Henry Seggerman is president of International Investment Advisors, and manages a Korea equity fund. His fund is up 38% on the year, and has outperformed the KOSPI (in dollar terms) by 20%. It also has an annualized five year return of 29%. According to Bloomberg it is the best performing among the 65 Korean equity funds it covers. Here the fund manager shares his views on what the new government should do.
You have spoken of the "Embarrassing Korea Discount". What do you mean by that?
Seggerman: Recently the Korean stock market was trading on a P/E ratio of 6.67 times, based on I/B/E/S estimated 2002 final earnings. It's the cheapest market in Asia and the cheapest market in the OECD. By contrast, the Taiwan market was trading on a 2002 PE ratio of 20.74 times. Why is Taiwan trading on a PE ratio more than three times higher than Korea? After all, Taiwan is a medium-size, mid-level GNI per-capita Asian nation with robust electronics exports, and a decades-old unresolved military confrontation - just like Korea. The "Korea Discount" is an embarrassment. President Roh and his new administration should make it their mission to remove it as soon as possible.
The "Korea Discount" should not be viewed as a foreign investor problem. The Korean stock market is bigger, and Korean stocks have a higher foreign ownership percentage, than most of the world's stock markets. The "Korea Discount" is also the result of Korean individuals, whose equities exposure is 7% instead of 14% as in the US, and Korean pension funds, whose exposure is 2% instead of about 50% as in the US. Many Korean individuals and institutions harbor deep worries about Korea and deep suspicions of the Korean stock markets.
When Korea removes the discount holding the KOSPI PE ratio below seven times, then its market should logically rise to the Taiwan level. An investor holding one million won in the Korean stock market today will have more than three million won when that happens.
As an investor, what recommendations do you have?
Our firm has some recommendations on what President Roh and his new administration can do which will help remove Korea's embarrassing discount.
Our first, is to get the US Troops out of Korea. Korea's decades-old unresolved military confrontation is more dangerous than Taiwan's because at all times, the North Koreans are poised to turn Seoul into a "sea of fire." Beijing certainly wants Taiwan to return to its rule, but it will accomplish this by means of diplomatic and financial pressure, not by raining missiles on Taipei. North Korea has 15,000 artillery tubes pointing at Seoul, plus hundreds of Scud missiles. It has an army more than twice the size of South Korea's. North Korea could kill one million residents of Seoul in twenty-four hours, without even one of its soldiers stepping across the DMZ. Though extremely unlikely, this massive firepower trained on South Korea's capital results in a permanent risk to Korea, its economy, and its stock markets.
The 37,000 US troops now stationed in Korea would be utterly powerless against this onslaught. Parading them around in military exercises serves no purpose. In any case, wars are fought very differently today. In the extremely unlikely event of serious North Korean hostilities, within a few weeks, the US would counterattack with a powerful aerial bombardment. During this bombardment, it would assemble a large invasion force in the hundreds of thousands. As with Kuwait in 1991, whether the US has zero soldiers or 37,000 soldiers stationed in Korea, this counterattack strategy is guaranteed and will always be the same. The 37,000 US troops now stationed in Korea have no impact whatsoever on the US counterattack strategy, and are not needed.
We do not subscribe to the Bush administration's argument regarding "weapons of mass destruction." It is believed that North Korea already has nuclear weapons, and even if it agrees to rigorous inspections, it can probably hide them going forward. The United Nations, the US, Russia, China, Japan, and others will certainly continue applying diplomatic pressure on North Korea to discontinue its nuclear programme. At best, this will evolve into a stalemate as with Israel, with evidence - but no disclosure - of secret nuclear weapons. Likewise, the US will push to eliminate North Korea's conventional weapons export business. However, as these exports represent about 25% of North Korea's overall economic activity, they are likely to continue in secret despite these pressures. Moreover, in the event no chemical or biological weapons are found in Iraq, the US may be obliged to generally tone down its "mass destuction" rhetoric. In any case, no one should forget that the weapons used in the September 11, 2001, attacks were box-cutters.
