The hospitalization of Lee Kun Hee, the 72-year-old head of Samsung Group that includes Asia’s biggest technology company, has heightened scrutiny of succession planning at South Korea’s family-run conglomerates as they hand control to the next generation.
In contrast to the 1980s and 1990s, when many current chaebol chairman took charge, wealth transfer is taking place amid tighter controls and growing activism against governance perceived to harm minority shareholders, including the system of cross shareholdings that has allowed the families to control their groups despite holding only small stakes.
With the chairmen aging and scions facing large inheritance tax bills, the chaebol are under pressure from the government and investors to unravel cross shareholdings and form holding companies with a more transparent ownership structure that also free up capital. Speculation that the process will now accelerate at Samsung has lifted the market capitalization of Samsung’s 17 listed companies in recent weeks.
“There is the implicit problem of the ticking time bomb for the chaebol heirs,” said Shaun Cochran, the country head of South Korea at CLSA Asia-Pacific Markets. “They know that if the market loses faith in the family to run the company without the chairman alive, then they become more vulnerable, because right now, in some instances they don’t directly control the stock.”
Tax incentives aimed at encouraging the chaebol to unwind cross shareholdings mean there’s a 50 percent chance that key Samsung companies will be split into holding and operating companies within 18 months, CLSA said in a report published yesterday. President Park Geun Hye has also banned the creation of new cross shareholdings as part of legislation to improve corporate governance.
Samsung’s Lee, South Korea’s richest person, and his family control 49.7 percent of Samsung Group’s 74 companies while holding a combined 1.53 percent stake, the Korea Fair Trade Commission said in a report published last year. Lee’s holdings include 3.38 percent of flagship Samsung Electronics (005930) Co.’s common stock and 0.05 percent of its preferred shares, 21 percent of Samsung Life Insurance Co. (032830) and 1.37 percent of Samsung C&T Corp. (000830), according to data compiled by Bloomberg.
Lee’s son, Lee Jae Yong, who became vice chairman of Samsung Electronics Co. in December 2012, faces a tax bill of about 2 trillion won ($2 billion) to inherit his father’s holdings in Samsung Life, viewed with unlisted Samsung Everland Inc. as the keys for controlling the group if it shifts to a holding company structure.
The younger Lee may use the listing of systems integration unit Samsung SDS Co. this year to finance the tax payment, say analysts including Park Joong Sun at Kiwoom Securities Co. Shares of Samsung’s 17 listed companies have gained a combined 14 trillion won in value since May 7, the day before Samsung announced plans to list SDS shares on the Korea Exchange.
One potential model for restructuring would be a merged Samsung Electronics, Samsung C&T and Samsung Everland into a holding company, analysts said. Samsung Group declined to comment on the group’s restructuring plans in an e-mail.
How SDS fits into Samsung Group’s succession has long been controversial. The elder Lee was pardoned by former President Lee Myung Bak after a court in 2009 found him guilty of causing losses at SDS by selling convertible bonds to his son at artificially low prices in the 1990s.
“For Lee Jae Yong and his siblings, Samsung SDS only has value as leverage for the succession,” corporate watchdog CEOSCORE President Park Ju Gun said in an interview. “Despite being the nation’s best systems integration company, SDS isn’t globally competitive. That will need to change after its role in helping the succession is over.”
LG Group was the first of the major chaebol to streamline its corporate structure using holding companies, according to the Seoul-based Center for Good Corporate Governance, which monitors the conglomerates. The group split its main chemical and electronics businesses into operating and holding companies, and merged the holding companies to form LG Corp. (003550)
“The groups that have historically relied on affiliates for cash to start new businesses cannot turn to circular shareholdings anymore,” said Park at CEOSCORE.
Chaebul.com, another chaebol watchdog, estimated most recently in 2012 it would cost as much as 27.6 trillion won for the nation’s six-largest conglomerates to reorganize into holding companies -- 10.8 trillion won alone for Hyundai Motor Group, the umbrella group of the nation’s largest automaker. The Center for Good Corporate Governance estimates the total cost to be about 6 trillion won for Hyundai.
The task at Hyundai is greater than at Samsung because Chung Eui Sun, 43, Chairman Chung Mong Koo’s son and probable heir, holds no meaningful stakes in Hyundai’s core companies. At Samsung, Lee Jae Yong does hold 25 percent of Samsung Everland, likely to be a key part of any restructuring.
