Since Korea entered the IMF assistance/restructuring  program, M&As have taken two general forms. One is by foreign investment; and the other is by independent companies or affiliates of large conglomerates in pursuit of their own restructuring programs to ensure their survival in the face of the financial crisis. Foreign direct investment in Korea amounted to a record high of US$8.85 billion in 1998, of which M&A type investment accounted for $4.7 billion, or 53.1 percent of the total.

The figure represents a sharp  increase against the $840 million  recorded in 1997 in terms of value, while the total number of cases also increased, climbing to 132 from 19 in 1997. After the economic crisis, domestic companies found themselves unable to effect takeovers of other companies through M&A, a process which requires injections  of huge amounts of capital, due to  their weakened financial state. However, as the economic situation   has improved, the trend to acquire venture firms or small-scale firms with potential has been on the increase.

In addition, the corporate scene has  been marked by instances such as  the merger of three to five affiliated   companies within a large conglomerate, large-scale business swaps among such conglomerates or merger among financial institutions.

Current Situation Regarding Foreign M&A of Domestic Cos.

Buoyed by the Korean government's measures to promote inbound investment and further open the domestic market, a wave of merger and acquisition activity among local enterprises by foreign firms is under way.

Hostile M&A by foreign companies was allowed from May 1998. The real estate market was also fully opened to foreign investors enabling foreigners to purchase land freely for both business and non-business purposes. The number of businesses categories closed to foreign investment was cut drastically through legislative revision in April 1998 and again the following month, eradicating virtually almost all barriers to foreign investors wishing to advance into the local market.

Since Korea entered the International   Monetary Fund's (IMF) restructuring program, the government has set in motion a raft of initiatives to expedite capital liberalization, putting into place the legal and institutional framework necessary to invigorate  cross-border M&A. The result is that  since hostile M&A was legalized,  foreign activity in this regard increased sharply from 1998 onwards after amounting to only $699 million in 1997.  

Foreign investors have shown particular interest in high-tech domestic companies in the areas of electronics,  machinery components, precision chemicals, and advanced production/possessing facilities, plus those with established marketing networks in the fields of retail  distribution and pharmaceuticals.

Domestic companies are selling off subsidiaries in increasing numbers to drive their corporate restructuring  programs, while foreign companies have been taking the lead in the M&A market as buyers, their chief focus being the subsidiaries of the major conglomerates or chaebol.

Foreign enterprises have  been identifying M&A targets through their branches in Korea or their Korean partner firms. M&A deals have been concluded in a matter of days in cases involving major multinational enterprises  seeking to acquire key business divisions of domestic conglomerates.

Foreign companies typically put business potential ahead of size,  opting for merger and acquisition with companies that offer a high degree of brand recognition, large  market share, competitive technology, stable labor-management relations, and financial transparency. Barriers  to M&A most often include the obligatory maintenance of the employment  of existing personnel, excessive and  interlocking transactions among the subsidiaries of the same conglomerate, and distrust of financial statements. Due to such barriers, many would-be foreign buyers have opted to acquire particular assets or business divisions in preference to entire companies. Although commonplace in Western industrialized nations, foreign direct investment through acquisition of existing stocks has been a rare occurrence in Korea. This situation changed from 1998.

For example, M&A in the first half of 1998 soared to $ 698.4 million from only $86 million in the same period  of the year before. In fact, 24 or 39.3 percent of the 61 projects in the first half of 1998 involving over $10 million were in the form of M&A. The figures indicate the rapid pace at which foreign M&As of domestic enterprises have begun to take place.

Since the financial crisis hit the   nation at the end of 1997, Korean business has been under pressure to step up efforts to restructure itself,  M&A emerging as one of the most feasible means to that end. Foreign enterprises, for their part, were able  to take over Korean firms at relatively lower prices, taking advantage of the depreciation of the Korean won and lower stock prices of local companies.

Foreign M&As of both domestic  and foreign-investing enterprises  have increased sharply under the IMF stewardship of the economy.  Many M&As of domestic firms were conducted by foreign firms which were invested in Korea through their local branches. From March 1997 to June 1998, German firms topped the list of foreign enterprises effecting M&As of domestic firms in value terms, ahead of corporations from Canada, Japan, the United States and Malaysia. Meanwhile, American and Japanese corporations accounted for the largest number of investment projects before Germany, the Netherlands and Malaysia over the same period.

M&A through acquisition of existing stocks and assets has emerged as the dominant form of foreign investment during the IMF era. Target enterprises have been motivated to invite foreign capital participation by the need to secure ready   cash. Selling off even lucrative and core business divisions over their more marginal ones has proved an effective means of coping with the financial crunch in the face of a degraded state overseas credit rating.

M&A investment accounted for 53.1 percent of all foreign direct investment in 1998. In the paper sector, which attracted the largest amount of investment in 1998, 73 percent of the newsprint market was claimed by foreign enterprises through M&A. Domestic firms looked to M&A as an opportunity to improve their financial statuses while foreign companies took the advantage of a depreciated Korean won and lower acquisition costs for local enterprises. The Korean government has taken measures designed to expedite foreign M&As through flexible application of the anti-trust laws, plus revision   of all other related laws, systems,  procedures together with the establishment of a "one-stop" service for foreign investors, among others.

