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On August 3 the share price of Daesung Resources, a company in the normally underperforming mining sector on the Korean Stock Exchange (kse), stood at w171,000 ($209.82) about nine times its low for 1995.
Daesung shares had been climbing furiously between July 23 and August 2, hitting the daily permissible upper limit every single trading day. And just three weeks later, they had slid 35% from their peak. The rush on the shares was prompted by rumours that the government would permit the coal company to turn its mine sites into casinos. By mid-August, though, it became clear that the rumours had been just that. Moreover, analysts began to refer to Daesung as a chakcheonju, literally a "strategy stock" strategy in this case being an imaginative tale spread in order to drive up share prices and hoodwink gullible investors. In other words, Daesung had been the object of an old-fashioned ramp.
The Daesung caper is only the most recent indication that transparency is not one of the Korean stock market's strong points, in spite of highly publicized official promises to rid the market of unsavoury practices. In fact, on the eve of South Korea's hoped-for entry into the oecd, the Korean equity market still appears to maintain a high degree of tolerance for questionable standards of investor protection, unusual reporting practices by listed corporations, and capricious interference by bureaucrats.
But the bad news doesn't stop there. This year, Korea's key export industries were hit by a cyclical downturn, a sudden unfavourable change in exchange rates, as well as labour unrest. Late last year stock prices plummeted on news that the country's major business conglomerates had been funnelling hundreds of millions of dollars in off-the-book payments to two former presidents. And, as if that was not bad enough, in August the Kospi (Korea Shares Price Index) was down 20% from this year's high. The decline is, in large part, the result of too many new issues hitting the market.
One would think that, given such potential for downside risk, foreign investors would be dumping their Korean shares at any price. On the contrary, in spite of the deluge of bad news, foreign investors have increased their portfolios of Korean stocks by $2.6 billion since April 1, when the ceiling on foreign shareholding was raised to 18%. For the first six months of the year, foreign investors increased their net holdings on the kse by $3 billion. Moreover, in mid-August, many foreign institutions eagerly went bottom fishing while others lined up to pay premiums as high as 80% for the newly floated American depositary rights issue of Korea Mobile Telecom, even after the firm's shares declined by more than 16% over three successive trading days in Seoul, hitting the maximum permissible decline on each day.
Such bad news was by no means limited to Korea Mobile Telecom. The kse has been so illiquid that the Korean government has had to postpone plans to privatize Korea Telecom, the domestic phone carrier. All the same, foreign analysts and investors still want to accentuate the positive about Korea.
"Korea's problem is that its products are no longer the cheapest but they are not yet at the top end, so Korean firms have to compete in the middle where competition is the toughest," says Ed Merner, a Tokyo-based senior executive of fund-management firm Atlantis. "The fact is that in the end you can count on Korea to get things right," says Merner, who has managed several Korean funds in the past. "If you bought Korean stocks in the early 1980s, in the deep recession that followed the assassination of president Park Chung Hee, you'd be doing very well now. There'll be some rough ups and downs, but you have to know how to ride the waves if you want to do well in the Korean market."
Led by electronics
It is this kind of optimism that has been driving foreign investors toward purchasing shares in Korean telecommunications manufacturers, non-life insurers and banks, as well looking for bargains in the depressed semiconductor industry.
Suh Sung-won, electronics analyst at Deutsche Morgan Grenfell's Seoul office, is among the most optimistic observers of the Korean market today: "Although the economy is experiencing a slowdown, the government is committed to spending w45 trillion over the next 20 years on the Korea Information Infrastructure Project." Suh adds that more than $12 billion of the total $55 billion has been set aside for a fibre-optic cable network to link every town and village in South Korea in faithful imitation of us vice-president Al Gore's information superhighway concept. An immediate beneficiary of this announcement has been Sungmi Telecom, Korea's largest manufacturer of fibre-optic transmission equipment. In contrast to the general collapse of share prices in the rest of the Korean electronics industry, Sungmi's shares climbed from w70,000 earlier this year to a peak of w220,000 won earlier this summer. In mid-August Sungmi shares were changing hands at w189,000. lg Information and Telecommunications is another firm expected to benefit from the Korean telecoms boom. Counting the effect of a 10% bonus issue, lg's shares have almost doubled in six months at a time when the Kospi index as a whole slipped to 780 from a high of 980. One indication that the Korean government is committed to keeping up with the rest of the world in telecoms was its sudden decision earlier this year to grant licences to 27 telecoms carriers.
