Lead managers Goldman Sachs and UBS Warburg will undoubtedly be hoping for the same response as 2001 when investors purchased KT&G as a defensive yield play in uncertain and volatile markets following the September 11 attacks.
Pre-marketing of a 52.7 million unit sale will begin tomorrow (Wednesday), with formal roadshows scheduled to run from September 26 to October 9, followed by pricing on October 10. With one GDR equaling 0.5 shares, the sale should raise up to $390.8 million based on Monday's Won17,750 close and no discount. Alongside the leads, Dongwon and Hyundai Securities are joint bookrunners, with Deutsche Bank, ING Bank, LG and Samsung Securities as co-leads.
Terms remain exactly the same as June when the government last attempted to shift a 14% stake in the group, but decided to pull the deal ahead of roadshows after markets weakened and a poorly handled domestic offering made an international deal almost impossible to execute.
This time round, the offering has a number of technical and fundamental advantages in its favour.
KT&G typically has an inverse relationship to the Kospi index and while the latter has seen nearly all of its 2002 gains reversed over the course of the summer, the former has steadily outperformed. Having hit a year-to-date low of Won15,000 on August 2, KT&G has risen consistently since then and is now down 8.51% on the year compared to an 18% loss when the government last pre-marketed the GDR in mid-June. At that point, the Kospi was up 17% on the year, where it is now up roughly 3.5%.
The company's share price performance has also been underpinned by its share buy-back scheme - 5% of shares held by the KDIC were recently purchased and are about to be cancelled. Korean specialists say that when the government first embarked on its privatization programme in 1999, the company made a commitment to improve shareholder value and has since pursued a policy of share buy-backs and a sustainable dividend policy.
This has resulted in a 30% CAGR (compound annual growth rate) in dividend per share between 1998 and 2001. Indeed in a research report published last week, Salomon Smith Barney noted that KT&G pays the third highest dividend of any Asian consumer company behind Want Want and Thai Union Frozen. At 8% its dividend also ranks far higher than the 2.3% average of the Korean stock exchange and 4% average of the world's tobacco stocks.
For potential investors, the key investment decisions concern future upside from a stock, which has enjoyed a mini bull run and whose long-term performance rests on the company's ability to maintain high dividends and EBITDA in the face of encroaching foreign competition notably from BAT and its enormously popular Dunhill brand.
But specialists say company officials have stated that a W1400 dividend per share will continue to be paid through to the end of 2002 and that going forwards, dividend payments will rise in tandem with net income growth.
Most houses still have a buy recommendation on the stock and consensus opinion indicates 10% to 15% upside from current levels. Salomon, for example, has an outperform rating on the stock and has just increased its target price from Won19,000 to Won21,500.
Analyst Mark Rosenfeld comments, "Investors are not in love with this name and we understand their reticence. It's not the easiest story to broke when a company's market share is going through the floor. But that trend involves some dirty tactics on the part of its rivals. And intuitively, its market share ought to settle at somewhere between 75% to 80%.
"Margins are coming through more strongly than ever," he continues. "Cashflow is sound (even allowing for the recent share buy-in) and dividends look to be safe and well covered."
Local analysts say that KT&G's market share has averaged 75.6% from January through to August, hitting a low of 74% and high of 80% as recently as June. Many argue that foreign competitors will never be able to replicate KT&G's extensive distribution network, but most acknowledge that foreign brands are having an impact at the high end of the market, where future growth is expected to be strongest.
KT&G has about 26 different cigarette brands, of which about 15% lose money. However, it has also made a strong push into premium brands, which have risen from 35% of total sales in 2000 to 56% in 2002.
It has also increased its net selling price per pack by 40% since the beginning of the year, although higher taxes have so far offset the gains and the company reported disappointing second quarter results. Net income, for example, fell 35% year-on-year to $54 million.
But analysts also note that the company has been able to steadily increase its operating margins from 17.5% in 1999 to 26.4% in 2001 and a forecast 29% in 2002. Part of this stems from efficiency gains as a result of increasing the ratio of cigarettes per employee per hour (26,000 targeted by end 2002) and importing a greater percentage of foreign tobacco leaves (20% in 1999 to 29% in 2002), as they are considerably cheaper than domestic leaves.
Aside from the fundamental equity story, which appears to have already priced in potential negative news regarding market share, the company has a number of technical factors in its favour. Firstly, it is coming to market at the right time of year, since Korean stocks pay dividends at year-end and high yielding stocks such as KT&G tend to be strongly supported by local investors in the few months beforehand.
Secondly, the share price has not wobbled as a new divestment has become apparent. Observers say this is because the privatization overhang, which has long plagued KT&G share price performance, is about to be removed. As a result of the GDR, the government's stake will drop from 32% to 18%, of which 10% consists of shares backing the IBK exchangeable into KT&G and the remaining 7.5% represents long-term investments held by Seoulbank and a domestic investment management company.
A secondary consideration has been the large amount of Treasury stock held by the company. But again, of the 33% equity KT&G holds, some 23% backs exchangeable bonds including the $408 million domestic exchangeable completed in late June.
This government's botched efforts to sell a 19.4% stake through the domestic market represented one of the main stumbling blocks to the completion of an international deal. Having forced a domestic placement at Won16,200 per share - a 4.5% premium to close - the government not only found that its domestic demand evaporated, but realised that it would not then be able to justify discount pricing to foreign investors. KT&G subsequently absorbed the excess stock through an increased exchangeable.
How close the lead managers will be able to price the new deal to parity will be one of the most interesting tests of the forthcoming transaction. In October 2001, the government was able to sell a 20% stake via a $309 million GDR at parity to the stock's Korean close. But this was largely felt to be because foreign investors were capped at a 5% holding through the domestic market.
Until recently, the overall foreign investment limit was 35% (including the 5% domestic limit), but this has now been raised to 49%. Foreign investors currently own 16.89%. However, on completion of the privatization and subject to the next AGM, the domestic limit should be scrapped, reducing much of the premium attached to GDR ownership.
