With the announcement Jan. 6th by the LG Group it would transfer its entire 59.95 percent equity holding in its semiconductor operation to the Hyundai Group, the drive to restructure the top five domestic conglomerates, or chaebol, has gone into high gear, and presents a vastly different picture to what obtained at the beginning of 1998.
The two companies agreed to the basic principle of enacting the "Big Deal" (i.e. a swap of business interests for purposes of restructuring corporately) on Sept. 30th last year. On that day, the presidents of each company met to designate a consulting firm by October, and agreed to select a leading entity responsible for the management of the combined operation. A week later, the two agreed to an equity split in the operation of 7:3 in favor of one or other of the companies, and complete the arrangement by the end of December. However, as ADL began due diligence, fissures began to appear in the agreement. LG expressed dissatisfaction over the evaluation criteria established for the Big Deal in the semiconductor sector, and made it clear that it would not accede to an evaluation under the circumstances which then obtained. At root was the fact the two giants had been in conflict with each other since Christmas Eve of 1998. However, after a series of behind-the-scenes discussions between key officials from the two companies, and a visit by LG Chairman Koo, Bon-moo to President Kim, Dae-jung a final agreement was quickly arrived at. The five key points of the government's corporate restructuring program were agreed between the then President-elect Kim and heads of the top chaebol at a Jan. 13th 1998 meeting. Under the program, the chaebol agreed to enhance the transparency of their corporate management, eliminate cross-payment guarantees between their affiliates, improve their financial structures, focus on core business sectors, and make management accountable for its decisions. Despite the many setbacks the program has experienced, the overall evaluation by domestic and overseas observers is that it has achieved remarkable progress. Positive Impact The Big Deal had been deadlocked since the Business Restructuring Implementation Committee rejected the plan submitted by the top five conglomerates, but the swap deal involving the automobile business of Samsung and the electronics business of Daewoo late last year served as an impetus to restart the process. Seeds of discord remain over issues such as whether production of Samsung Motors' SM5 Series will be discontinued, job security for the employees inherited by both chaebol, and the future of arrangements with sub-contractors. However, to address these issues, Samsung and Daewoo have called in multinational accounting firm Deloitte Touche Tohmatsu and negotiations to this end are currently proceeding. The swap of Samsung Motors and Daewoo Electronics between their respective owners is expected to impact positively on both groups. The arrangement allows Samsung to relinquish control of its controversial auto unit with honor, it having been the focus of criticism because of excessive investment, and allow the group redirect its resources toward its core activities. At the same time, the Daewoo Group will emerge in a healthier financial condition by handing over Daewoo Electronics since it stands as guarantor of the unit's debt to overseas lenders.
Samsung Electronics will increase its market share by its takeover of Daewoo Electronics, which derives 95 percent of its turnover from home electronics sector. However, the move does not seem likely to precipitate a significant synergy effect because Sam-sung previously decided to reduce the scale of its involvement in home electronics in order to focus more on semiconductors and IT technologies. In line with the government's program to effect business swaps to spur the national corporate restructuring drive, the top five conglomerates announced a plan to select three to five core businesses and reduce the number of their affiliates from 264 to 130. In addition, they signed an agreement to improve their financial structures with 25 major financial institutions, in an attempt to reduce their total assets of 302.4 trillion won (as of the end of 1998) down to 269.6 trillion won by the end of 2000. Powerfully Leveraged However, this is not the only restructuring-oriented initiative taken by the conglomerates. They also disclosed a plan to exit less profitable businesses and focus instead on strategic interests. The Korea Economic Research Institute (KERI) estimated that the successful completion of the restructuring program by the top five conglomerates could trigger an increase in GNP by an annual average of 0.64 percent, while the Korea Institute for Economics and Trade (KIET) predicted the Big Deal could generate bigger profits by achieving greater economies of scale through the alleviation of excessive competition. The Korean memory semiconductor industry is now powerfully leveraged in world markets following Hyundai Electronics' takeover of LG Semicon-ductors. Apparently, there will be no change in Korea's share of the world market which currently stands at 34.5 percent, but a significant change is evident in that the integrated company will assume the world No. 2 position directly behind Samsung Electronics. As of the end of 1997, the market share rankings in the world semiconductor industry according to IT research and consulting firm Dataquest were as follows: Samsung Electronics held 18.8 percent, Micron Technology, 14.1 percent, NEC of Japan, 12.1 percent, Hyundai Electronics, 9 percent, Hitachi, 8.2 percent, and LG Semiconductor, 6.7 percent. Following the integration of Hyundai Electronics and LG Semiconductor the total market share of the integrated company will climb to 15.7 percent, attaining the No. 2 position behind Samsung Electronics. Hyundai Electronics and LG Semiconductor currently produce 15 million 64 Mega D-RAM units per month, and in terms of production volume, industry analysts expect the integrated company to eventually seize the world's top spot from Samsung Electronics which produces 18 million to 20 million pieces per month. The move will also result in the elimination of redundant capacity and consolidate R&D expenditures. More than 200 billion won is expected to be saved on R&D costs, which currently stands at 660 billion won for both companies.
