IN OCTOBER 2005, Hynix Semiconductor launched a $1.9 billion sale of shares, part of the stake held by its creditors acquired after the completion of what is arguably Asia’s most successful debt restructuring.
The stake, 23.4% of Hynix’s shares, was launched at a price of W19,300 ($18.43) a share. That compares with an estimated average acquisition price by creditors of about W12,000 a share. Creditors have already recovered nearly half of their total exposure to the Korean chipmaker. More significantly, the banks still hold 50.3% of the company. Based on the current share price of about W35,000 (see price graph) they are set for windfall profits as and when that stake is monetized. Credit Suisse recently issued a target price of W45,000. At the very least, the banks’ exposure is more than twice covered by the collateral held.
Hynix’s restructuring has been so successful that it is becoming a benchmark for similar deals in the region. Inevitable comparisons are being made with Asia’s largest and arguably least successful restructuring, that of Indonesia’s Asia Pulp and Paper. Although similar in size and nature, the Hynix and APP deals could not be more different in outcome [see Same start, different outcome, this issue]. Indonesia’s largest state lender, Bank Mandiri, has even sent a delegation to Korea to quiz the management of Korea Exchange Bank (KEB), the lead creditor for the Hynix restructuring, on the reasons why the deal worked so well.
Now Hynix is in a position to discuss with its creditors a possible to move to raise $1 billion in the equity markets. Whether or not they will agree is debatable, but it’s a sign of the company’s new-found confidence. That is entirely due to the restructuring, though its success was far from guaranteed when it first started.
Hynix was created from a merger between Hyundai Electronics and LG Electronics Semiconductor in 1999, a deal that sowed the seeds of trouble after the group assumed too much debt. There were more problems to come.
“It was a combination of three perfect storms,” says OC Kwon, senior vice-president at Hynix’s strategic planning office, and the man who led the company’s restructuring efforts from start to finish. “Like many chaebol, Hyundai carried a lot of debt: in 1999 we had more than W13.5 trillion in debt [approximately $12 billion at the time] and by 2001 we had W6 trillion falling due, just as chip prices went into free fall – by an average of more than 80%. The collapse of Hyundai Group meant that the credit umbrella had gone: we had no choice but to restructure the debt.”
Erasing memory
Hynix’s problems were not limited to keeping the banks at bay. As the company’s parlous financial position became apparent, customers and suppliers insisted that business with the company be done on strictly cash terms. “We needed a W1 trillion cash injection each month or we’d go bankrupt,” says Kwon. “Our annual interest burden was W2 trillion and rates were 20%. So we went to creditors and said: If you don’t do something, the company’s dead.”
| “What was the key ingredient here? It was that creditors took control of the company, changed management and restructured it” Robert Fallon |
The reaction of the banks was to seek a buyer for Hynix’s core memory business as rapidly as possible. It was a policy at odds with the management’s view, yet was supported by a Korean government eager to keep Hynix’s 14,000 workers in employment. “Hynix was an embarrassment to creditors following the collapse of the Micron deal,” says Anthony Steains, former head of mergers and acquisitions for Deutsche Bank in Asia, and the key financial adviser to Hynix throughout the restructuring.
That approach produced a deal with US semiconductor manufacturer Micron Technology, which offered to acquire Hynix’s memory assets then valued at $3.8 billion with payment in Micron stock. When Micron’s stock began to slide, however, the deal rapidly assumed a different character. “Micron refused to adjust the share exchange mechanism,” says Robert Fallon, chairman of KEB. “The Korean reaction was: ‘You’re kicking us when we’re down.’ After they signed heads of agreement, management of Hynix put the deal to the Hynix board, who unanimously rejected it.”
The banks and government were apoplectic and exacted retribution, with senior management at both Hynix and lead bank KEB sacrificed.
“The government wanted to avoid a catastrophic collapse of Hynix,” says Fallon. “There were thousands of employees and their preferred route was a sale to Micron. When the Hynix board rejected the bid the KEB chairman resigned and the president of Hynix was replaced too.”
Kwon was at the centre of the negotiations with Micron and says the board took a brave decision but one that was evidently correct, even during Hynix’s most straitened circumstances. “If the deal had gone ahead, Micron would just have taken advantage of Korean engineers and technology,” says Kwon. “They weren’t going to build new factories in Korea.”
Hard sell
With the Micron deal dead, Hynix and the banks were thrown together, like it or not. Although negotiations were difficult for months, a critical factor in moving the restructuring forward was that the future of the company’s key lenders was closely tied to the financial resuscitation of Hynix. That was a fact that took some beating into the banks. “The creditors had deal fatigue,” says Steains. “They’d just had enough and couldn’t see a way through.”
Kwon says: “It was very difficult and very stressful. We told the banks they had two choices: keep [Hynix] alive or liquidate. Recovery was below 20%, but keep it alive and there’s a possibility that you can recover all your money: the market can come back.”