Analyst Suh is upbeat even about Samsung Electronics. The company raked in a record $3.1 billion in profits last year, thanks to high demand for dram computer memory chips. All that changed when Samsung reported profits of $558 million for the first six months of 1996. Given the decline in dram prices, some analysts have begun to worry whether Samsung may actually break even next year. Samsung's shares plunged from a high of w111,000 on April 25 to w65,100 on May 30 a 41.3% loss. Although a senior Samsung executive told Euromoney in July that the firm has developed alliances with Intel and Motorola to diversify into high-value-added non-memory chips, Suh is recommending Samsung because of the company's position as the undisputed world leader in drams. "The secret of survival in the dram market is to keep on investing in bad times," says Suh. "Samsung can afford to do so while its Japanese and Taiwanese competitors are showing signs of pulling back." There is an added incentive for those foreign investors with nerve to buy on weakness: for the first time in years, foreigners can purchase Samsung Electronics shares without having to pay a premium.
Analysts also expect non-life insurers, such as Dongyang, Dongbu, Samsung and Hyundai, to increase profitability in the second half of this year. This is because government-mandated motor insurance premiums are being raised. The government also provided some good news this year for Korea's otherwise weak banking sector by lowering the reserve requirement ratio for bad loans from 9.4% to 7.4%. Although an analyst at a branch of a foreign securities company in Seoul called the move "a cynical book-keeping measure aimed at improving the declining profitability of Korean companies as a whole", lowering the reserve requirement raised the average loan spread of the country's seven major commercial banks to 3.69% for the first six months of 1996. The government has also made it clear it would encourage mergers in the banking sector in preparation for the increased competition from foreign banks that are expected to move into Korea once Seoul's entry into the oecd is approved.
In a recent report, analysts at Coryo Securities list Kookmin Bank, Korea Exchange Bank (keb) and three provincial banks Pusan, Daegu and Kyungki as likely players in merger and acquisition scenarios. It is widely believed that Kookmin and keb are complementary institutions: the former, once designated by the government to handle small company loans, has an extensive domestic network, while keb, a specialist in foreign exchange, has overseas experience but a less developed domestic base. The provincial banks are seen as potential providers of branches for Seoul-based commercial banks. Indeed, in the first six months of 1996, of the six most popular stocks among foreigners, five have been bank issues.
But the reason for the flurry of foreign buying in the banking sector is not so much desirability as availability. Earlier this year, among more than 700 stocks on the kse, only 88 had reached the 18% ceiling put on foreign investment. This is because listed companies are capitalized at low levels, making them unattractive for purchases by large foreign institutional investors. Worse still, as the Daesung caper indicates, lack of transparency and poor supervision make the majority of small-cap stocks a dangerous place for foreigners to tread. In late July, for example, the weekly stock market report in the Korea Herald pointed to "news of possible investigation of stock price manipulation of small- and medium-cap stocks that had shown a rapid rise recently" as a reason for a decline in stock prices. It is interesting to note that once the government made clear that there would be no investigation, share prices recovered, at least temporarily.
But the Daesung caper is more than just a minor blemish on the reputation of an otherwise active market. As indicated by kse figures, in terms of turnover the Seoul market ranks ninth in the world at $185 billion per year. But given the low level of market capitalization and the large number of small- and mid-cap issues, what these figures seem to indicate is that this high turnover is achieved through frequent trades, often aimed at speculative short-term gains. In other words, in spite of the highly publicized elimination of false-name transactions by president Kim Young Sam in August 1993, a move that did much to drive undeclared grey funds managed by wealthy individual investors from the stock market the kse has yet to rid itself completely of its past reputation as a speculation-driven market where anything goes.
