In the days before the financial crisis, KEB was arguably Korea's most highly regarded, and international bank. It only later became the bank with the weakest capital adequacy ratios in the whole of Korea.
But now with its entry as the 51% majority owner of KEB, Lone Star has single-handledly solved the capital adequacy problem. Indeed, S&P immediately upgraded KEB to BB+ from BB on the basis that the tier one ratio of the bank had been increased by Lone Star's capital infusion from 4.8% to above 7%.
Lone Star has invested $1.2 billion in Lone Star for a 51% stake and management control. This values the bank at $2.4 billion, and makes it non-Japan's Asia's biggest ever private equity investment.
To put the deal in perspective, it is worth comparing a few numbers with another Korean bank that is majority controlled by a private equity fund, namely Koram, which is controlled by Carlyle. In this case, the cash amount being paid by Lone Star is three times that paid by Carlyle, for a slightly bigger stake. However, looked at another way KEB is a much bigger bank. It has $54.5 billion of assets (according to Fitch) whereas Koram has $37.6 billion. Koram's market capitalization is $2.23 billion versus the $2.4 billion this deal values KEB at.
There is obviously a major difference between the two banks, which is that Koram's asset quality is significantly higher and this explains its higher valuation.
Lone Star - whose success in investing in Asian distressed debt (including KEB's own) is well known - is clearly a savvy operator and it is thought that when it was valuing the bank, its ability to price the bank's assets gave it an advantage over most potential buyers.
Not only that, but it also has the experience of buying a bank in Tokyo. That bank, which it renamed Tokyo Star Bank, was purchased in 2001 and turned around quickly. However, with an asset base of only $8 billion and operations only in Tokyo, it is a much smaller beast than KEB.
In KEB it has bought a bank that retains a reasonable franchise, especially in forex and trade finance, and is able to throw off $1 billion of free cashflow per year (when not provisioning against NPLs). Its major problem was a lack of capital, especially as the government had set a rule that any bank that fell below a 4% tier one ratio would be immediately closed. Since both major shareholders (the government and Germany's troubled Commerzbank) had failed to put up new capital, it was essential for the bank's management to find someone who would.
After failing in its bid to win Seoulbank last year, it was well known that Lone Star was keen on buying a Korean bank. In this case it is using its capital to bridge KEB's capital problems and could look very smart indeed two or three years from now.
The deal will see massive dilution of the existing shareholders, however. Commerzbank will be diluted from 32.55% to 14.75% (not a great investment thus far for the German bank, which invested $800 million), the government to 20.19% from 43.17% and EXIM Bank of Korea from 32.5% to 14%.
Thanks to Lone Star injecting W1 trillion of new capital, S&P says "With a strengthened balance sheet, KEB will be able to expedite it cleanup of non-performing assets."
Among its problems are KEB Credit Services, the credit card business that Citigroup was on the verge of buying in 2001, just before 9/11. Like all the Korean credit card businesses this has some serious issues, and will be a major priority for Lone Star.
No one doubts that as with Newbridge at Korea First, much work will have to be done by Lone Star to turn KEB around. "They're not thinking about M&A at this stage," said one banker close to the deal. "They just want to roll their sleeves up, get inside the bank and get to work."
However, no private equity firm ever goes into a transaction without considering its exit strategy and in this case the situation is not clear cut. Both the previous private equity investment made in the Korean banking sector (Carlyle in Koram and Newbridge in Korea First) were made during the financial crisis and prior to consolidation. Thanks to an improving economy and some government pushing, a consolidation into four major banking groups occurred. Quite suddenly, the Korean banking sector didn't look that structurally different from the UK or Australia.
However, that consolidation had happened without either of the private equity firms participating and in our March issue (see article pg 46, Out in the cold) we reflected the view of many local experts that the private equity firms had maybe missed the boat.
The view that the four big franchise (Kookmin, Woori, Shinhan and Hana) would dominate and get bigger at the expense of everyone else, left many wondering what, if any, were the exit strategies for the private equity firms - especially as bank stocks had tanked in the wake of the consumer loan problem.
With this background in mind, one has to say that Lone Star's decision to enter the fray totally counters the conventional wisdom recounted above. Clearly it has taken a long hard look at the Korean banking scene and thinks that KEB is either big enough to consolidate with either Koram or Korea First into a fifth major player, or that one of the other four majors will want to buy it somewhere down the line. The latter would be a classic piece of M&A, while the former would see Lone Star's exit ultimately through the equity markets.
But all of that may be a way off. As for now, Lone Star was advised on this transaction by Citigroup and Morgan Stanley advised KEB and its major shareholders.
