Korean government pre-markets Cho Hung GDR

The Korea Deposit Insurance Corporation (KDIC) began pre-marketing a roughly $500 million GDR offering on Monday.

Formal roadshows are likely to start around Monday June 3 after two weeks of pre-marketing under the joint lead of Credit Suisse First Boston, UBS Warburg, LG and Samsung Securities. Co-leads are ABN AMRO, Daewoo Securities and JPMorgan.

The government is planning to sell a 15% stake, which would raise $558 million if the deal came with no discount and was priced off yesterday's (Wednesday) closing share price of W6800. Given that the bank now has a market capitalization of $743.5 million, the 101 million secondary share deal will also trigger the $500 million Opera bond launched last December.

Under the terms of the deal, a QPO (Qualified Public Offering) occurs if the stock reaches a liquidity threshold of $1 billion. At this point, the four-year straight debt instrument becomes a pure exchangeable and can be converted into stock at a conversion premium of 18%. The conversion price is determined as the lower of the QPO price, or the weighted average price of the stock over 10 days trading volume. Once a QPO has occurred, the deal can also be called after 18 months subject to a 130% hurdle.

To protect investors, the deal also incorporated a special put in the event that the government decides to sell more than 25% of the bank to a strategic investor. However, the government has said it hopes to sell 15% to 20% of the bank to a strategic investor during the second half of the year and if this fails, will divest 10% to 15% in a placement to domestic institutions.

Since the beginning of the year, Cho Hung's share price has performed strongly rising 64.25% year-to-date, hitting a high of W7780 on April 22. Since then it has suffered a sharp W2000 decline after the sale of Hynix to Micron fell through and then recovered W1000 after creditor banks, of which Cho Hung is one of the biggest, moved to take over the semiconductor company.

But even at current levels, the leads are likely to argue that the bank is undervalued relative to its peers. Trading on a current price to book value of roughly 1.75 times 2002 earnings, Cho Hung is below the average of the better rated Korean banks such as Kookmin, Hana, Shinhan and KorAm, which average just under two times.

For potential investors, there are likely to be three key issues, which Cho Hung will need to address. The first concerns the overhang of the government's privatization programme. Currently the KDIC holds 80.05% of Cho Hung and has said that after the sale of a strategic stake, it will divest the remaining 40% to 45% in stages from 2003.

Secondly, there is the issue of Cho Hung's provisioning, which has previously been the chief drag on its share price. The main problem lies with its classification of loans to the Ssangyong group and Hynix as precautionary rather than doubtful. Therefore, while the bank has officially reported a loan loss cover ratio of 90%, the real figure has always been more like 50%.

At the recent announcement of first quarter earnings, bank officials said that Cho Hung would raise provisions against Hynix from 40% to 80%. However, while some Korean banking experts say the bank is still finalising the exact amount it will set aside, others report that the management has already provisioned to 80%.

At the end of March, the bank reported an NPL ratio of 2.7%, a 0.6% fall from 3.3% at the end of last year. Again, however, this figure would not include Hynix since the company was still in discussions with Micron at the time. But analysts note that by the time the bank reports second quarter earnings, the figure may fall even if Hynix is included, since Cho Hung has been using its rising operating profits to progressively write NPLs down.

The third issue facing Cho Hung is the consolidation of the banking sector. Analysts say that the growth of the Kookmin and Woori groupings is leaving Cho Hung behind and that it will either need to merge with another Korean entity or face the prospect of becoming a niche player.

Net income for the first quarter rose 49% to Won20.4 billion ($15.8 million). Operating profit pre provisions amounted to Won436 billion.

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