Battle of Wills

Battle of Wills
By Charles S. Lee in Seoul
Far East Economic Review
August 26, 1999
President Kim Dae Jung's top priority has been to open up the economy to real competition and foster new growth. He can only succeed if he forces once-mighty Daewoo to play by the new rules and sell off its best units to repay debt. Other conglomerates might then fall into line.
The August 15 speech was billed as the lift-off for the second stage of Kim Dae Jung's presidency. The text went through four drafts in five days, with Kim personally strengthening the language. In the end, Kim's message to the South Korean nation on the 54th anniversary of independence from Japan was a renewed declaration of war on the inefficient conglomerates that still dominate the economy. "I am determined to go down in Korea's history as a president who first accomplished corporate reforms and straightened things out in the economy," Kim said. "I will remain firm."
The very next day, the government announced a sweeping restructuring plan for Daewoo, the second-largest and most recalcitrant conglomerate, whose refusal to pare money-losing affiliates and repay 57 trillion won ($47 billion) in debt has threatened to derail South Korea's fragile economic recovery. The plan calls for Daewoo to strip down to six units by year's end, from the current 25. The electronics and securities units are to be sold; shipbuilding and construction will be given independent status in preparation for later sale. A victory for Kim? Not yet. Significant as the blueprint is, it falls short of what had been expected. More importantly, it's still just a plan--and Daewoo Chairman Kim Woo Choong has proven to be a master of evasion when it comes to cooperating in his own company's orderly dismemberment.
The problem is that the government needs Daewoo's cooperation to avoid the messy by-products of formal bankruptcy, such as heavy lay-offs and a stampede out of Korean stocks and bonds. Kim Dae Jung is locked in a battle of wills with Daewoo's Kim, who wants more time to turn things around. Whether the president can hang tough with Daewoo and force its break-up will determine the success of his crusade to introduce market rules to Korea's economy, making a decisive break with the past.
"This is the last test for Korean economic reform," says Jang Ha Sung, a professor of finance at Korea University and a leading critic of the conglomerates, or chaebols. "The handling of Daewoo will determine where the Korean economy will go from this crossroads."
Most importantly, propping up Daewoo indefinitely while Chairman Kim stalls on selling assets would send a dangerous signal to other chaebols that they, too, can avoid restructuring. It also would leave Korean taxpayers footing an open-ended bill for life-support systems for Daewoo and other terminally ill corporations, diverting money that could be better spent fostering competitive companies with real growth prospects. The sums involved are huge: Daewoo's declared debt (and most analysts suspect the real figure is higher) is almost as large as the bailout provided by the International Monetary Fund to keep the entire Korean economy afloat in late 1997. The four other top chaebols--Hyundai, Samsung, LG and SK--altogether owe more than 175 trillion won.
Breaking up Daewoo, on the other hand, could help usher in a truly accountable managerial culture over the long term. In addition, Korean banks would no longer regard the chaebols as too big to fall and would stop showering them with cheap funds for senseless expansions, giving smaller, more nimble companies a serious crack at credit.
How Korea deals with Daewoo also has implications for other recuperating Asian economies. Daewoo's debt includes nearly $10 billion owed to some 200 foreign banks that underwrote its global growth spree. Defaulting would deal a devastating blow to Korea's international image and could prompt some foreign creditors and investors to reassess the riskiness of other Asian corporations. "Because people tend to see the emerging markets as a whole, there could be a lot of potential spillover effects," says Stella Um, a credit analyst at Barclays Capital in Hong Kong.
President Kim doesn't have much time to fix the Daewoo mess: As the April 2000 national assembly elections near, he will find it harder to force painful restructuring.
More than a year and a half already has passed since Kim embarked on a top-to-bottom renovation of Korea Inc., the once-mighty engine of industrial growth fuelled by lock-step government-business cooperation. Key laws have been amended to allow more foreign competition; new laws protect the rights of minority shareholders, forcing more managerial transparency. But when it comes to the chaebols, reforms remain more rhetorical than real. Several chaebols, such as Daewoo and Hyundai, have actually expanded and taken on more debt since the national financial crisis began in November 1997. Daewoo, known for making second- or third-rate products for the bottom end of the market and already struggling, didn't think twice about taking over the sputtering Ssangyong Motor in December 1997. It also continued ramping up risky investments in places like Vietnam.
