Showdown In Korea
`Taming wild horses." That's how South Korea's Lee Hun Jai describes his job. But the animals in question aren't ponies romping on Korea's windswept slopes. Lee means the chaebol, the giant business groups that have long ridden roughshod over the economy and whose gluttonous borrowing triggered Korea's economic meltdown last year. Lee, 54, is a career civil servant whose zeal for reform has led to death threats in the past. Now, as chairman of the Financial Supervisory Commission (FSC), he has to straighten out the financial and corporate sectors. He has quickly reshaped Korea's banks. But he's having a tougher time with the chaebol. "Sooner or later, we'll put the saddle on them," he says.
But wait. Weren't Korea's big conglomerates supposed to be so severely whipped by the crisis that they would follow quietly along the path of reform? Weren't they promising to sell off assets and streamline operations in order to emerge leaner and more comPetitive than before?
It hasn't happened that way. The chaebol are fighting with the ferocity of cornered animals to preserve the only structure they know: one that values size over profitability, diversification over specialization, and massive debt over a solid equity base. "I am really unhappy at their slow progress," says Lee.
Nowhere is this desire to preserve power greater than in the boardrooms of the Big Five chaebol: Daewoo, Samsung, Hyundai, LG, and SK. These titans have long dominated the Korean economy. And to the amazement of observers, they have actually strengthened their grip since the crisis began. One year after Korea's momentous decision to seek assistance from the International Monetary Fund, fundamental reform of the top chaebol is as elusive as ever.
HEAVY BREAKFASTS. The unwillingness to change has set the stage for a battle pitting President Kim Dae Jung and his band of determined reformers against Korea Inc. Kim has summoned the heads of the five leading chaebol to the presidential Blue House for an unprecedented session to demand urgent reforms. Meanwhile, Lee and other officials have laid down the law to the chaebol at recent breakfast meetings, making it clear they expect to see more than a few token asset sales. And they've drafted stiff regulations to cap off debt levels, mandate consolidated financial statements, and eliminate cross-guarantees for debt.
Seoul officials are convinced that if the chaebol are not reined in, the economy could end up with not only a Japanese-style recession but also a second crisis. "This is the real war against our old backward institutions," says Lee Yoon Jae, a senior economic aide to the President. If they don't prevail, "there's no hope for this country. This is our last chance."
The reformers' argument is simple but compelling. Despite their tremendous achievements, the top chaebol are now a tremendously destabilizing force. They suck up the economy's available credit, smothering opportunities for smaller businesses. Their focus on size rather than profits leads them to squander capital by churning out commodity products. Their huge debts hold the banking system hostage, since no bank can afford to let a top company fail. In global industries, the chaebol's practices put Korea at a disadvantage. A recent McKinsey Global Institute study found that productivity in South Korea was only half U.S. levels in key industries. If Korea is going to grow again and if its enfeebled banks are going to rebuild themselves, the chaebol need to strip down to core businesses and improve productivity.
The showdown between the chaebol and the reformers comes to a head this month. The government has set a Dec. 15 deadline for the chaebol to come up with plans for big mergers and comprehensive restructuring. That's in keeping with an end-of-the-year deadline from the IMF for the chaebol to improve corporate finances, reduce debt, and cut reliance on bank loans--conditions of the IMF's $58 billion bailout package. As the deadline approaches, the government has kept up a steady stream of public announcements intended to bully the chaebol and their bankers into reforming. They've moved to crimp bank lending, and, lately, to restrict access to the bond market---to shatter the corrupt ties that have welded the chaebol, banks, and the state into an iron triangle of cronyism.
The angry rhetoric of the government has stunned chaebol executives. "We sacrificed our lives for the economic development of the country," protests Lee Sang Hoon, Daewoo Corp.'s senior managing director. Now, he adds, the chaebol are being blamed "for having close ties with politicians, for taking advantage of economic development to be personally rich. That is not fair."
The chaebol also complain that the government is acting in a blatantly interventionist manner. It's certainly true that frustration at the slow pace of reform is pushing the Kim administration to take more of a hands-on approach. Lee Hun Jai and his FSC staff, for example, go over chaebol restructuring plans with a fine-tooth comb and send back those they don't like. The impatience of Kim's team raises the danger that they may act rashly, forcing the chaebol into mergers that don't make business sense just to effect change. The government is also still unwilling to shut down excess capacity because of the impact on unemployment, which is at record levels.
SWEET DREAMS. But the chaebol keep dragging their feet. Debt-to-equity ratios at the top 30 chaebol have swelled from 400% last year to an average of 550% now. They have begged the government for more time to clean up their books--and used the breather to go on a borrowing binge. The Big Five have been the best at defending their turf. As interest rates have eased, they have backed off negotiations to sell ailing units and instead borrowed more money. Domestic debt by the Big Five rose 12% during the first 10 months of the year, to $128 billion. As banks called in loans, the big chaebol have instead raised $40 billion selling new bonds, commercial paper, and stock. "The more the government tries to merge them, the more they dig in," says a veteran foreign executive. "The chaebol aren't going to be forced into reforming themselves."
Take Daewoo. Chairman and founder Kim Woo Choong has long aimed to become one of the world's top 10 auto makers. It is No. 17 now. Unwilling to let go of that dream, Kim is tripling Daewoo's capacity in Poland, to 670,000 vehicles a year. In India, the $71.5 billion group is expanding despite an auto glut there.
Yet Daewoo can't even begin to sell all the cars it now makes. Analysts say Korean carmakers have had to scale back to just 53% of capacity. In November, Daewoo and other auto makers were fined a total of $1.6 million for forcing employees to buy their cars. Daewoo strong-armed workers at its recently acquired Ssangyong Motor Co. unit to buy Daewoo cars in an effort to soak up unsold inventory. "It's not only illegal, it's ethically wrong," says Lee Nam Kee, vice-chairman of the Fair Trade Commission.
