Heightened tensions on the Korean peninsula will likely elevate interest in the $444 million initial public offering of Korean defence contractor LIG Nex1, according to two sources familiar with the matter.
Tensions between North and South Korea intensified sharply on August 20 when the North fired at loudspeakers broadcasting anti-Pyongyang propaganda across the heavily defended demilitarised zone dividing North and South.
South Korea reportedly responded with return fire, sending artillery rounds across the 38th parallel, as the demarcation line between the two Koreas is known, into the North.
While Seoul and Pyongyang dialed down tensions by reaching an agreement to end the standoff five days after the exchange of fire, the two Koreas remain technically at war -- a situation which has existed since an armistice ended open conflict in 1953.
As such, the LIG Nex1 IPO is an opportunity to invest in the South's defense industry which is expected to grow by W232 trillion ($214.7 billion) between 2016 and 2020. The annual rate of increase is about 7% from this year’s military budget of W37.4 trillion, according to South Korea’s defense ministry.
The North has a so-called "military first" policy and reportedly spends around 15% of its gross domestic product on military expenditure, while the South, one of the world's most developed economies, spent 2.38% of GDP on the military in 2014.
Shoring up defence stocks
LIG Nex1 is offering a total of 6.9 million shares in the Reg S IPO, including 2 million new shares and 4.9 million existing shares sold by shareholders. The IPO could raise a maximum of W524.4 billion, based on the indicative price range of W66,000 – W76,000 per share.
The company's post-IPO implied equity value will lie between $1.23 billion and $1.42 billion.
The shares will be offered in a typical 60/20/20 split between institutional and retail investors and company employees.
A source familiar with the matter said LIG Nex1’s relatively conservative pricing makes it a good substitute for competitors like Korea Aerospace Industries and Hanwha Techwin, defence contractors for the country's armed forces.
At W66,000 – W76,000 per share, LIG Nex1 is valued at 28.7 – 33.0 times 2014 earnings, or a discount of 40% – 48% against Korea Aerospace which trades at 54.8% price-to-earnings. Hanwha Techwin, meanwhile, reported a loss in 2014.
Both Korea Aerospace and Hanhwa Techwin have outperformed the benchmark index this year amid heightened tensions between the two Koreas. Korea Aerospace shares rose 136% year-to-date while Hanhwa Techwin jumped 34%, well above the KOSPI Index’s 1% gain.
In the first six months of the year, LIG Nex1 reported stellar profit growth of 79.5% year-on-year to W34.3 billion. Its debt-to-asset ratio stood at 78% at of the end of last year, compared to Korea Aerospace’s 51%.
Lull in the action
The company planned to start bookbuilding on September 1 but postponed the start by half a month pending a government review of test results of a portable anti-tank missile that LIG Nex1 had a hand in developing, according to a source familiar with the situation.
Under the new timetable, LIG Nex1 will take institutional orders on September 17 and 18, followed by a retail offering on September 22 and 23. The company will debut on the Korea Exchange on October 2.
Proceeds from the IPO will be used to finance the company’s facility expansion plans.
Even at the bottom end of the range, LIG Nex1 will still be Korea's largest IPO this year, surpassing Mirae Asset Life Management's $307 million deal in June.
NH Investment & Securities and Korea Investment & Securities are joint managers of LIG Nex1's IPO.
PE joins ranks
LIG Nex1 is a major Korean defense contractor and develops a range of military systems used in warships, jet fighters, submarines, tanks and armored vehicles. It also supplies guided missiles and radar systems to the South's military.
The company was set up in 1976 as Goldstar Precision and was subsequently known as LG Innotek and then NEXFuture1.
In 2013, South Korea conglomerate LG sold a 49% stake in LIG Nex1 through its subsidiary LIG Corporation to eight private equity investors for W420 billion. The price equated an implied equity value of W857 billion, or 36.9 times price-to-earnings.
According to the terms, LIG is required to take LIG Nex1 public by the second half of 2016, or the PE investors will have the right to purchase the remaining 51% in the company.
The private equity investors were STIC Investment, Hana Daetoo Securities, Dongbu Securities, KB Asset Management, Daishin Securities, Heungkuk Asset Management, KTB Private Equity and AJU IB Investment.
