Kumho Tire roadtests IPO

Korean Tire manufacturer presents investors with a turnaround story less than two years after its forced sale to the Military Mutual Aid Association.

Kumho Tire will finish pre-marketing an unusual dual listing in Seoul and London today (January 18) via lead managers JPMorgan and Daishin Securities. The group hopes to raise $300 million to $400 million from the deal, which includes a strategic investment by Cooper Tire.

The US tire manufacturer has agreed to purchase 11% of the company's enlarged share capital at the eventual IPO price. Pre deal the company has a shareholding structure whereby Korea's Military Mutual Aid Association (MMAA) owns 50%, Kumho Industrial 30% and creditors 20%.

The IPO incorporates the sale of both old and new shares, with a one third/two thirds split in favour of new shares. All the old shares are being sold by MMAA.

Post IPO and pre greenshoe, MMAA will drop down to 25%, Kumho Industrial to 21% and creditors to 14%, with Cooper on 11% and 29% in freefloat.

Based on a pre money 2005 profit forecast of $125 million, the deal is being pre-marketed on a P/E range of 7 to 8.5 times earnings and will have a post money market capitalization of $750 million to $1 billion. Investors have a very clear pricing comparable in the form of Hankook Tire, which is currently trading at roughly 8.5 times 2005 earnings.

This means that Kumho is being pitched at a discount of roughly  21% to 6% to Hankook. After taking into account the need for an IPO discount, Kumho could potentially price through Hankook at the top end of the range.

The two companies share very similar business models and have comparable global market share sales figures of 1.7% (Kumho) and 2% (Hankook).

One of the most obvious differences between the two is that Hankook pays a small dividend (2.88% forward yield), whereas Kumho will not - at least for the immediate future. The lack of a dividend and most of the differences between the two all relate to Kumho's forced sale to MMAA in April 2003.

At the height of the financial crisis, Kumho Industrial was one of the most heavily indebted groups in Korea and opted to hive off its tire manufacturing arm in order to reduce its gearing levels from 390% at the end of 2002. It mandated Credit Suisse First Boston as its M&A advisor and later the same year, Carlyle and JPMorgan Capital partners put in a $1.2 billion bid for an 80% stake in Kumho Tire.

At the time company officials said they were rejecting the bid on the basis of price. Kumho Tire was subsequently sold to MMAA less than six months later for exactly the same amount. However, MMAA only purchased a 50% stake and specialists say this was the real sticking point. Kumho Industrial wanted to retain control.

Specialists say it also wanted the option to buy back the company once it had restored its financial health, although this was never publicly stated. Kumho Industrial now looks like it will achieve this aim since it has an option to purchase shares from MMAA once an 180-day lock-up expires following the IPO.

So far, details of the strike price have not been released. However, Kumho Industrial is said to have told investors it wants to build its stake back up to at least 30%.

On the surface, the biggest loser would appear to be MMAA. Post IPO, its remaining 25% stake will only valued at a maximum of $500 million and it does not look like it will be sitting on it for long enough to reap the dividends it needs to ensure some form of a return on its initial $1.2 billion outlay.

But analysts say an IPO makes sense in the broader context of Kumho's expansion plans and growth prospects. Given that it is still in debt reduction mode, equity is clearly its best option. As of September 2004, for example, Kumho Tire reported a net gearing ratio of 87.1% compared to 26.5% at Hankook.

Proceeds will be used to pay down debt and to expand into China where cost savings and earnings growth are much higher than Korea.

This is where the deal's main selling points kick in. Hankook is also more advanced in this respect since it has already shifted more manufacturing to China where labour costs in particular are a lot more flexible than Korea.

By the end of 2004, Hankook had capacity of 34.8 million tires per annum of which 15.9 million were being produced in China. Kumho, by contrast, was producing more tires overall (40 million), but far less in China (seven million).

In 2005, it hopes to bridge the gap. Analysts' research shows it is planning to boost capacity by 17.5% over the course of the year - all in China. By the end of the year, it should be producing 47 million tires per annum, of which 35 million will be made in Korea and 12 million in Nanjing, China.

So far, Hankook has only said that it will boost production by 2.5 million tires in 2005, bringing overall capacity up to 38 million. During 2003 and 2004 it was running at full capacity.

By 2007, Kumho says it hopes to have built a second China plant in Tianjin producing 5 million tires per annum.

Moving production to China should help Kumho close the earnings gap with Hankook. As of 1H04, Kumho reported sales of $740 million and net income of $50 million, versus sales of $875 million at Hankook and net income of $80.5 million.

In 2003, Kumho recorded a net profit of $82.1 million, versus $97 million at Hankook. Between 2003 and 2004, analysts are forecasting a 28% increase at Kumho ($105 million) and 48% at Hankook ($144 million). Between 2004 and 2005, the respective net income growth figures are 28.5% at Kumho ($135 million) and 24% at Hankook ($218 million).

Both companies are viewed favourably by analysts, who say that Hankook has traded at an average P/E ratio of 11.6 times over the past few years and a peak ratio of 14.1 times. Over the past year, it has returned 5.91% and as a low to mid price manufacturer has traditionally traded at a discount to global tier 1 tire manufacturers such as Goodyear, Michelin and Bridgestone.

Michelin is currently trading at about 12 times 2005 earnings and Bridgestone at about 20 times.

Most analysts expect both of the Korean companies to post strong growth during 2005 based on increasing ASPs (Average Selling Prices), improving cost competitiveness (China) and improving sales mixes (more high margin Ultra High Performance tires).

The main downside variables are raw material costs and the prospect of a downturn in the Chinese economy. At Kumho, raw materials - rubber, oil and steel - account for about 41% of its operating costs.

However, rising ASP's have in part reflected the tire makers' ability to pass on increasing costs to the consumer. Analysts forecast average ASP expansion of about 7% in 2005, slightly down from 8.5% in 2004.

Analysts also say that while input costs are volatile, the tire makers have a far less volatile earnings stream than auto manufacturers. This is because the bulk of their earnings are derived from the replacement market.

Kumho sells about two thirds of its tires into the replacement market and about one third to Korean OEM's such as Hyundai and Kia. About 60% of its tires are exported.

Roadshows for the deal will start on Wednesday and pricing is scheduled for February 3. The company's decision to seek a Seoul/London listing is an unusual one and specialists say it has been driven by the less onerous reporting requirements in London versus New York.
Co-leads are CLSA and Deutsche Bank, with ABN AMRO, BNP Paribas Peregrine, Macquarie and Nomura as co-managers.