That assertion was based on an unshakeable belief in the future of the company’s core business, says Kwon. The key was to get that message across to the banks, although they were left with little choice but to agree to a restructuring, given the extent of their exposure. “We felt that with the right financial structure we could be better than anyone,” says Kwon. “It wasn’t a blind gamble: our only problem was financial: how can you service W2 trillion of interest and W6 trillion of principal every year? It was a hard sell to the banks. They asked: ‘If you’re so good, why aren’t you making money?’ But fundamentally they had no option but to support the company. Their balance sheets were so weak that they couldn’t take the impact of the write-off.”
The numbers support this assertion: Hynix’s four largest creditors – KEB, Korea Development Bank (KDB), Cho Hung Bank and Woori Bank – each had exposure to Hynix of more than $1 billion.
“KEB lost $845 million on Hynix,” says Fallon, “and our capital adequacy ratio hit 6%. Plus there was more loss to come from the restructured loans: we were forced to provide against them.”
With the banks at best reluctant participants in a self-rescue of Hynix, the company and Deutsche Bank negotiated an intricate restructuring plan that comprised three key phases of debt recapitalization starting in May 2001, including loan rescheduling, an issue of convertible bonds, a debt write-off and a debt-equity swap that left the banks controlling almost 74% of Hynix’s equity. Remarkably, the restructuring entailed no new cash for the company, a prerequisite of the banks. Hynix was forced to survive on its own cashflow, something that it was able to do since even when chip prices crashed, the company made operating profits.
“We always generated positive ebitda,” says Kwon, “which means that the market price [for memory chips] never went below our cost price. That was a key reason we told the banks we would survive.”
Coopting creditors
Although the banks remained sceptical, they did at least continue to support the company. The implementation of Korea’s Corporate Restructuring Promotion Act (CRPA) a form of Chapter 11 protection under which Hynix was placed in October 2001, provided some assistance in corralling recalcitrant lenders. Equally important, though, was the change in management of lead lender KEB that led to new management being installed, including chairman Robert Fallon after US fund Lonestar acquired a controlling interest in KEB in 2003.
| From strength to strength: recent impact on Hynix share price of restructuring |
| Source: KEB |
“The CRPA gave us a framework of consultation with the banks,” says Steains. “Everyone was on the same page but it was still immensely difficult. Under the previous management, KEB was very reluctant to accept our advice: it took us months to convince them. Once convinced, however, creditors galvanized around the common objective of stabilizing and deleveraging the company. From the time that KEB ownership changed, the bank played a very proactive role in managing the series of transactions that we completed.” That role entailed keeping a syndicate of some 135 different banks and creditors in line, a task that Fallon admits was challenging. “It was very difficult to lead the 135 or so creditors,” he says. “Everyone had their own agenda and there were some who refused to cooperate. Some made comments that were naive or unrealistic.”
One of the most difficult creditors was KDB, which was, after KEB, Hynix’s largest creditor and still a 7.2% shareholder. A key supporter of the Micron deal, KDB was notable for resisting many of the new management initiatives following that deal’s collapse. “Under the terms of the CRPA, we only needed agreement of 75% of the creditor group to act,” says Fallon. “Fortunately we had that consensus.”
When the banks began to monetize their stake in Hynix, KDB was the only bank that refused to participate. According to statements made in the local press, KDB is keen to retain some control over Hynix given the turnaround.
The rehabilitation of Hynix did not rely solely on restructuring bank debt. Critical to the deal’s ultimate success and, simultaneously, repositioning Hynix for future growth was the operational restructuring undertaken by management. This entailed some key deals including a strategic alliance to develop NAND flash memory with ST Microelectronics signed in April 2003, the sale of Hynix’s system integrated circuits business to CVC in October 2004, and another joint venture with STM to establish a wafer fabrication plant in China in November 2004.
Turning point
Arguably it was with these deals that Hynix’s luck began to change. As DRAM prices recovered more rapidly than expected, the NAND flash memory joint venture with STM took off, with demand from cellphone and MP3 manufacturers far in excess of industry expectations. The result of Hynix’s early entry into this market is that the firm already holds a dominant position in the NAND flash market where, given market dynamics, prices and margins are much higher than in the company’s traditional memory chip market.
“We owe the start of this business to STM,” says Kwon. “They’ve been a great friend. They saw the potential of Hynix and were aware of our value even through the difficult times. The deal helped us to regain our confidence and pride. Now, we can’t meet demand. As fast as we produce, we’re sold out.”
