Investors get access to Korean small caps

A groundbreaking new CBO fund targets foreign investors seeking exposure to Korean SMEs.

The Korean government - along with Tong Yang Investment Bank, TD Securities, the Korean Development Bank (KDB) and Hong Kong-based ADM Capital - have unveiled a new fund offering international investors a slice of the Korean small and medium sized business sector. The fund - called the Koromas Fund - is being sponsored by the Small and Medium Business Administration (SMBA), a department of the Korean Ministry of Industry and Energy.

The Koromas Fund aims to raise $300 million through the issue of three classes of notes. The senior A class note and participating C class notes will be sold to international investors together. The A notes will get a credit wrap from KDB. The C notes will be backed by the equity of companies in the fund. The B class junior notes will be sold to Korean investors without the KDB credit wrap.

The money raised will be used to buy a series of Eurobonds with warrants attached from a pool of 60-70 Korean SMEs. The companies will each sell their individual eurobonds via Tong Yang and TD Securities to the fund. The warrants attached to the bonds will be roughly equal to 20% of the individual company's market capitalizations. For those companies that are not listed, KPMG will provide a valuation.

The investors in the fund will essentially be buying a collateralized bond obligation with the credit guarantee of KDB and the upside equity potential of 60-70 small cap Korean companies. This enticing structure should ensure the deal's success. As a further enhancement, the fees that the advisors and managers would usually charge have been cut to a minimal level and the advisers and managers will instead be getting their pay through free participation in the fund.

Despite the fact that the Korean government is involved, the SMEs will be paying a market rate for their money. The coupons and yields on their Eurobonds will be set at market rates, as will the terms of the warrants. All the Eurobonds, the notes and the fund itself will be listed in Luxembourg to further enhance the transparency of the deal.

"This project is very important for Korea as it is our chance to shows our capabilities to foreign investors," said Hyoung Keun Oh, Director of the SMBA, speaking at the fund's launch. Indeed, the fund is being marketed as the first chance foreign institutional investors will have to invest in the chosen companies.

The fund was launched in Hong Kong on Thursday amid a roadshow featuring some 17 of the participating companies. There was standing room only in the presentation room as a variety of international fixed income, straight equity and private equity investors listened to the small companies make presentations about their businesses.

The participating companies are being selected out of a universe of 400 SMEs invited by the SMBA to participate. Approximately 40% of the chosen companies will be from the IT sector, 20% will be biotech or related companies and the rest will be from a variety of other industries. The companies include a sewage management company and a video game manufacturer. Generally, they will be companies that are leaders in their field due to technological skill but are too small for international investors to take an interest. They will also be export orientated so that their earnings will be immune to Korean Won currency shocks.

Tong Yang has proved itself something of a leader in the issuance of bonds with warrants from Korea. Earlier this year, it issued a five-year dollar deal for Hanaro Telecom to international investors. The firm's managing director, Kim Chong-Dae reports that Tong Yang has issued over $1 billion of bonds with warrants attached in the past year alone.

ADM Capital is a specialist Hong Kong fund manager, founded four years ago by the exuberant pairing of Chris Botsford and Robert Appleby. Initially, it was a distressed debt investor but the firm has since expanded into corporate advisory services and investment management activities.

The present deal, if successful, will serve as a useful blueprint for attracting foreign capital into companies that have trouble accessing international money due to their small size and credit concerns. Indeed, the group that put the fund together report that there could be interest in a similar scheme in China or Singapore. It will be interesting to see if they can repeat their success or if someone will copy their idea first.

The fund aims to close on November 19, but between then and now the final list of companies has to be decided and then each company will have to issue its Eurobonds into the fund. The paperwork is apparently keeping three firms of accountants, three law firms and the two investment banks busy 18 hours a day, seven days a week. Given that Korea only issues around 20 Eurobonds a year, the scale of this undertaking is huge. The commitment shown by the arrangers and managers of the deal to take their fees in the upside of the fund, shows how much they believe - and hope - it will work.

Anthony Wood, a director of ADM Capital, showed the team's belief when he noted, "the fund will provide investors with an exposure to a high quality mix of small cap companies in Korea, It is from these companies that we anticipate seeing the stars of tomorrow."

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