Meanwhile, there are 15,000 artillery tubes pointed at Seoul. South Korean civilians are hostages in a dispute over, on one hand, what may be an unstoppable nuclear weapons program and, on the other hand, a weapons export programme that does not affect them. South Korea has been very successful working out with North Korea agreements over family reunions, the Mount Keumkang tourist project, and the Gaeseong economic zone. Now, South Korea should ask for something from North Korea in return - moving the 15,000 artillery tubes away from Seoul. South Korea should voice its opposition to North Korea's nuclear weapons programme, but it should focus most of its efforts on moving this artillery away from Seoul, as this represents the most tangible day-to-day threat to its population. Obviously, this can be done more easily without US troops on Korean soil. We believe North Korea can be coaxed to move the artillery away from Seoul in gradual stages, perhaps linked to shipments of much-needed wheat and fuel oil.
What else?
Aggressive Chaebol Reform is extremely positive for Korea's stock market. If falsified financial statements or insider trading are exposed at a listed company, its share price will fall. If falsified financial statements and insider trading are investigated widely, the share price of companies demonstrated to be without falsified financial statements or insider trading, however, will rise.
Recently, Kookmin Bank's CEO, JT Kim stated that more chaebol falsified financial statements and insider trading will be found. If the Korean government does not expose these companies guilty of falsified financial statements and insider trading, then the Korean economy and stock market will behave as if all Korean companies are guilty. It is utterly illogical and ridiculous to say that keeping these abuses swept under the carpet will help maintain economic or stock market stability. They should be eliminated without delay. Delay hurts the economy and stock market and perpetuates the embarrassing Korea Discount.
What other reforms are required for corporate Korea?
Shareholders who control chaebol affiliates have used many deceitful methods in order to control them with minimal investment, often far below 10%. One of these numerous tricks is circular shareholding structures in which Affiliate A owns shares in Affiliate B, which owns shares in Affiliate C, which owns shares in Affiliate A. This type of circular shareholding structure is the same thing as cross shareholding, and should be prohibited in accordance with regulations banning cross shareholding.
Will class action lawsuits not help to remove some of these problems?
Company Directors - whether inside or outside - have a fiduciary obligation to represent the interests of all the shareholders, not rubber-stamp the rulings of the controlling shareholders. One day in the near future, an independent outside shareholder who lost money investing in a badly managed company will be paid a large financial damage award that Korean courts have judged and collected from company directors personally. Company directors will lose large sums of money personally for breaching their fiduciary obligation to represent the interests of shareholders by allowing bad management. This will be a watershed moment in Korea, and will perhaps be the biggest factor in reducing the Korea Discount.
Successful, non-"lip service" class action lawsuits will require honest judges who cannot be manipulated by controlling shareholders. We are concerned that within Korea's court system there may be some of the same elderly chaebol buddies as in the Supreme Prosecutor's Office. Efforts must be made to ensure class action lawsuits are handled by judges and courts which are 100% free from manipulation by chaebol controlling shareholders. Class Action Lawsuits should not be limited to any type of company whatsoever, and should apply to small companies, large companies, chaebols, non-chaebols, 100% Korean companies, and joint-ventures with foreigners. Simply put, if any shareholder has suffered financial damages as a result of bad management of any company, the company's Directors should be made accountable through the potential damages they could suffer personally in a Class Action lawsuit.
Do you have other recommendations for the government?
Yes, the Government must stop keeping "Zombie Companies" alive. It comes as no surprise whatsoever that the US is imposing a whopping 57% tariff on Hynix imports. From the founding of Hyundai Electronics years ago, Korean taxpayers have indirectly kept this redundant, egotistical, inefficient, unprofitable enterprise alive. The procedure has changed little. In the bad old days, the government just ordered up a "Policy Loan." Today, these have a new euphemism, "National Service Loans" - just a quiet telephone call from a mid-level minister to one of many banks still dependent on government business or stabilizing measures, and the loan is rolled over, the fresh capital injection approved. It's time to stop wasting Korean taxpayer money in any more Dr. Frankenstein efforts keeping Hynix or any other "Zombie Companies" alive. We include with this any remaining so-called "workout companies." If they haven't "worked out" their problems after all these years, they never will, and they should just be shut down. Keeping "Zombie Companies" and workout failures alive only serves to hurt the repective business sector, the overall Korean economy, and most importantly, real companies with a real business plans that don't soak up taxpayer money.