At the moment, however, it would appear that the kse's imperfections accurately reflect the business standards of a large number of Korean companies. Earlier this year, Yu Han-soo, president of the prestigious posco Research Institute, raised serious questions about the accuracy of corporate reporting in Korea. Writing in the Seoul Economic Daily, Yu recalled that after the introduction of real-name financial transactions in 1993, the press began to report a sudden increase in gold imports; this was interpreted as meaning that underground funds had at long last surfaced and begun to move into other areas of business activity in Korea. It turned out that the gold imports were part of a ruse engineered by Korean trading companies to artificially inflate their trading volumes. Once the companies had succeeded in driving up their trade volume they resold the gold abroad. Yu also pointed to the same practice among department stores, which "just before the end of each year artificially inflate their sales by using the credit cards of store employees. Once the sales are recorded, the charges are cancelled". According to Yu, the same is true on the kse where securities firms regularly inflate the volume of transactions by selling and then buying back shares in their custody. Yu concludes: "For these reasons, data on the volume of securities transactions are generally unreliable."
Korea's biggest scandal of this year has been the trial of former presidents Chun Doo-hwan and Roh Tae-woo in connection with maintaining huge slush funds, obtained through shakedowns of Korea's powerful business conglomerates, the chaebol. One fallout from this has been a focusing of public attention on the accounting practices of Korea's listed corporations.
It turned out that contributions, such as Samsung's $33 million into the coffers of ex-president Roh, did not appear on any corporate balance sheets at least none presented to shareholders. Roh admitted taking several hundred millions in unreported contributions from Korean companies. kse chairman Hong Inkie has pointed to the "crippling political scandals involving two former presidents' secret funds" as one of the major reasons for the bearish mood of the Korean stock market since last year.
Towards transparency
The kse under Hong is considering taking action to assure a greater degree of transparency for individual investors. An aide to Hong told Euromoney recently: "If you have holdings of 3% in a company you will have the right to demand to see the books." But, given the relatively tight cross-holdings of chaebol companies and the tiny portions of individually held shares, one wonders just how far such a 3% rule will go to further the cause of transparency in corporate reporting.
In July the ministry of finance and economy (mofe) did make an attempt to respond to popular indignation over financial hanky-panky. The mofe unveiled what officials called the "Korean Big Bang", a package of reforms aimed at guaranteeing a higher quality of ipo issues. The move was in response to the most recent scandal to hit the kse, the arrest on June 2 of Paik Won-ku, chairman of the Securities Supervisory Board, for receiving bribes from corporations wishing to have their shares listed on the kse.
But the view of at least one commentator in Seoul is that while the mofe will have decreased the arbitrariness of the ipo process that allowed Paik to accept bribes, the new rules for listing have been tightened to such a degree that of the 200 companies waiting to be listed some two-thirds will no longer qualify. In other words, what mofe gave with one hand, it took away with the other.
It is too early to gauge investor response to this Big Bang. mofe's decision to combine the unveiling of the reforms in ipo regulations with an announcement of measures aimed at placating oecd negotiators resulted in a sudden drop of 2.6% in the Kospi. Among the measures announced together with the Big Bang was a pledge to suspend use of the Stock Market Stabilization Fund, a pool of capital the government delved into in the past to prevent prices from dropping too low. The incident illustrates a special cultural feature of the Korean market, in that individual investors, who account for 40% of stock ownership, continue to exhibit a strong faith in government action to help prop up the market in bad times.
Moral force of officialdom
Among many reasons for the persistence of this attitude are: the traditionally strong role of government officials in Korea; the fact that the recent dramatic growth of the kse has been the result of government guidance; and the traditional belief that officials should exert a moral force to ensure fairness in the market. These differences in expectations between Korean individual and international institutional investors came to a head two years ago when prices of Korean blue-chips, such as Samsung Fire and Marine, Samsung Electronics and Korea Mobile Telecom, soared, while small- and mid-cap shares, the preferred investment instruments of local individuals, languished.