After Daewoo won a six-month extension for 7 trillion won in loans and 4 trillion won in new loans in mid-July, the government took charge of the chaebol's restructuring. Officials talked about across-the-board debt-for-equity swaps and about forcing Daewoo Chairman Kim to step down. Under the actual plan announced August 16, the government and creditors are to closely monitor Daewoo's implementation and sell off the collateral they hold if the chaebol drags its feet. But the only unit that creditors are actually taking over is profitable Daewoo Securities. In addition to Daewoo Motor, the group will retain Daewoo Motor Sales Corp., Daewoo Corp. (minus the construction unit), Daewoo Heavy Industries (minus the shipbuilding unit), Daewoo Telecom and Daewoo Capital. Its total assets will be about 56 trillion won--still 3 trillion won more than in December 1997.
As for Chairman Kim, a master political player and survivor of several past bankruptcy scares, the latest government announcement says he may stay on to help run Daewoo Motor after its turnaround if that's what shareholders want. Jang, the chaebol critic, says disapprovingly: "Allowing someone who ran the company aground to continue participating in the restructuring process opens the door for its failure."
On the positive side, Daewoo has found a buyer for most of its electronics assets, Walid Alomar Associates of the U.S. And Daewoo Motor is talking with General Motors about forming a strategic alliance that may include ceding managerial control.
If the restructuring plan is fully implemented, South Korea's economic recovery will power ahead with minimal disruption, government officials say. Swift and decisive action will reassure investors. And the fact that even the biggest conglomerates can be dismantled rather than bailed out will make an indelible impression on other corporations.
"Basically, chaebol owners used to run their companies with other people's money and when they got in trouble, they could count on their relationships with politicians to get help," says Nam Il Chong, a senior fellow at the state-funded Korea Development Institute. "But now if they fail, they have to give up their special privileges. That's what the market wants."
A radical restructuring of the Daewoo group could rejuvenate some of its affiliates. Take Daewoo Motor. Any arrangement that marries Daewoo's low-cost manufacturing with GM's research, marketing and financing prowess will give rise to a potent new car maker. Hyundai Motor and Kia Motors, the current leaders in South Korea's domestic market, would be forced to seek alliances of their own with leading foreign car makers. South Korea's car industry would then become a lot more efficient.
However, skeptics say that even President Kim is sometimes willing to put off long-term reforms for short-term political expediency. In July, he caved in to popular pressure in the politically important Pusan region to keep the insolvent Samsung Motors plant running and protect 50,000 jobs despite the Samsung group's decision to file for bankruptcy.
Any sign of second thoughts on the Daewoo asset sales could trigger a crisis of confidence in the financial markets. At the centre of this potential maelstrom are investment-trust companies, which collectively hold 77% of Daewoo's outstanding bonds and commercial papers--worth about 22 trillion won in face value but significantly less on the open market. Under the worst-case scenario, investors worried about the soundness of the investment-trust companies would rush to redeem their accounts. This would force the ITCs to dump stocks and bonds, triggering a market-wide sell-off. Interest rates would jump, and the resulting liquidity crunch could set off a new round of corporate bankruptcies. The government has moved to prevent this situation by placing temporary redemption restrictions on the ITCs and getting ready to inject public funds into them in case of a cash squeeze.
The Daewoo crisis has already forced into limbo much-needed reforms of Korea's banking sector. The government wants to sell nationalized Korea First Bank to U.S.-based Newbridge Capital and Seoul Bank to HSBC. But the deals have been indefinitely postponed due to differences over responsibility for bad loans arising in the future--including loans to Daewoo. What's more, Seoul has charged the pliant KFB with leading the creditors' group supervising Daewoo's restructuring, making the government less willing to bring independent-minded foreigners into the bank for now. So much for the government's plan to introduce international banking standards through foreign takeovers.
Even if the government holds firm, some analysts think it will take one to two years to completely clean up the mess. "It's naive to assume that Daewoo will raise huge amounts of cash within an extremely short period," says Jonathan Dutton, deputy head of research at Warburg Dillon Read in Seoul. And when the auction is over, Daewoo will likely still be 20 trillion-30 trillion won short of meeting its liabilities, analysts say.
The government can foot that bill without much difficulty because South Korea's national debt is still relatively small at less than half of gross domestic product. Korean taxpayers are likely to be more willing to cover the bill if Daewoo has been brought to heel than if the conglomerate is still operating under the old management, drawing up reckless expansion plans to be funded with other peoples' money.
As for Kim, nothing less than his presidential legacy is at stake. Slipping up on Daewoo could leave him a lame duck until his single term ends in 2003, no longer the great reformer but just another president with a half-finished agenda.

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