CLSA Our proposals for capital market reform Korean strategy CLSA Our proposals for capital market reform Korean strategy Samsung C&T shares Share price movement of old Samsung C&T and new Samsung C&T (old Cheil) initially shot up due (W) -Cheil Industries (Current Samsung C&T) -Old Samsung C&T (RHS) (W) Why Korea needs mandatory bid rule (MBR) to hope of activism 220,000 Many other countries Korea is an exception in that it does not have a mandatory bid rule. Many campaign but did not have M&A rules that other countries around the world have M&A rules that protect minority last long 75,000 200,000 protect minority shareholders from being stripped of their returns. The most widespread and shareholders from 70,000 effective rule is the mandatory bid rule (MBR) common in Europe, UK, South being stripped of their returns America (Columbia, Peru, Brazil and Chile) and parts of Asia (see the table 180,000 65,000 below). The essence of MBR is to protect minority shareholders. Under MBR, if 60,000 the acquirer of a company is paying a premium to acquire the stakes of the 160,000- controlling shareholder (usually over 30% stake in most countries with MBR), 55,00 it must also purchase the stakes of minority shareholders at the share price equal to the price paid to the controlling shareholder. 50,00 120,000 Mandatory bid rule Mandatory Bid Rules 5/26/2015, when merger - Country Details 100,000 + - 40,050 exists in major Asian countries Over 30-33% stake (30% for most member countries including UK) Feb 15 Mar 15 Aug 15 Sep 15 Over 30% stake (China Securities Regulatory Commission grants exceptions case by case) Dec 14 May 15 except Korea Hong Kong Over 30% stake (below 50%) and over 2% of equity ownership change within two years Source: CLSA, Quantiwise Thailand Over 30% stake (below 50%) & over 1% equity ownership change within six months The merger went The merger of Cheil Industries and Samsung C&T was later approved during Source: CLSA, ERRI through with higher- C&T's shareholder meeting on 17 July 2015. Voter participation was 83.57%, than -expected with C&T receiving 69.53% approval from participating shareholders. This Korea had previously implemented an MBR during 1997-98 through an approval rate was higher than market observer expectations at the time Korea previously implemented an MBR amendment of the Securities and Exchange Act. However, the rule was Elliot afterwards exercised the put-back option but later filed to the court that from 1997-98 abolished after just one year because of the suggestion by the IMF's bailout the put-back option price was too low and asked for an adjustment. However, programme in order to support restructuring of companies through easier M&A. Consequently over the past two decades, minority shareholders in the court ruled favour of Samsung C&T and on 24 March 2016, Elliot finally Korea suffered from countless opportunity losses due to M&A premiums that accepted the price of put-back option, effectively ending the dispute. were only given to controlling shareholders. The market price is Korean legal cases mostly concluded that as long as companies involved in M&A used the merger ratio - which seems to be the best proxy for the market Mandatory bid rule is In countries such as Korea - where the board is controlled by, and solely not always right and a minimum protection works for the interests of, the controlling shareholder - a mandatory bid rule hence merger ratio price - it is deemed fair. But it is interesting to see that the Seoul High Court for minority is a minimum protection for minority owners during M&A. By contrast, in the may not always has ruled against the long-held doctrine in Korea's legal system. The court shareholders USA the board has the fiduciary duty to make decisions based on the interest be fair mentioned that merger ratio was not fair for Samsung C&T shareholders and of overall shareholders and the rule works - at least partly because it is easy suggested a higher put-back option price. to sue the board of directors for violating their fiduciary duty to shareholders. Acquisitions of controlling stake We see two main benefits of a mandatory bid rule in Korea: Korea does not have a Korea does not have a mandatory-bid rule (MBR). It would require that any 1. It would rejuvenate the stock market; and mandatory-bid rule shareholder who takes over control of a firm by purchasing a controlling stake must also extend an offer for the remaining shares at a fair price. 2. Constrain chaebol-style expansion of affiliates In developed It is minority shareholders that trade in the stock market and hence set the No developed There is no developed country in the world that has such a high management country has such a premium as Korea. But it is in a league of its own in the case of its controlling countries, heightened stock prices. In developed countries, heightened M&A activity helps to boost M&A activity helps management premium shareholders. High management premiums paid for acquisitions usually have the stock market valuation because it is a proof that someone is paying a as high as in Korea nothing to do with rest of Korea's minority shareholders. We have illustrated boost stock premium to acquire companies at current price. A mandatory bid rule can market valuations this using the mergers of KB-Hyundai Securities and Mirae Asset-Daewoo vitalise the stock market in Korea through fairer division of M&A premiums among shareholders. Securities as examples. But there are countless more acquisitions that do not lead to mergers. Below is an example of is a typical acquisition in Korea. MBR will Additionally, a mandatory bid rule could alleviate issues around chaebol-style Kumho Corporation's acquisition of Kumho Industries improve chaebol expansion methods via investing through affiliates. A key characteristic of chaebols - which also poses a problem for the regulators - is that they have After paying a 147% In December 2015, controlling shareholders (former creditor banks) of Kumho ownership structure too many loosely-owned affiliates that often make up the grand circular premium, Park Industries sold their 50.39% stake to Kumho Corporation and CJ Express at ownership structure. To significantly reduce the cost of takeovers, chaebols Sam-gu re W41,213 per share worth W723bn. A 147% premium was paid in a deal that only acquire just enough stakes in companies that will not jeopardise their management control allowed the chairman of Kumho Asiana, Park Sam-gu, to regain management control of management. To further reduce the cost, they often use the assets control of Kumho Industries through a special-purpose company (SPC), Kumho of the acquired company to invest in another business which also invests in a Corporation. The reason for the high premium was because the company holds different firm and so on, creating circular shareholdings. a 30.08% stake in the group's largest subsidiary, Asiana Airlines which controls 15 May 2017 paul.choi@clsa.com 15 May 2017 paul.choi@clsa.com 11