In October 2004, Hynix completed the sale of its non-memory semiconductor business to CVC in a leveraged buyout valued at $954 million. The deal, which took almost two years to negotiate and complete, is perhaps the most visible turning point in Hynix’s fortunes. KEB’s Fallon proved critical to the consummation of the deal. “There’s a reluctance in Korea to let go of anything,” says Fallon, “and negotiations had stalled. CVC called me and said: ‘We’re about to walk: we’ve been negotiating this for two years but nothing’s happening.’”
Recognizing the significance of the deal for Hynix, Fallon convinced CVC to increase its offer price and agreed to lend CVC capital to fund the additional consideration.
“I don’t think any other Korean bank would have taken additional exposure to Hynix at that time,” he says. “When the dust settled, the deleveraging effect [on Hynix] was $1.2 billion and debt dropped by $1 billion.”
A clever deal structure entailed CVC buying back part of Hynix’s indebtedness to the banks at a discounted valuation, enabling Hynix to remove a significant debt burden from its balance sheet and book a profit on the disposal. Hynix creditors benefited since the discounted debt purchase had already been provided for, which meant they wrote back recovery of lost loans as well as receiving CRPA loan repayment.
The company’s joint venture with STM in China was equally crucial to Hynix’s future, says Kwon, especially in the light of countervailing duties levied on Korean chips by US and European authorities following the Hynix restructuring, arguing that the deal constituted a government subsidy. The Chinese location of the fabrication plant, which will manufacture 12-inch wafers, will enable Hynix to supply western customers with its product despite the duties. “Arguably, the European Commission did us a favour,” says Kwon, grinning, “It forced us to go to China.”
The China joint venture with STM makes sound economic as well as strategic sense. For a $500 million contribution, that includes $200 million of existing fully depreciated equipment, Hynix will control two-thirds of the venture.
Graduation day
In June 2005, Hynix completed a $1.25 billion refinancing of its CRPA debt with existing creditors, two years earlier than scheduled, through a $1.8 billion financing package including an issue of bonds and floating-rate notes, a syndicated loan and a credit facility. The company’s early graduation from the CRPA normalized relations with its creditors, removing many of the onerous financial and operating restrictions on the group. The deal also marks Hynix’s graduation from investment pariah towards blue-chip status.
| Kwon, Hynix: “We told the banks they had two choices. Keep Hynix alive or liquidate” |
The company reported strong fourth-quarter results for 2005 that show continued improvement in market share and profitability as well as a strengthened balance sheet. Debt to equity as at December 31 2005 stood at less than 30%. That compares with a ratio of more than 200% at the height of Hynix’s financial crisis. So dramatic has the turnaround been that Hynix is perhaps now underleveraged for a company of its size and profile. That might be so but it is of little concern to Hynix management now as the group continues to consolidate its position in its core memory chip business. The company oozes confidence. “The memory market will continue to grow,” says Kwon. “With continued digitization, especially NAND: even the PC market is growing. Supply growth is constrained for both DRAM and flash memory: it’s already an oligopoly: five companies supply 80% of the market. There’s not much room for new entrants.”
Even the prospect of the monetization of the creditors’ remaining stake in Hynix, a controlling interest of 50.1%, gives Kwon no cause for concern.
“The creditors should monetize,” he says. “It’s not their business to hold. The problem is, to whom and how quickly? There’s no feasible strategic investor, we’ve been on the market for five years. We were put up for sale at $1 billion and now our market cap is $15 billion – bigger than Micron! The most realistic way is for the creditors to sell in the capital markets.”
The disposal of a controlling stake in Hynix leads to worries about the potential overhang on the Hynix share price of such a huge capital markets process. Steains argues, though, that these concerns are overstated. “The most logical plan is to have an orderly monetization,” he says. “Who else would be a logical buyer for this business? The market’s already consolidated and it’s dominated by Hynix and Samsung.”
One bank that has special cause to consider carefully its future strategy over Hynix is KEB. The bank’s own future remains inextricably linked to the transaction. With a potentially ruinous credit exposure turned into probable windfall profits, the ownership of those profits and extracting value for them will be a key component to the imminent sale of KEB by Lonestar [see The long shadow of Hynix, this issue].
Human capital
While the banks consider their next move to cash in on the Hynix windfall, Kwon remains philosophical about the experience. “Since the debt restructuring we never borrowed any more money until the global bond,” he says. “The banks never gave us a single cent, even when we were in desperate need of cash. They just stood there and we had to survive. We’re very good at memory in Korea, but really it’s about people. All those big names in consulting – McKinsey, etc, came in and said: ‘It’s not possible’. They recommended we sell because they believed in physical capital: how can you survive without more capital? They were missing a big factor: the human capital. Money’s the same the world over, but humans aren’t.”
Hynix’s restructuring is a financial success for the company’s creditors but it is also a triumph for the company and its management team. As Hynix’s banks enjoy the extraordinary profits from the deal, it would be heartening to think that they have also learnt those human lessons from the process and might in future allow similarly sound companies an easier route to restructuring.
