean growth companies, but we are not looking to take control. We invest alongside the major shareholders and try to help them with their business," says Kent. "In this way our interests are aligned."

In longer term, NPS is expected to deploy increasing amounts of capital in private equity - its asset base will more than triple in size over the next 15 years - and it will support the greater diversification offered by domestic GPs that are able to invest overseas. MBK has been active throughout North Asia since its inception and others are likely to try and follow suit.

"If domestic GPs want to grow bigger, they need to have more international capabilities," one Korea-focused manager says. "This is especially important given Korean LPs are willing to give more money to domestic GPs. The Korean market is limited so you have to go overseas."

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• Topics
• North Asia
• Buyouts
• Exits
• South Korea
• IMM Investment
• M&A
• Outbound investment
• CLSA Capital Partners
• buyout
• Mirae Asset Private Equity
• Exit