At that time the government actively intervened to help small individual shareholders, creating a spate of new regulations by fiat which made purchases of large-caps expensive and inconvenient. Although the attempt to appease local investors backfired, because foreign institutions temporarily became net sellers, it remains to be seen whether Korean officials will be able to resist local pressure to intervene in the market. One question being asked is why the Stock Market Stabilization Fund is being suspended as Korea is waiting for a response from the oecd on its membership and not totally disbanded, as might be expected if the mofe were truly serious about turning over a new leaf.
For the most part, however, watchers of Korea's stock market are putting the blame for the present downturn less on Korea's regulatory environment than on the crisis facing the economy as a whole. "The most important indicator for how the stock market does is the current account balance," the kse's Hong told Euromoney in a recent interview. Hong said the kse commissioned a study in which it found a 0.88 positive correlation between movements in the current account balance and the Kospi: "That's almost as good as one to one." Put simply, this means if Korea's exports rise, so does its stock market. In the case of the Samsung chaebol alone, profits from Samsung Electronics' dram exports accounted for more than 80% of profits for the group as a whole.
Earlier this year, however, the performance of chaebol exports which as recently as 1994 accounted for 57% of Korea's total exports began to show serious signs of deterioration. In May and June of this year, Daewoo Motors, which recorded a 150% increase in exports in 1995, was unable to meet monthly targets. Orders and prices were declining from all corners, in semiconductors, automobiles and ships. To compound the difficulties of Korea's cyclically vulnerable industries, the Japanese yen, which had soared high enough in early 1995 to cripple many of Korea's Japanese competitors in overseas markets, suddenly declined by 25% against the us dollar. The change in currency values greatly restored the competitive edge of Japanese exporters.
But the low yen was not Korea's only problem. The majority of Korean business leaders appear to think that the deterioration in the competitive abilities of Korea's industries goes much deeper. Of 1,000 corporate executives surveyed by the Korean International Trade Association, 38% said the quality of Korean products falls below that of the competition, some 61% said they are dependent on foreign technology and an equivalent proportion said that they had made no provisions for after-service of their export products. In this present recession it has become clear that Korean companies lag behind their Japanese competitors in two key areas: r&d expenditure and labour-management relations. As a proportion of outlays, South Korean firms spend less than half of what their Japanese competitors do on r&d.
As for labour, in spite of average annual wage increases of 15% since 1990, South Korean workers staged walk-outs at major motor and auto-parts manufacturers this year. Korea's contentious labour climate has been seen as the main reason for the mass migration overseas of major Korean corporations. Daewoo, for example, has recently invested in car plants in Poland and India; and Kia, another car maker, has pledged to sink $1 billion into a car plant outside Moscow. But the problem is not simply a matter of labour cost. As far back as two years ago, when Korea's three export jewels cars, ships and semiconductors were still glowing brightly, a team of reporters from Weekly Choson, a magazine published by Korea's largest newspaper, pointed out that Korean car makers were 15 years behind their Japanese competitors in technology; that a Korean car worker produced less than half the number of cars per year that a Japanese worker does; that Japanese shipyards produced the same kind of ships as Korean yards in less than two-thirds of the time; and that Korean semiconductor makers faced trouble ahead because they failed to make investments in non-memory chips.
The consensus among analysts monitoring Korean industries is that the kse will recover only when Korean industry has addressed issues of quality, labour and efficiency. To add to the difficulties of Korean industry, bank interest has risen. Korean corporations are heavily leveraged and as a result are capital-hungry, even in bad times. The rise in corporate bond rates from about 10% to more than 12% in the past six months has also exacerbated the kse's liquidity problems as investors transfer their money from a risky market into safe bank deposits.
But for those who want to accentuate the positive, there are at least three factors which could help propel the Kospi upwards, albeit for technical reasons. First, a double taxation agreement is expected to be signed between Japan and Korea later this year. This will make it possible for Japanese investors to participate in the Korean market far more easily than before. Given the unimpressive performance of Japanese stock markets in recent years, a fair number of Japanese investors can be expected to diversify into Korea. More funds can also be expected from other overseas sources as the kse will raise its ceiling on foreign participation by 2% later this year and then by 3% per year from 1997 to 1999, finally eliminating the quota altogether in 2000.
Every time the ceiling has been raised so far, foreign funds have poured in by the billion in both good times and bad. AH
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