Oddly enough, one of the reasons Daewoo--and others--can finance such plans is because of the banking crisis. The Big Five have taken advantage of government moves to pump money into the cash-starved economy. With banks and investors reluctant to finance smaller companies, the big groups are the ones raking in the cash. More than three-quarters of all new corporate bonds and commercial paper issued this year have gone to the five biggest chaebol. Until the government put an end to the practice, the banks were the biggest buyers--even though they are supposed to reduce their exposure to chaebol debt.
The chaebol are also enjoying sizable export earnings, as Korea is on track to pile up a record $40 billion trade surplus. The chaebol have used the cash to pick up new assets and prop up tottering old ones. LG Group spent $215 million earlier this year to bail out its merchant-banking affiliate. So far this year, the top 30 chaebol have managed to boost their gross assets by 20%, to $351 billion. While many smaller chaebol are staggering--and 16 of the top 64 are in formal workout proceedings with their banks---the five largest keep growing.
Hyundai's expansion plans are ambitious, to say the least. It's paying North Korea $935 million over the next six years for exclusive rights to send tourists to scenic Mt. Kumgang, near the birthplace of 83-year-old company founder Chung Ju Yung, in a venture that is almost certain to lose money. It plans to spend $1 billion on a sprawling new tourist complex in North Korea that will include everything from a golf course to a casino.
But these projects pale beside Hyundai Motor Co.'s hubris in beating out Ford Motor Co. in a recent takeover bid for bankrupt Kia Motors Corp. That means spending $6 billion for a group whose debt is already more than five times its equity--and in a depressed auto market. Far from frugal, Hyundai has also snatched up Grace department store for $40 million and has used government financing to buy a merchant bank this year. It's also expanding at its giant shipbuilding facility in Ulsan, already the world's largest. "It's unbelievable," says Kim Hun Soo, head of research at Merrill Lynch & Co. in Seoul. "Every single Hyundai company we cover saw its debts increase in the first half of the year."
Profitable Hyundai units are pouring their earnings back into the group. Although its shipbuilding unit, Hyundai Heavy Industries, is earning roughly $100 million a month in operating profits, the profits are going to sister companies. Despite the record earnings, Hyundai Heavy Industries saw its debts mount 28% in the first half.
The chaebol insist they are making progress toward meeting government demands. Although Daewoo Chairman Kim bristles at demands for radical restructuring, the idea that Daewoo is resisting change is a "misunderstanding," says Lee Sang Hoon. He believes the disagreements are only over the timetable for change--not about chaNge itself. The government wants rapid sales of assets, while chaebol executives say they need more time to slim down and shape up. Given their track record so far, it seems unlikely.
Like its competitors, Daewoo is slashing costs. The company used to give allowances for everything from haircuts to bus tickets to employees returning to their hometowns for the autumn harvest holiday. No more. It's also cutting back on uniform allowances and housing subsidies. White-collar pay is down 20% to 30% at Daewoo and at other major chaebol. Capital spending and research budgets have been pared.
Yet cutting fringe benefits cannot substitute for a radical overhaul. Although Daewoo has promised to get out of some minor business, such as aircraft parts and railroad rolling stock, it continues to expand its core operations. A just-released company document gives lip service to change but talks mostly of expansion. Daewoo is hoping to prop up its operations by luring $7 billion in foreign capital by the end of 2000. "You have Korean companies cutting costs by knocking down wages. But we don't see companies withdrawing from unprofitable businesses," worries Stephen E. Marvin, head of research at Jardine Fleming Securities in Seoul.
VAST TASK. Cutting costs also does nothing to unravel the web of mutual debt guarantees that prop up so many chaebol but that compel strong companies to cover the loans of weaker affiliates. As a result, there's no easy way for a group to get out of failing businesses without damaging its best companies. Samsung Motors has borrowed $3 billion from the banks and its sister companies to start up its assembly plants. But if the auto division shut down, the banks would go after other Samsung companies that have guaranteed the debt. So the $150 million yearly interest bill that Samsung pays to keep the auto business limping along is small change by comparison. "We would be glad to sell it," says a Samsung executive. But no one would pay $3 billion for a me-too carmaker running at just one-quarter of its capacity.
What asset sales the top chaebol have managed are dwarfed by the magnitude of the task that remains. British Telecommunications PLC has just bought a 23.5% stake in LG Telecom for $400 million, a deal that took seven months to pull off. That's an eternity by U.S. standards, but LG insists this was an unusually rapid transaction for Korea. "The government never understands how painful and time-consuming the process is for finishing a transaction," says Lee Chong Suk, executive vice-president of the group's newly formed executive office for corporate restructuring. Yet LG is far from meeting its goal of wooing $6.5 billion in foreign capital by the end of next year.
Meanwhile, Samsung and Hyundai are negotiating with Mitsui & Co. to sell Mitsui control of the hopelessly uncompetitive petrochemical operations they both built in a fit of megalomania. The deal would have been considered large in pre-crisis times. But it's a tiny step toward the restructuring and asset sales required for the groups to stay healthy.
Much more is needed. Yet never before has Korea been led by such a determined reformer as President Kim. "It's like a cop chasing a thief," says You Jong Keun, governor of North Cholla province and a leading economic counselor to Kim Dae Jung. "Usually, the thieves are one step faster than the cops. But if the cops are determined, they can usually catch the thieves." Still, it's going to take smart, speedy cops to corner the chaebol.
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