Kookmin Bank raised W1.26 trillion ($1.24 billion) yesterday (June 16) after disposing of almost all the Treasury shares it purchased from the government in December 2003. The deal represents the largest Korean equity deal since Korea Telecom's $2.2 billion offering in 2001 and may pave the way for a number more as a result of regulatory changes applied by the FSS (Financial Supervisory Service).
After consultation with lead manager JPMorgan, the Korean regulator has modified some of its complex and contradictory regulations governing domestic equity deals. Primarily these concern rules about the discount level a deal can be priced at and who it can be allocated to.
If shares are being sold by a third party, lead managers have always had the leeway to price a placement at a discount of up to 7% to the spot close and can offer stock to both domestic and foreign investors. Shares are then crossed from issuer to investor on-market via a one-hour window before the exchange opens the following day.
However, problems arise when the company itself is selling shares - either in the form of primary equity, or Treasury shares. If this is the case, lead managers are not allowed to price a transaction at a discount of more than two ticks, which equates to Won100. This effectively means they have to be priced at no discount at all.
Companies can get round this in one of two ways. When Shinhan Bank divested Treasury shares in March 2004 it could do so under the 7% discount rule because the shares were held by subsidiary and this technically meant the deal was considered a third party sale.
However, bankers say Shinhan was the exception to the rule. The majority of Korean companies with large holdings of Treasury shares retain them at the parent level.
This means the two ticks rule applies unless the transaction is completed off-market. If a trade is crossed off-market, lead managers have a more leisurely three-day settlement window.
However, large blocks are difficult to execute this way because historically only domestic investors were allowed to participate. Off-market trades are also more expensive, as they are subject to a 50bp transaction tax compared to 30bp for-on market trades.
Kookmin has broken new ground because the FSS has allowed foreign investors to participate in off-market trades for the first time. This allowed it to structure its deal with two tranches: one block of 26.68 million common shares and one tranche of 742,989 GDR units.
Its GDR offering constituted an unregistered Reg S offering that will become fungible with the group's ADR float after 40 days. The bank opted out of a concurrent ADR tranche because it does not have an existing shelf registration and did not want to have to make a formal filing that would entail documentary hassles and the market risk of a review period.
But it still wanted a dollar-denominated tranche in order to maximise investor participation and attract those offshore accounts that did not want to incur foreign exchange risk.
The transaction was launched after Wednesday's close in Korea and priced after New York's close later the same day at Won46,000 per share, or $45.34 per GDR. One unit equals one share.
This represented a 4.96% discount to the stock's Won48,400 close on Wednesday, or a 0.6% discount to the $45.60 ADR close. Both these discounts are in line with levels achieved by previous big blocks out of Korea.
In 2004, for example, there were two jumbo placements in Hana Bank and Hyundai Motor. The former comprised a $930 million deal at a 4.9% discount to spot and the latter a $912 million offering at a 5% discount to spot.
Kookmin's deal was marketed at a zero to 5% discount to spot, although pricing at the tight end was never very likely given a recent rally in the bank's share price. Year-to-date, the stock is up roughly 15% and had enjoyed a nine-day run ahead of the deal.
On the day it launched, the stock closed up 2.54%, although the ADR went on to fall 2.4% under short selling pressure. When trading resumed on Thursday, the stock fell 3.9%.
At Won48.400, Kookmin was trading 7.6% off its 52-week high and most analysts had turned from a bullish to neutral stance. Unsurprisingly, investor price sensitivity to the new deal was high and the combined order book was closed when hit roughly one-and-a-half times covered.
About 125 investors are said to have participated of whom 90% opted for the domestic tranche and 10% for the GDR. About 35% to 40% of the overall book constituted Korean institutions and the remaining 60% to 65% was roughly split 40% Asia, 40% Europe and 20% offshore US.
On a pre-money basis, Kookmin was trading at 1.5 times analysts' average forward price to book ratio and 1.4 times post money. At this level, it ranks second only to KEB, whose valuation is currently inflated by M&A fervour.
The Korean banks as a whole average just 1.2 times forward price to book. This places them right at the bottom of the Asian rankings, which currently average about 1.8 times price to book. Hong Kong sits at the top of the scale on 2.64 times, with the Philippines just above Korea on roughly 1.4 times.
In turn, the Korean banks are presently trading marginally above their local market average. Despite the sector and the country's perennially cheap valuation, analysts remain unsure what the catalyst for a major re-rating will be.
In Kookmin's case, some analysts believe the removal of such a massive overhang will give the stock price near-term momentum. The transaction equated to 8.15% of Kookmin's total outstanding shares and expanded the freefloat to 87%. It now holds just 0.9% in Treasury shares.
Because the shares were sold at a higher price than the bank purchased them from the government, it has been able to book a capital gain that will boost its tier 1 equity. This will rise 0.92% to 8.1%.
Analysts believe that further share price performance will depend on how it deals with this fresh infusion of capital. Most are hoping the bank will return it to shareholders through a big dividend pay-out ratio.
Some houses hope the bank will pay out up to 50% of net income in 2005, which would result in a forward dividend yield of over 5%. Others believe a 40% ratio is more likely, which will result in a yield closer to 3.5%.
Either way analysts say that investors have shifted their focus from asset quality to growth. Over the previous decade, Korean banks expanded via corporate lending (which resulted in the Asian financial crisis and the unwinding of the chaebol), then consumer lending (which resulted in a credit card crunch).
Over the past nine months positive stock price performance has been driven by the sector's emergence from the asset quality problems created by the credit card crunch. The question now is where next given that loan growth has remained sluggish over the past two years.
In a research report published this week, Credit Suisse First Boston concluded that weak loan growth and a margin squeeze will constrain the likelihood of visible re-rating. But it concluded that, "The sector will deliver a number of compelling investment themes for investors in 2005 and 2006, including positive earnings surprise, more swiftly stabilised credit costs than expected, a decent dividend yield and improved capital ratios."