At Hyundai, the cross shareholding system underpins the group’s ownership structure. The elder Chung, 76, owns stakes in five of the group’s 11 listed companies, including 5.17 percent of Hyundai Motor Co. (005380), 6.96 percent of partsmaker Hyundai Mobis Co. (012330), 11.51 percent of logistics company Hyundai Glovis Co., 11.84 percent of Hyundai Steel Co., and 10 percent of Hyundai Hysco Co., according to regulatory filings.
The key to Chung’s overall control of the group’s 57 companies lies with Hyundai Mobis, which owns 21 percent of Hyundai Motor. South Korea’s biggest automaker in turn holds 34 percent of Kia Motors Corp. (000270), which has 17 percent control of Hyundai Mobis. Chung’s son Eui Sun owns none of Mobis, and less than a percentage point of Hyundai Motor, according to data compiled by Bloomberg.
Chung Eui Sun’s inheritance tax is likely to exceed 3.5 trillion won, according to Chae Yi Bai, a researcher at CGCG, which means he may have to give up all of his holdings in Hyundai affiliates in order to get his father’s holdings, estimated to be worth over 7 trillion won. Instead, the group may try to raise the value of shares that Eui Sun owns or lower the value of those he needs to buy to take over, Chae said.
“It’s pretty clear that Chung Eui Sun is going to be the next chairman of the Hyundai Motor Group,” Chae said. “It’s also pretty likely that there will be losers and collateral damage during the process of making him the chairman.”
One clue may be Hyundai Glovis, a logistic services provider already 32 percent owned by Chung Eui Sun. The Chungs, Hyundai Motor, and the Hyundai Motor Chung Mong-Koo Foundation together hold 53 percent of Glovis worth about 5 trillion won, according to data compiled by Bloomberg. Glovis shares have surged 61 percent in the last three years as of yesterday, compared with a 22 percent fall at Mobis, a 21 percent drop at Kia, and a 4.9 percent drop in the benchmark Kospi index.
The elder Chung may also make use of tax-free donations to smooth the transfer of power. He donated his Glovis shares, worth 17 percent of the company’s total shares, to the Chung Mong-Koo Foundation in exchange for being pardoned from a jail sentence for embezzlement in 2008. With its holdings, the foundation will back the Chung family at shareholder meetings, strengthening the Chungs’ governance over the group.
The strategy isn’t without risk, CLSA’s Cochran said.
“If the regulators were to target this practice and say that the tax exemptions only apply to charitable foundations with no relationship to the benefactor, this loophole could be easily closed,” he said.
In a group restructuring, Hyundai Mobis would probably become the holding company, CEOSCORE’s Park said. That would require severing the cross holding structure between Mobis and Kia to put Mobis at the top of the structure. Eui Sun will probably try to acquire Kia’s 17 percent stake in Mobis to increase his hold on the new holding company, he said.
Given the growing opposition to cross shareholdings, that’s something that Hyundai should be doing anyway, he said.
“Cross shareholdings cannot last because it’s become the Achilles’ heel for the chaebol,” Park said.
Hyundai Motor declined to comment in an e-mail on whether the company has plans to change its corporate structure.
Window for Change
After President Park fulfilled her election pledge to ban new cross shareholdings, the groups may have almost four years to the end of her term to complete restructuring before they again become caught in the cross-hairs of an election.
Transportation conglomerate Hanjin Group last year broke up its system of cross shareholdings that had given Chairman Cho Yang Ho, 65, control primarily through his 9.6 percent stake in Korean Air (003490) Lines Co. The group split Korean Air into two companies, and listed the Hanjin Kal Corp. (180640) as the group’s holding company in September.
Pressure to change is not always welcomed by the companies themselves. Limiting or banning cross shareholdings would put pointless pressure on companies, cause investment to shrink and hamper job creation, the Federation of Korean Industries said in August 2012, ahead of the presidential election. It also makes companies vulnerable to foreign takeovers, it said.
That’s not the view of the International Monetary Fund, which blamed the chaebol’s system of cross shareholdings and hidden debts for contributing to the nation’s 1997-1999 financial crisis, which led to the collapse of the Daewoo and Hanbo groups and forced South Korea to seek a bailout.
Still, structural changes may not alter the family-centric management of Korea’s chaebol, CLSA’s Cochran said.
“People take orders from MK Chung because he is the chairman. Why’s he the chairman? Because he is a member of the Chung family and fought an internal family battle for the share of group assets that he controls today,” he said, referring to Hyundai Motor Group Chairman Chung. “The family control of these companies in many respects has nothing to do with how much they own. It’s cultural.”
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