Hutch's kimchi port of call

Hutchison has announced a $215 million acquisition of three major ports in Korea.

Li Ka-shing's conglomerate, Hutchison Whampoa has made its first foray into Korea. And bearing in mind his famous 'cluster strategy', the acquisition of Korean ports may herald his entry into Korea in a much bigger way.

Yesterday, Hutch announced it wanted to buy three Korean container ports for $215 million. Should the deal get past the Korean Fair Trade Commission (the only antitrust body in Asia), Li will have the largest market share in the Korean port business.

Li had already sank around $759 million into a new container port in Kwangyang - the home of POSCO. With his new acquisition he will have two ports in Kwangyang and two in Pusan - the latter being the third largest port in the world now after Hong Kong and Singapore (indeed the world's top five ports now reside in Asia).

This follows Hutch's so-called 'two ports' strategy and allows it to maximize its leverage in the feeder line business - in this case from Russia and Japan into Europe and the US. Li will dominate the Korean ports business - with the Korean government having the second biggest market share.

It is the Hong Kong tycoon's first major investment in Korea, but it follows a well-plied strategy. His so-called 'cluster strategy' became well known when he bought Felixstowe port in the UK before using this experience to expand into other businesses such as mobile telephony (Orange) and retail.

It might herald a similar approach in Korea, where it is well known that British Telecom is keen to sell it stake in LG Telecom. Analysts find it difficult to value whether Li has got a great, average or poor deal for the Korean ports.

Both Hutch (advised by Goldman Sachs) and the debt-laden seller, Hyundai Merchant Marine (advised by CSFB) have been in negotiations since July. It is near-impossible to compare port business along global metrics, or use standard valuation multiples. Tariff schedules differ markedly between ports in different regions, and the business is really about a series of contracts with shipping companies.

As one banker put it, these are more like property or hotel deals. The only good way to value ports is using discounted cash flow. Hutch investors probably need not get too concerned about the deal's immediate impact. The new Korean port's business will make up less than 1% of Hutch's profits.

However, it does offer Hutch a chance to diversify away from Southeast Asia (it owns a port in Malaysia) and into North Asia. It will also allow it to consolidate its own greenfield port in Kwangyang (of which it owns a third) with its new acquisition.

Since ports have high fixed costs, and since both are in their early stages, if volumes suddenly take off this can have a stunning effect on the bottom line. The deal may initially be financed out of Hutch's famed cashpile, but in the longer term, analysts say that US dollar debt will be used.

Most ports run 70/30 debt to equity balances. Typically, Korean ports have borrowed 30% of the money in local currency and the rest in US dollars. Given Hutch's high international borrowing standing, it could end up being the best credit in the local Korean won bond market.

As one wit put it, "it will certainly have a lower cost of funds than Hyundai."

Hutch normally targets a 15% rate of return for it investments, and as one analyst notes: "For Hutch's ports business to grow at 10-15% per year, it needs to do deals like this." Next stop, hints the same analyst, might be India, where ports are also up for sale.