Monday, February 9, 2015

Korea's growing M&A activity

First published in The Korea Herald.

Mergers and acquisitions in Korea scaled new heights last year as companies undertook massive restructuring and big deals were struck.

According to the Global M&A Market Review published recently by Bloomberg, the M&A market nearly doubled to $79.7 billion in 2014 from the previous year. This is also four times more than the $20.4 billion recorded in 2011.

It is not very difficult to guess the reasons for the M&A boom. For starters, many companies were sitting on massive cash piles, while the slowdown in the economy and their weak earnings forced businesses to restructure and discard their poorly performing units.

A string of megadeals including the merger between Daum Communications Corp. and Kakao Corp. and the merger between Samsung SDI and Cheil Industries contributed to the growth in the total M&A volume.

Other notable deals were the acquisition of Oriental Brewery by Belgium’s Anheuser-Busch InBev and the acquisition of Tyco Fire & Security services by The Carlyle Group.

One recent megadeal that made headlines involved Korea’s biggest chaebol, Samsung Group, which struck a deal a few months ago to sell four of its chemical and defense affiliates to Hanwha Group for 2 trillion won ($1.8 billion).

According to industry experts, we can expect more M&A this year given the cheaper financing costs under low interest rates and also because of moves by the Korean government to tax companies sitting on huge cash piles.

In October last year, the Bank of Korea cut its benchmark interest rate by a quarter percentage point to 2 percent, matching a record low set in the aftermath of the global financial crisis. It is widely expected to cut rates again to boost the tepid economic growth -- its next monetary policy committee meeting is scheduled for Feb. 17.

News reports suggest that as many as 700 local companies are likely to be hit by a new tax on internal cash reserves, which is part of the government’s three-pronged taxation initiative announced in August.

Companies that have more than 50 billion won in capital will face the new tax. A single 10 percent tax will be imposed on companies that use less than 80 percent of their annual revenues for investment, wages and dividends from this year.

The initiative is a cornerstone of the economic plan of Finance Minister Choi Kyung-hwan to boost the domestic economy by forcing businesses to use some of their cash to raise employees’ wages, invest in facilities and raise dividends for investors. However, some companies might try to reduce their cash reserves by actively seeking out acquisitions.

As economic theory suggests, the M&A benefits are manifold. They can generate cost efficiency through economies of scale, enhance revenue through gains in market share and even bring the companies tax gains.

To narrow it down, the benefits can be listed as increased value generation, increase in cost efficiency and increase in market share.

All this should be good news for the Park Geun-hye administration, which announced proposals in March last year to give a much-needed boost to M&A activity and expand the local market.

It aimed to increase the volume of the local M&A market by announcing proposals to amend and abolish a number of regulations so as to encourage corporate takeovers and more private-equity-backed M&A deals. The plans include easing regulations on private equity firms and providing capital for M&A.

To boost private equity-backed M&A deals, the government said it would discard voting right restrictions and also strict disclosure obligations placed on PEFs under the fair trade law.

The government also announced it would make it easier for PEF-owned companies to list their shares on the local stock market. Until now, strict rules on investor protection blocked such companies from going public.

Other steps include expanding the size of a fund for the M&A activities of startups and small and medium-sized firms to around 1 trillion won within the next three years, and also introducing tax-exemptions for M&A deals carried out through a share exchange.

On the face of it, the volume of M&A activity in 2014 appears to suggest that the government push seems to be working. However, a closer look shows that not everything is as rosy as it looks.

The number of M&A deals were actually lower at 468 last year, versus 482 in 2013. A few deals have been very large, which in turn pushed up the total volume of transactions.

The M&A deals that occur in Korea take place mostly to improve the financial health of large companies by selling affiliates, rather than acquiring venture companies related to the new growth engines. In contrast, overseas M&A deals are more focused on means to secure new growth engines.

Mergers between affiliates of a large company and the division of a large company into affiliates for a shift in corporate governance continues to be one of the most active types of domestic deals.

Meanwhile, business transfers and mergers by large companies to diversify business -- apart from a few -- have declined due to uncertainty in the economic environment. Abroad, deals between companies in the same industry and across all different industries for external growth and business diversification are active. The Korean M&A market has clearly been dominated by acquisitions of domestic companies in the country. While cross-border deals are still lower, accounting for less than 3 percent of the total M&A transaction volume. This needs to pick up for the companies to make a global mark.

Without a doubt, much more progress is needed in the M&A sphere in Korea, and one should not just go by the transaction volumes that have been recorded. It is still in a nascent stage.

Another point that needs to be made is something that has been largely glossed over by economic commentators -- the impact of M&A activity on economic growth.

Neoclassical economic theory is primarily concerned with why M&A occur and views them either as responses to industry shocks, such as new regulations, technologies, liquidity constraints and competition or as responses to industry life cycles. The implications of M&A for economic growth, however, are largely ignored.

In Korea too, the consequences of M&A remain less studied than the reasons why mergers occur. Maybe it is time for Korean economists to do a comprehensive study on the impact of M&A activity on the domestic economy. It is bound to provide valuable policy advice to our policymakers.