Hyundai's True Trial: Better Performance

Its chairman's surprise three-year prison sentence aside, Hyundai needs to accelerate in the face of many challenges

No question, the surprisingly stiff three-year prison sentence handed down to Hyundai Motor Chairman Chung Mong Koo on Feb. 5 is a huge psychological blow to the proud South Korean automaker. However, this is South Korea, where convicted execs usually get preferential treatment. Chung won't serve his term behind bars and will be able to influence the direction of the car company pretty much as before.

Moreover, industry watchers see no big change in its strategy and only limited impact on its financial performance. A Seoul criminal court ruled that Chung, 68, is guilty of embezzlement and breach of trust but allowed him stay free on bail "to minimize impact on the economy."

"I don't think it is wise to try to read too much out of the ruling," says Cho Chuel, auto industry specialist at the state-funded Korea Institute for Industrial Economics & Trade. "The costs have been paid and a lesson has been learned when Chung was arrested last spring. The fact of the matter is that he'll still call all the shots."

Sales Challenge

Investors seemed to agree. Shares in Hyundai Motor fell as much as 3% on news of his prison sentence, which was harsher than the suspended sentence that the market had widely expected. But by the time trading ended on the Seoul bourse, all that loss was recouped and the stock ended trading at $75.20, unchanged from the opening. On the broader market, the bourse's benchmark Kospi index ended the day up 0.34%.

Hyundai officials were quick to stress that the automaker's management and operation won't be affected by the verdict. "Obviously, we are greatly disappointed by the court's ruling, and it's the chairman's intention to file an immediate appeal," says company spokesman Oles Gadacz. "However, Chairman Chung retains full operational control and authority to make strategic decisions."

With Chung's planned appeal, top management will continue to be distracted by legal proceedings. But the real challenge, unrelated to the legal drama, is on Hyundai to improve its global sales performance and overall competitiveness by developing and selling great cars. That's the real trial the company must endure. "Hyundai certainly faces a tough year ahead," predicts Stephen Ahn, auto analyst at Woori Investment & Securities in Seoul. "It had a poor showing last year, but I don't expect much improvement this year either."

Won Woes

Worrying signs abound for the largest carmaker in Korea, which controls nearly 50% of the local market. It's grappling with chronic labor strife, falling market shares at home and abroad, and a strong local currency. In the all-important U.S. market, Hyundai's sales were flat in 2006, and its January sales dropped by 8.2%, a contrast to gains reported by major Japanese rivals, led by Toyota Motor (TM).

Corporate analysts say the company, which has made big strides in improving quality in recent years, is beginning to lose its price competitiveness by the strength of the Korean currency. The won has gained about a quarter of its value against the dollar in the past three years and strengthened more than 9% against the Japanese yen in the past year (see, 12/25/06, "Hyundai: Too Far Too Fast?").

That resulted in a 34% net profit plunge to $1.64 billion last year. The company, which cited a production loss of nearly $2 billion because of labor strife in the past year, reported a 0.2% fall in revenues to $29.4 billion, but it aims to raise sales this year by 14%. "The biggest challenge Hyundai management faces now is its relations with the labor union, and today's court ruling doesn't augur well," says Chang In Hwan, chief executive officer at Seoul-based fund manager KTB Asset Management Co.

Pressure to Clean Up

Chang points out that the union has refused cooperation with management, arguing that Chung's "emperor-like" rule in the company has enriched his family at the expense of workers. "I don't see a better management-labor relation at Hyundai unless Chung could prove that he has cleaned up his acts," he says.

On Feb. 5, the Seoul court found Chung guilty of illegally raising some $75 million of slush funds for kickbacks and costing the company more than $200 million by transacting intragroup deals through Hyundai Motor affiliates that largely benefited the family at the expense of other shareholders.

Shareholder activists welcomed the verdict. Kim Sun Woong, head of the Center for Good Corporate Governance, says continuing legal proceedings against Chung would keep the pressure on management at Hyundai and big conglomerates in general to take steps to improve Korea's corporate-governance system. "Today's ruling could take some steam out of Chung's campaign to build up its brand image abroad," says Kim. "But for Hyundai to really burnish its image, the management will have to have a clear break from past practices."

Before it's here, it's on the Bloomberg Terminal.