The enhanced advantage of the Korean industry is not limited to the ability to control prices. When profits from their existing product line-up begin to wane, manufacturers are committed to switching to next-generation D- RAM products including the 256 Mega D-RAM, and 1 Giga D-RAM. Finding Synergy Kim, Young-hwan, president of Hyundai Electronics disclosed in a Jan. 6th press conference that the newly-established semiconductor company will seek to attract between $500 million and $1 billion worth of foreign capital. Hyundai plans to reduce its debt ratio below 200 percent by in this manner, as well as selling-off assets and increasing its capital stock. What will be the fall-out of the Big Deal in the semiconductor sector? Experts predict it will spark a price increase in semiconductors, eventually returning the industry to profitability. Meanwhile a study on the synergy the integration will generate forecasts a cost reduction of $6.2 billion over the next five years, a major reason why Hyundai anticipates no major difficulties in its drive to attract foreign capital. The estimated economies are as follows. Cost-savings from having only one plant instead of two to manufacture 12-inch wafers will approach $2.5 billion, while that from R&D will be $2 billion. Savings on ordinary administrative expenses will amount to $1 billion. On top of this, royalties and patent costs of some $700 million engendered as a result of over-lapping competition can be saved on. The integration will also produce intangible effects which should not be ignored, among them, enabling the company to focus on the development of new technologies and higher value-added product. Hyundai Electronics director Choi, Soo said the "cost reductions equivalent to 7.5 trillion won over the next five years can settle all the debts of one company. In addition, the integrated company is also projected to benefit from a market revival." The integration means the diluted competition makes it more possible to exert greater price support by controling production to reflect market conditions. Reciprocal benefits are also expected for the company in terms of technology. Currently, LG has an advantage in the advanced technologies of next-generation ultra-high speed semiconductors such as 64 Mega RAM BUS D-RAM chips, while Hyundai has shown an edge in large capacity semiconductors by successfully developing 256 Mega Synchronous D-RAM prototypes. Thus, the integration will allow the new company to capitalize on both high-speed and large capacity semiconductor technologies. The elimination of differences in the manufacturing processes of the two companies will likely require a significant amount of investment as in the case of Micron Technology, which funneled a huge sums into production line replacement after its takeover of Texas Instruments' (TI) memory semiconductor sector. A looming challenge for the two companies is whether they can afford the required capital. Hyundai Electronics has accordingly decided to reduce the debt ratio of the integrated company to below 200 percent by the end of this year through shutting down non-semiconductor activities, and attracting foreign capital. Another challenge is the difference in corporate cultures and employee job security resulting from the integration. In meeting his challenge, the potential exists for serious conflict between labor and management. The Age of the Big Three Other hurdles include the differences in marketing strategies, logistical infrastructures, methods of asset management and accounting, and computer systems, all of which will require a significant amount of time to be overcome. If these issues are not settled successfully, any expected synergy effect resulting from the integration may simply remain a pipe dream. LG has expressed a strong commitment to intensive investment in its core business sectors, namely petrochemicals, energy, electronics, communications, services and finance with the capital gained from the handover of LG Semiconductor to Hyundai. Industry attention is now focused on the price Hyundai will pay for LG Semiconductor. The value of a company is based primarily on its share price. However, there is an additional variable to be computed in this case, namely the anticipated synergy effect. The projected cost-saving of $6.2 billion over the next five years implies Hyundai will be able to save $3.1 billion on investment it would otherwise have had to make in order for it to maintain its market position. In this context, a combination of the share price and the future intangible effect would amount to a 4.16 trillion won benefit to Hyundai. However, it is still undetermined how much Hyundai will actually pay LG. Domestic and foreign industry observers believe the Korean semiconductor deal will trigger repercussions throughout the world semiconductor market. The deal is being viewed as a major M&A, equivalent to Micron's takeover of TI's memory semiconductor sector. The acquisition enabled Micron to climb to the No. 2 position in the world market. The world semiconductor market is shaping up to be tri-polar in nature, dominated by the so-called "Big Three": Samsung Electronics, Micron and the emerging, integrated company of Hyundai Electronics and LG Semiconductor. The D-RAM sector typically requires huge increases in investment compared to the resultant increases in capacity, a situation which allows only the largest companies to compete and survive.