The bankruptcy process in Korea is slow and constipated. Bankruptcy judges, whose job is to protect the interest of creditors who are already losing a fortune, often instead take up the cause of protecting controlling shareholders and employees deriving income from the bankrupt companies, with the result that NPLs continue rising at lending banks, with overcapacity continuing to squeeze profit margins throughout the sector. We urge President Roh and his new administration to pursue bankruptcy reform, with the goal of shutting down redundant, unprofitable enterprises rapidly and selling off assets without delay, for the benefit of creditors. This is the only way to purge the banking system of perpetually bad loans.
What's your view on the consumer finance issue?
For decades, banks focused most of their lending on chaebol affiliates. Five years ago, this began to change, as they were urged to extend more lending and services to Korean individuals. Today, due to rapid growth, there are rising credit card NPLs. This is largely due to aggressive marketing, little or no credit analysis, and a business plan stuck in the rut of 30-day terms and usurious cash advance charges. Instead, these banks should be encouraged to offer revolving credit lines to customers with reasonable credit histories. Some 98% of all Korean credit cards today are on 30-day terms, unlike much of the rest of the world, where revolving credit lines are the norm. The introduction of cheques would also help modernize Korean consumer finance. All too often, personal bills are paid in cash, through usurious cash advances, whose high interest rates reduce cardholder spending power and also make banks dependent on the most naïve customers for a sizable portion of their credit card income.
The mortgage loan-to-value ratio in Korea is still under 40%, far below the US and Europe. The government should encourage banks to lend against a greater portion of prudently-appraised home values. Other than in the Kangnam area of Seoul, there is no "housing bubble" in Korea, and Korean homeowners with reasonable credit histories could have a greater degree of spending power if they were able to borrow 60 or 70% against their real estate holdings, rather than 35%.
Any other recommendations?
End Socialism in South Korea.
If there is a 100% monopoly, as in fixed-line telecom, power and gas distribution, Korean individuals should be protected via price controls. However, if there exists as little as two available competing providers, all controls should be completely removed. There are three competitors in wireless telecom. Let them set any rates they wish, give out as many free handsets as they can. If one of the three goes bankrupt, supply and demand will allow the two surviving companies to raise rates and reduce handset subsidies. As wireless is an open market with more than one service provider, free market principles should govern its behaviour. There is no need for any government regulation in this area whatsoever. Particularly nonsensical were last year's forced capex demands made by MOIC on wireless providers to spend large sums of money on risky venture IT companies. The wireless providers were not even told which IT companies they had to invest in; the MOIC just issued a government decree requiring them to make the investments.
Korean brewers are required by law to pay four times market prices for Korean barley. They are legally prohibited from buying Chinese barley, which costs one fourth the Korean price. Korean barley growers clearly have an inefficient, unprofitable business plan, and are being kept in business by government-imposed price controls. Why continue this?
Wireless telecom, and barley are just two examples of socialist price controls in Korea. Not a month goes by in which we don't read about another example of nonsensical price controls which defy free-market principles. Although, please note that we have equally strong disagreement with steel import tariffs and farm subsidies in the US.
As an investor, what's your view on Korean labour issues, which are often very difficult?
The Labor Reform Act in 1998 opened up the possibility of layoffs in Korea, but these were strictly limited to workout companies and bankrupt companies. It is still illegal for healthy companies to conduct layoffs in Korea. If a financially healthy company decides to discontinue any aspect of its operations, automate, or outsource, it is legally prohibited from laying off the employees from that area. How can any business hope to pursue and develop profitability with these strictures? Once again, the law of supply and demand should govern labour-management relations. If a workforce has unique skills much needed by management, it has the leverage to negotiate higher wages and better terms. If a workforce does not possess any such unique skills and can easily be replaced, then the government should not step in to force any kind of job protection. There should be neither "illegal strikes" nor "illegal layoffs." Where collective bargaining agreements have been negotiated, these should be enforced by law and violators on either side subject to civil prosecution.
True labour flexibility requires a complete and effective social safety net. Unemployment insurance needs to last a long time, perhaps as much as one year, and needs to be applicable to small, medium, and large companies alike. Korea has an excellent education system, with third grade math students recently ranked #1 in the world, and average families investing heavily in their children's education. Why not put this system to work in retraining and re-educating laid-off workers in skills to work in faster-growing, higher margin business sectors? Instead of perpetuating redundant enterprises, overcapacity, and bad loans, through lifetime employment protected by law, why not migrate the workforce intelligently into areas far more stimulating to Korea's economy on a long-term basis?
