Dissecting the ‘Korea discount’

2014-03-03 17:12

Dissecting the ‘Korea discount’

By Andrew Salmon
Ah, the ups and downs of a journalist’s life. Having been a hack for over a decade, I have experienced more than a few of the downs. Sources agree to speak ― then change their minds.  
Your story is scheduled, but news breaks news and your article gets delayed or simply killed. Then there are copy editors. You can trust them to slap an inappropriate headline on your story, demand extra information, or, when chopping your piece to fit space, cut key information.
Bad news: My last column, concerning why foreign investors underprice Korean companies, suffered the latter fate. Good news: As the point was critical, it is worth devoting a full story to the issue. So without further ado…
A topic much debated in financial circles is the “Korea Discount” ― why foreign investors are reluctant to pay as much for Korean stock as for related stock in other countries.
The discount is visible in the price-to-earnings (PERs) ratios of top Korean companies versus global counterparts. According to Bloomberg data, Samsung Electronics trades at a PER of 10.92 while Hyundai Motor trades at 12.40. Meanwhile, Sony trades at 17.21, Apple at 13.05 and Honda at 40.09.
So why are Korean firms undervalued? I once asked a finance minister: He turned puce and gruffly declined to answer. But while ministers can evade such embarrassing questions, it is less easy for regulators or investor relations executives at related companies to give a “no comment.” So they have a prepared answer: “North Korea risk.”
This is a convenient response. As North Korea lies beyond their control, they cannot be blamed for either (1) failing to regulate the problem out of existence; or (2) failing to deal with an issue inside their companies.
But the international money managers who decide what price they are willing to pay for Korean stocks do not cite “North Korea risk.” (Note: Investment bankers, fund managers and asset managers tend to discuss this off-the-record, because they don’t wish to make enemies of regulators and corporate executives.)
They say that North Korea risk is already priced in. (Explaining why stock prices fluctuate so little amid North Korean tensions). The reason they do not pay premiums for Korean firms is corporate governance risk.
Why has this long-running and contentious issue not been dealt with locally? I would suggest several reasons.
First, the concept of investor as company owner ― i.e. whoever buys a share in a company is literally buying a chunk of the company ― is not well recognized nor respected in Korea. Here, company founder families are widely seen as owners (even if they hold minimal shares).
These powerful figures are notorious for embezzling company money, engineering inheritance scams, granting sweetheart deals, using company money to prop up ailing affiliates, etc. All these take money out of shareholders’ pockets.
And as big bosses customarily do not attend annual general shareholder meetings, they are unavailable for public questioning by their shareholders.
Then there is the “white knight” issue. Korea’s financiers were customarily closely inter-connected to business and politics. It is probably fair to say that the establishment looks after its own, hence major local investment firms do not call management to account.  This is also one reason why there is controversy over whether the National Pension Fund, Korea’s largest investment body, should be more activist.
Lastly, major Korean companies hardly reward their investors with generous dividends. According to Bloomberg data, Samsung Electronics pays 1.06 percent while Hyundai Motor pays 0.8 percent. Compare these with Apple (2.3 percent) Honda (2.19 percent) or even Sony (1.40 percent).
So a discount persists, and creates problems for the wider economy. Because the stock market is so erratic, Koreans prefer to sink their money into real estate.
This undervalues companies, starves them of funds, contributes to the discount, and leads to shareholder in-activism. Bar a handful of bold civic groups, individual investors have been reluctant to raise their voices to management.
The good news? Things are improving. Due to public anger, the political sector is being forced to react. Related institutions ― notably the judiciary and regulatory bodies ― are gradually cracking down on corporate malfeasance.
This, in the long run, will upgrade governance. Once corporations are responsive to their shareholders, a key element of “economic democracy” will at last click into place.