The Need for Alliances The Nomura Institute of Japan predicted in 1995 the world memory semiconductor market would be dominated by five major companies by 2000. a prediction now being gradually being realized since Hyundai Electronics, the world's No. 3 D-RAM chip producer took over LG Semiconductor, the world's No. 6. Furthermore, Motorola in 1997 announced its exit from the memory semiconductor business, and late last year, Siemens of Germany said it had scheduled its memory semiconductor plants for closure. Competition in the memory chip market will be further heightened by the impending mass production of ultra-high capacity products such as the 256 Mega D-RAM, and 1 Giga D-RAM chips which requires astronomic developmental as well as investment costs, so threatening the existence of medium-level companies. Given such pressures an increasing number of companies will abandon the D-RAM semiconductor business, and more alliances will be formed among the medium-level companies. In this regard, Japanese chip makers Toshiba and Fujitz recently formed a strategic alliance to co-develop 1 Giga D-RAM chips. NEC has cut back heavily on semicon production due to a deficit of 20 billion yen and has slashed investment by 30 billion yen, impinging significantly on the portion alloted to its memory sector. In the face of deficits amounting to 80 billion yen, in 1997, Hitachi closed down its U.S. plants as part of an overall program to exit its money-losing business. The restructuring imperative has begun to take hold in European and Taiwanese industry players. Siemens cut back on its production line at its Dresden plant in Germany, and shut down other plants in the United Kingdom. The fall in price of D-RAM chips compelled Acer and Power Chip of Taiwan to downsize their memory chip sectors and switch their resources to non-memory development and production. In the current industry environment, the Big Deal between Hyundai Electronics and LG Semiconductor has emerged as the calm eye of a surrounding storm. The main impetus behind the worldwide accelerated drive to restructure in the world memory semiconductor industry is persistent market decline. The market dwindled to $13 billion last year from $40 billion in 1995. Further fueling price competition is the fact that major industry clients, the PC manufacturers, continually demand lower D-RAM prices. Hyundai's and Daewoo's approach to restructuring involves streamlining affiliates in tandem with the large-scale business swap. According to the Financial Supervisory Commission (FSC), Daewoo will eliminate 26 affiliates by the end of the year, including five in the first half of 1999. In the process, the total number of Daewoo's affiliates will fall to 10 from 41, while the total number of Hyundai's affiliates will shrink to 31 from 63. In the meantime, the Hyundai Group announced it would to sell off three to four of its 15 affiliates which have an asset in excess of 1 trillion won, and by 2005 will completely dissolve itself as a conglomerate. Hyundai Electronics disclosed Jan. 10th it would unload its non-semiconductor businesses such as its telecommunication sector in order to raise funds for the takeover of LG Semiconductor since it required more capital than it originally thought necessary. Hyundai had intended to establish a separate corporate to concentrate on its non-semiconductor areas, a plan now abandoned since such businesses will be hived-off. Aiming to be No. 1 Non-memory