Icahn's Korean Campaign [BW Online]
JANUARY 30, 2006
NEWS ANALYSIS
By Moon Ihlwan
He's demanding change at cigarette and ginseng maker KT&G, one of South Korea's best-run companies. Can management fight him off?
It's no secret that Carl Icahn likes companies in distress. So why is the New York billionaire sniffing around South Korean cigarette maker KT&G?
By many measures, KT&G looks pretty healthy. Though it lost its monopoly on tobacco sales in 1988, its ESSE, This Plus, Raison, and other brands still account for three-quarters of the Korean market. And despite its 1997 loss of its monopoly on ginseng, a traditional local tonic, that business is thriving as Koreans grow more health-conscious.
KT&G's share price last year jumped by 47%, in part because of its quality management. "KT&G has followed shareholder-friendly policies and certainly has one of the best corporate-governance systems in Korea," says Kim Sun Woong, head of the Center for Good Corporate Governance, an independent watchdog group.
MUCH EASIER. Dig a little deeper, though, and some flaws start to appear. For starters, sales fell 16.7% last year, to $2.28 billion, while operating profits plunged by a third, to $698 million. And KT&G's real estate and other assets are grossly undervalued, while its share price doesn't fully reflect the value of its ginseng subsidiary.
Of equal importance to anyone making a bid for the company, KT&G doesn't have a controlling shareholder. And since it was state-owned until 2002, it isn't part of one of the giant conglomerates, or chaebol, that control so much of Korean industry. Those factors make it that much easier for the likes of Icahn, who is believed to own a bit less than 5% of KT&G, to be heard.
In December, Icahn sent two representatives to Seoul to give KT&G's management a message: Slim down. Icahn didn't return phone calls seeking comment for this story, but KT&G said the messengers demanded that the company unload its real estate. Much of its holdings consist of valuable urban land where KT&G once had cigarette factories that it has since shuttered. The Icahn reps also asked that shares of Korea Ginseng, KT&G's wholly owned subsidiary, be sold in a public offering.
FLOOD THE MARKET? KT&G's answer: Get lost. On Jan. 25, Chief Executive Kwak Young Kyoon made clear that he won't yield to the pressure. Brushing aside Icahn's calls for change as "the usual demands by investors seeking short-term gains," Kwak said: "Our priority is improving longer-term corporate value."
There's little doubt that the book value of KT&G's property is low. On its books, KT&G carries its unused real estate at $62 million -- about a fifth of what the government values it at for tax purposes. That, in turn, is far below the price the real estate might fetch on the market. But Kwak says selling all the land immediately would flood the market and drive values down. Instead, he decided last year to branch out into housing development, which he says will allow the company to sell the land at higher prices over a longer period.
The ginseng subsidiary may also be worth more than KT&G's share price would indicate. But while execs allow that they might consider an offering, they say it would be better to wait until the unit's profits pick up as sales expand at home and abroad. "This is capitalism in action," says Kang Shin Woo, chief investment officer at Korea Investment Trust Management. "The New York billionaire is exercising his right as an investor, and management is doing what it believes is the best for the company."
SALES SURGE. Management believes it has the upper hand. In recent years it has spent roughly half its net profits on cash dividends. And on Jan. 25 the board approved a buyback of 3 million shares, or 1.8% of the total outstanding. All told, KT&G has bought 28.5 million of its shares in the past four years. "As long as we keep making money and give shareholders satisfactory returns, the majority will back management," says Kwak.
Even those falling sales and profit numbers don't look quite so bad in context. Sales surged in late 2004 as retailers stocked up in anticipation of a 50% increase in cigarette taxes, to $1.50 per pack. Then sales plunged early last year as those inventories were worked off and higher prices took a bite out of consumption.
Furthermore, despite all the problems, KT&G's profit margin stood at a respectable 31%. And this year the company forecasts a 9.6% rise in sales and an 8% profit gain. Of 21 analysts covering KT&G, 13 rate the stock as a buy, seven have a hold rating, and just one calls it a sell.
Still, Icahn has some potential leverage. Although it's unclear whether he'll wage a proxy battle to shake up KT&G, the company is 62%-owned by foreigners. The largest Korean shareholder, Industrial Bank of Korea, holds just 5.9%. If Icahn can persuade fast-moving hedge funds to follow his call for changes he believes will boost the stock price, then KT&G will likely have to do something to appease them.
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