Korea M&A: Regulatory relief

The agreement that saw South Korean PE firm Hahn & Co. take a 76% stake in Hanjin Shipping's bulk carrier business for KRW400 billion ($380 million) was predicated on the ailing shipping conglomerate's need to shed assets and pay down debt. The sale is part of a restructuring through which Hanjin hopes to raise KRW1.5 trillion through divestments and source an additional KRW444 billion in loans.

It fits neatly into a broader trend in Korea where cash-strapped conglomerates, many still feeling the sting of the global financial crisis, have been forced to jettison assets. The way the deal was structured was also typical of the circuitous paths Korean GPs often need to take when looking to carve out these lucrative assets.

Hanjin's assets will be spun out into a new joint venture, with Hahn & Co. holding 76% to the shipping conglomerate's 24%. The PE firm paid KRW400 billion for its share while assuming around KRW1.4 trillion in debt.

Were the GP a foreign vehicle this might not have been necessary. But as a locally-registered private equity fund (PEF) Hahn & Co. qualifies for a welcome capital gains tax exemption as well as some less welcome restrictions. These include being prevented from buying business units from Korean companies directly; the target must be a third-party entity.

It is hoped these limitations will be lifted as the country's Ministry of Strategy & Finance (MOSF) announced a set of regulatory changes to this month intended to make life easier for PEFs and local companies to participate in M&A transactions. What remains to be seen is how exactly these reforms will take place.

The changes - revealed as part of a three-year "economic innovation strategy" focusing on regulatory reform across a number of financial services segments - are expected to come into force in the second half of this year. They are intended to help facilitate the sale of an estimated KRW10 trillion in assets held by struggling conglomerates.

"The government wants to have a more efficient M&A market in a broader sense but the immediate objective is to provide some solutions for distressed companies," explains Jong-Koo Park, an attorney with law firm Kim & Chang. "There have been previous amendments to the private equity laws over the years - for example, rules regarding GP registration - but this time the government is looking to help private equity carry out transactions more easily."

M&A boost

The announcement comes against a backdrop of relatively strong deal flow. According to AVCJ Research, Korean buyouts reached $4.99 billion in 2013 across 27 disclosed transactions, the highest annual total on record. This pushed PE investment in the country to a high of $9.1 billion.

The largest recent deal was local GP MBK Partners' $1.67 billion acquisition of ING Life Insurance Korea, while there have been a number of others emanating from conglomerates under political and financial pressure to refocus on their core operations. MBK picked up water purifier business Woongjin Coway from the distressed Woongjin Group and Affinity Equity Partners bought digital music platform Loen Entertainment from SK Telecom.

However, it is the broader M&A market the government wants to see expand, with the MOSF wanting deal flow to grow from KRW40 trillion in 2013 to around KRW70 trillion by 2017. This involves encouraging PEFs which, according to Korea's Financial Supervisory Service, accounted for just 0.47% of GDP in 2012, compared to 0.72% in the US and 1.22% in the UK.

At the same time, the government reported that a total of 45 PEFs were established in the country last year, down from 60 in 2012.

Currently regulation of private equity in Korea is widely seen to be excessive and complex compared to more developed markets. It is one of relatively few jurisdictions, for example, in which GPs are required to register in order to qualify for local tax treatment.

The exact form the proposed changes will take is not yet known but the government has said regulations will be eased at the fund creation and investment, management and sale stages of the M&A cycle. In addition to making it easier for a Korea GPs to pick off attractive businesses from a parent company, the government will also streamline tax and financial support systems and rationalize the overall M&A procedure.

"For example, PEF's were previously required to hold a stake in a business for six months, but now they will be able to sell a portion of that stake so long as they can meet the minimum requirement of share ownership and management participation," says Kim & Chang's Park. "If the rule changes a GP will be able sell a portion of its stake as long as they maintain 10% ownership in the target company."

The reforms are not limited to facilitating carve-outs from distressed conglomerates but also seek to encourage corporate takeovers and investment in venture start-ups.

"The government's second objective is to support mid-sized companies. There have also been a number of initiatives around helping the overseas M&A of mid-sized companies," says Jay Kim, a managing director with Alvarez & Marsal.

Steps include enlarging the size of the Growth Ladder Fund, which was established by the government to help start-ups and their activities, to KRW3 trillion ($2.8 billion) from the current KRW1 trillion within three years. Meanwhile, tax benefits for M&A transactions carried out through share exchanges will increase and taxes levied on mergers of listed corporations will be reduced.

"The deregulation will open up more opportunities for venture companies for exit," adds Brian Koo of LB Investments. "And it will also give mid-size companies the chance to expand by buying domestic and foreign companies."

Overseas angle

But where does this leave overseas GPs who do not come under the purview of the legislation? The sizeable deals seen so far indicate that foreign investors will continue to have a big role to play in Korea's M&A market.

January saw the region's biggest ever PE exit when KKR and Affinity sold Oriental Brewery to Anheuser Busch InBev for $5.8 billion. And then this month The Carlyle Group acquired US-based Tyco's South Korean home security business for $1.93 billion. It is the largest-ever buyout in the country by a global private equity firm.

"The year started off with quite a bang because there have been a couple of huge deals coming out of Korea that have involved foreign PE funds," says Jaewoo Lee, a partner with Ropes &Gray in Hong Kong "Generally, public sentiment, media coverage and the government announcement all signal a positive environment for private equity."

The view is echoed by Kim & Chang's Park, who adds that any indication of the government liberalizing its stance on PE is good for both domestic and international funds as it shows that broader public opinion of private equity has improved when compared to a decade ago.

Another facet to this, however, is whether efforts to encourage greater involvement from Korean GPs in the M&A market might lead to global funds facing greater competition from domestic players. Indeed, many of the larger transactions in recent years have seen local firms bidding against their global counterparts. However, Ropes &Gray's Lee does not a see fundamental change.

"While I think in some ways this might foster more competition among PE funds going after the same targets, the broader picture is that many of the key players have been quite successful already, so I don't feel the changes proposed will affect the landscape greatly." he says.
Nevertheless, this promised progress must still be seen in the context of South Korea's track record for PE regulation.

Alvarez & Marsal's Kim observes that, given local PE regulation was much stricter 10 years ago, recent developments merely suggest a levelling of the playing field. "I think the general sentiment is that local PE funds are happy with the move but buyout funds would probably like more regulatory guidance and clarity on taxation and LBO issues," he says.

Equally, Kim & Chang's Park stresses that the tax issue is not thoroughly addressed in the announced package of liberalizations - although he is optimistic there may be movement in this area too. "We should wait and see what the government does," he says. "They may think about it."

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• Topics
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