activities to be put up for sale by Hyundai besides telecommunications include its monitor and LCD businesses. The revenue from these sectors in 1997 amounted to 2 trillion won, accounting for 28.08 percent of total company turnover. LG's acceptance of the deal derives from its acknowledgement of its loss of any leverage as a result of the integration, plus the stark reality of the financial strictures the company faces despite the upbeat market mood. When heads of the top five conglomerates were invited to the Blue House Dec. 7th 1998, LG agreed in principle to the integration of the semiconductor industry, based on an evaluation by ADL. Observers agree LG would have found it a severe handicap not to have complied with the consulting firm's evaluation. LG's eventual support of the deal, was, to some extent, prompted by Moody's pronouncement that a delay in the integration of the semicon industry would delay any upward readjustment of Korea's sovereign credit rating. However, what made the deal possible was, in essence, the desire by LG chairman Koo, Bon-moo to exit deficit-creating business sectors as early as possible. Also he was concerned a stalemate in the semiconductor deal could jeopardize the group's overall restructuring program. The current buzz in industry circles is that LG will gain in future deals for having given up its semiconductor sector. LG has been fingered as a likely candidate to take over Hanhwa Energy, which was originally to be acceded to Hyundai, and also acquire Onse Telecommunication and Dacom, but the final shape of future business swaps is far from clear. The integrated company will be controlled entirely by Hyundai, following LG's renunciation of further management rights. Hyundai's strategy is to solidly establish the integrated company as the world's No. 1 D-RAM semiconductor company, maximizing the synergy of the integration by tapping the existing human and material resources. Although officially second to Samsung Electronics in world rankings, the integrated company might actually outstrip Samsung when OEM exports are included. An Impasse Removed The settlement of the semicon Big Deal is expected to galvanize restructuring efforts in seven other business sectors of the five top conglomerates which got under way last August. Discussions to effect Big Deals in automobiles and home electronics are currently in progress between Samsung and Daewoo, while the Federation of Korean Industries, the representative body for the conglomerates, predicts rapid progress in nine business sectors of the top five conglomerates including petrochemicals, rolling stock, and oil refining now the impasse in the semiconductor sector, previously the biggest hurdle to corporate restructuring, has been resolved. |
The most likely scenario for an early conclusion of the Big Deal between Samsung and Daewoo is first, the handover of management rights of Samsung Motors and Daewoo Electronics, to their respective new owners, and the conducting of due diligence at a later stage, as was the case in Daewoo's takeover of Ssangyong.
The major bone of contention in the Big Deal between Samsung and Daewoo is the future of the SM5. In consideration of its many subcontractors, Samsung repeatedly insists on production of the SM5 continuing even after Daewoo's takeover of Samsung Motors, a proposition which has been flatly rejected by Daewoo on the grounds that such a commitment will inevitably incur huge losses for the group.