Overview of the Korean M&A market

There are many factors prompting  interest in Korea's newly emergent M&A market. Traditionally, suppliers and managers have been more highly  regarded in Korea over consumers  and investors. Capitalists previously opted for ownership and management simultaneously rather than  simple investment and took the assumption of business managerial rights for granted. Government, for  its part, protected the managerial rights of corporate owners with laws designed to reduce market access.

Under the circumstances, it was  difficult for an M&A market to take concrete form in the Korean economy. However, the massive wave of  liberalization initiated by the government throughout the Korean economy has involved a virtual  inversion  of existing M&A-related laws, so permitting a vitalization of what was a nascent market.

In order to prevent conglomerate, or chaebol, "owners" from wielding undue power, a law was drafted to empower minority shareholders with rights to counter such excesses and auditors with practical rights and responsibilities. Under Article 202   of the securities exchange law,  regulations on share holding limits and obligatory purchases of stakes through open means were abolished, further promoting market principles in the stock market.

The allowance of hostile takeovers   is expected to furnish foreign investors with the opportunity for further corporate bargains. Meanwhile, the emergence of restructuring and venture funds is likely to stimulate hostile as well as friendly M&As.  Foreign investors had previously complained about various barriers to  investment in the Korean market. They included debt commitments among subsidiaries of the same conglomerate, cross-debt payment guarantees, market access barriers against foreign investors, accounting systems  which lacked transparency, and excessive premiums on top of takeover prices. As the result of the government's commitment, however, solutions have been found to such problems and market principles have begun to take root.

Korea's M&A market took shape as a by-product of the corporate reform drive which has been directed by the government and supervised by the International Monetary Fund (IMF). In the process, foreign companies and domestic firms played the main and supporting roles, respectively.

M&A Prospects in Korea

Korea's M&A market, thanks to  its special merits, is expected to boom over the next five years.

First, Korea itself is vested with geographical advantages. Although Japan is one of the region's most  attractive markets for foreign  investors, it lacks openness and its economic structure is complicated. In comparison, Korea is a more open   and investor-friendly market. Despite its vast market, China represents risk  to investors on account of its less developed market system. Korea, vested with an advanced and liberal market system, offers a base for foreign companies from which to penetrate the Chinese, and the greater Asian market, as well.

Second, M&As occur most rapidly at a time of economic recovery and economic downturn. In this sense, Korea offers an optimal climate for M&As, in that it is on the verge of a full-fledged recovery from a macro-economic viewpoint, despite  a continuing stagnancy from micro-economic perspective.

To generalize further, M&As tend to occur most often among enterprises in the same business category during economic downturns, but by companies seeking to advance into new business areas during upswings.

The ongoing Big Deal, or swap of business divisions among conglomerates, will eventually give rise to industrial monopolies and an investment environment favoring gigantic foreign capital formations and multinational enterprises.

Third, the rise of monopolies and  the fortification of the rights of minority shareholders will create a climate most favorable to hostile M&As. Furthermore, the impact of such activity on share prices harbingers the emergence of both arbitrage and wider capital gains opportunities. In addition, Korea lacks the institutional controls to effectively control hostile M&As. Most companies have yet to learn tactics and accumulate experience in combatting hostile M&As, offering a superb opportunity for foreign M&A experts doing business in Korea to capitalize on such a knowledge and expertise "gap." The market tends to value monopolies highly and existing managers may attempt defensive tactics, enabling investors to reap high share profits.

Fourth, the Korean economy has a proven, excellent ability to overcome crises. While obliged to devote enormous sums to defense because of the current state of division of the Korean peninsula, Korea realized a brilliant level of economic development. Although dependent on imports for energy sources, it coped well with the "oil shock" of the early  1970s and has been efficiently addressing the ongoing financial crisis. Investors may find it attractive to do business in so resilient a nation.

Fifth, the government will likely further promote M&As by foreign interests, given their ability to correct unbalanced market mechanisms in a relatively short time span. M&As have been extremely effective in combatting over production and  rectifying dislocations between  supply and demand.  

Sixth, the excessive supply of U.S. dollars and the introduction of the euro will lead to an excess of money  supply in international financial markets. Additionally, the lingering economic crisis which continues to beset Asia, Latin America and Russia has resulted in shrinking consumption  and investment and an over supply  of money. Cash-rich fund managers   may focus on recovering markets and choose Korea as the most optimal place to invest. Short-term investments are likely to initially outweigh M&As, but the need by multinationals to set up global networks deserves particular attention. Such corporations are expected to channel further funds into the Korean market in order to expand their sphere of business, taking advantage of relatively cheap acquisition costs since the financial crisis.

Additional affirmative policies are  necessary to generate an appropriate climate in which M&As can be encouraged, building on the conditions created by Korea's economic  crisis. Meanwhile, Korean enterprises are moving to employ M&A as a  key business strategy for growth in the forthcoming 21st century.

By Soo-Deuk Sohn ( sdsohn@kotra.or.kr )