Fast-tracking Negotiations Also, the royalty of 1.5 percent per unit Daewoo must pay to Nissan as a licensee poses an additional burden. A further reason for Daewoo's refusal to give assurances about the SM5 is the model is superfluous to its product line-up. However, the most serious impediment to the process concerns Samsung Motors' 88 subcontractors. They are doomed to face bankruptcy should the SM5 be discontinued. Given Samsung Motor's outsourcing ratio of 70 percent, facility investment by to subcontractors to supply SM5 parts is estimated to amount to 2 trillion won. It was previously reported that Daewoo retreated from its previous position and agreed to produce the SM5 for the next two years at Samsung Motors' Pusan plant, which will later be retrofitted to produce Daewoo's popular Matiz model. Negotiations will soon follow in the fields of aerospace, ship engines, and railway rolling stock with the aim of establishing industry-specific integrated corporations by which to more effectively lure foreign capital. Korea Heavy Industries, which is scheduled to take over the manufacture of ship engines and power generation facilities from Samsung and Hyundai, has gone on record as committed to bringing its negotiations on the necessary takeover procedures to an immediate and satisfactory conclusion. Should Hyundai Refineries take over Hanhwa Energy as scheduled, the company has declared its intention to settle all required integration procedures as early as possible. As the restructuring programs of the top five conglomerates enter their final stages, subsequent negotiations are expected in the steel and petrochemical sectors. In case of steel, plans by creditor banks to auction off components of the debt-ridden, bankrupt Hanbo Steel and Sammi Steel are in progress. The electricity-generating facility sector, which has suffered as much as any other from excessive facility investment will also shortly present a restructuring blue print. Excessive and overlapping investment in the PCS sector is prompting ongoing negotiations between industry players. The petrochemical companies, located mainly in Yeochun Petrochemical Complex and the Ulsan Industrial Complex, will join the Big Deal. In particular, the four major companies of similar scale located in the Yeochun complex - LG Chemical, Honam Petrochemical, Daelim Industry, and Hanhwa Chemical - will be the first to conclude the Big Deal in their sector. The four are fast-tracking their negotiations in the belief that the integration of Hyundai and Samsung facilities at the Seosan Petrochemical Complex will crimp their competitiveness. After more than a year of negotiations and partner-searching, the conglomerates are on finally on the verge of completing their obligations under their January 1998 agreement, a move, which by its impact on the country's credit rating and international competitiveness, is set to place Korea once again in the center of the global economic mainstream. by Soo-Deuk Shon
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In the process of reaching an accommodation
with Hyundai, LG finally gave up on its goal of
becoming a majority partner in the operation
following the 7:3 equity split recommended by
outside consultants Arthur D. Little Inc. (ADL)
in favor of Hyundai, and decided instead to
relinquish control. The integration of the two
semiconductor companies has resulted in the
creation of the world's No. 2 producer of
memory chips, enabling Korea to boast of
having the world's top two manufacturers in the
D-RAM semiconductor sector.
However, in logistical and marketing terms the
swap is not entirely welcome to Daewoo.
Samsung's SM5 occupies the same market
niche as Daewoo Motors' Leganza.
Furthermore, the two unit's respective
production technologies and engine-related
parts are not compatible with one another as a
result of their separate alignments with two
major overseas manufacturers: Daewoo with
General Motors, and Samsung with Nissan.
With the takeover, Hyundai Electronics has now emerged as a
major market player with the ability to set prices in the world
D-RAM industry where the dictum "Production volume equals
price influence" holds sway. Moreover, one industry observer
predicts should Samsung Electronics and Hyundai Electronics
collaborate, they might dominate the memory chip sector in the
same way Intel dominates the CPU market.
Negotiations over the
automobiles-for-electronics
swap between Samsung and
Daewoo are also moving
ahead. Deloitte Touche
Tohmatsu has been
selected to evaluate the
trade-off between the two
companies, and its top
executives have met with
those from Samsung and Daewoo responsible for corporate restructuring to prepare
the ground for this particular Big Deal and resolve major, controversial issues. They
include the future of Samsung Motors' SM5 series, job security, and the position of
Samsung's commercial vehicle and Daewoo Electronics' overseas operations in the
deal.
Another approach might be
Samsung assuming a portion of its
auto division's debt, which
amounts to 4 trillion won. In the
previous scenario, Samsung would
assume debts to the sum of 2
trillion. Under the deal between
Daewoo and Ssangyong, the
management rights were
transferred under a tentative
agreement that the total debt of
3.4 trillion won will be shared.
Daewoo was to bear 2 trillion won,
and Ssangyong, 1.4 trillion. After due diligence, though, Ssangyong had to assume an
additional 30 million won worth of debt.
Daewoo is leary of
committing itself to so
doubtful a project as the
SM5 while having to assume
a portion of Samsung
Motors' considerable debt,
which amounts roughly to 4
trillion won. Although the
actual amount Daewoo will
have to assume is subject to
negotiation, the entire sum
will generate interest charges of 40 billion won at an annual rate of interest of 10
percent. Daewoo is also prohibited from exporting the SM5 under the terms of the
licensing agreement Samsung struck with Nissan. The Pusan plant has the capacity to
produce 260,000 units per year, much of which will remain idle if Daewoo is unable to
export the model.