Lone Star pulls out of KEB sale to Kookmin

Bankers call it a "fiasco" and say Korea's image among foreign investors has been damaged. But why has the $7.4 billion sale been aborted, and what happens next?
ôThe Kookmin-KEB deal will close, probably early next year,ö was the prediction of one well-connected Korean banker that FinanceAsia recently spoke to in Seoul. ôBut if the deal falls apart, it will be a fiasco.ö

Well, fiasco it has become. Yesterday evening, Lone Star announced that it was pulling out of the sale of KEB to Kookmin û KoreaÆs largest bank. The move was not entirely surprising, given the deal had become emotive and highly politicised.

The deal in question is the W6.95 trillion ($7.4 billion) sale of Lone StarÆs 64.2% stake in KEB. The deal has been delayed since May by ongoing legal investigations into Lone Star and KEB. The deadline for the closure of the transaction lapsed on September 16.

At the root of the controversy is the fact that the US private equity firm will make just over $3.5 billion of profit and not pay any Korean tax on the gain. This has energised public opinion and left-leaning politicians, and stirred a somewhat xenophobic backlash against foreign private equity firms in general.

The South Korean prosecutor's office has been trying to establish that some wrongdoing accompanied the sale of KEB to Lone Star. To this end, the prosecutorÆs office has spent months investigating Lone Star, KEB and virtually any institution connected with the sale.

The prosecutor began by looking at the 2003 KEB sale itself and tried to establish that bureaucrats, KEB bankers and Lone Star executives were in league to cook KEBÆs books and fraudulently make the bank look more distressed than it really was.

However, that strategy began to unravel when the Board of Audit and Inspection gave the deal a clean bill of health in the summer. The FSC also stated it had found nothing improper about the transaction. ThatÆs when the prosecutorÆs office started to investigate KEBÆs acquisition of KEB Card, and raided CitigroupÆs headquarters in Seoul to trawl through emails that surrounded that transaction. (Citi was KEBÆs advisor on that deal.)

The charge was share manipulation. KEB Card, like the other major Korean credit card companies, was in financial distress and KEB tendered to buy out the minorities. However, there was a big drop in KEB CardÆs stock price after KEB indicated that it might do a share cancellation û a move that would have wiped out all minority shareholders ahead of a recap. In the event, KEB did not follow through with this, but simply tendered to buy their stock.

No one talked about this decision very much at the time û in part because KEB Card was a basketcase. However, it suddenly became a sensitive issue in the wake of the recent investigation. Indeed, the prosecutor, Chae Dong-wook, alleged that KEB gained W17.7 billion by spreading false rumours about its credit card unit ahead of Lone StarÆs acquisition.

The prosecutorsÆ office said it found incriminating documents in CitigroupÆs offices and has sought to arrest Paul Yoo, the head of Lone StarÆs local unit, and detain Lone StarÆs vice-chairman, Eliot Short. The Seoul District Court rejected these applications in early November, a move which was interpreted as a serious blow to the prosecutorsÆ case.

At the time of this ruling, Lone StarÆs chairman John Grayken noted: ôThis ruling confirms that the Korean legal system ultimately can be relied upon to deliver justice. We hope this indicates that the prosecutor's year-long investigation will soon draw to a close."

Grayken and Lone Star have consistently denied any wrongdoing.

However, in a further application to the court on November 20, arrest warrants (for questioning) were granted for two US executives at Lone Star û Short and Mike Thomson, its legal adviser. Warrants were therefore granted for two people who are not in Korea, and yet not for Paul Yoo, who is based in the country.

It was after this news that Lone Star finally decided to pull the plug on the deal, a move which will be a major blow to Kookmin BankÆs expansion strategy and to foreign investor confidence in the Korean market.

It seems like Lone Star has finally called the bluff of its antagonists in Korea. Unless something major changes, the US firm may just sit on the asset and just draw dividends. Given that that bank is making around $2 billion per year, these should be fairly healthy.

Meanwhile, foreign investors and local investment bankers have watched the whole episode unfold with a mixture of distaste and trepidation.

Underlying everything is one indisputable fact. Back in 2003, KEB was on the verge of bankruptcy and lacked adequate tier-1 capital. Its tier-1 ratio stood at 4.8%, which was dangerously close to the 4% level where the Korean governmentÆs own rules ordered that a bank must be closed. In the subsequent sale, not a single Korean bank bid for KEB. Newbridge considered bidding, but walked away. Lone Star was the only bidder.

It is plausible to state that if Lone Star hadnÆt invested there would be no KEB today û at least not in its current form. Lone StarÆs capital infusion of $1 billion took the tier-1 ratio above 7% and immediately after making its investment, S&P upgraded KEBÆs credit rating.

ôItÆs not right to criticise the deal,ö says one investment banker. ôI liken it to a patient dying in hospital. If you do nothing the patient dies. If you treat the patient, they might live. KEB was dying and the deal saved it. Everyone has become so obsessed by how much money Lone Star is making that they forget this simple point. And Lone Star risked a large amount of capital when no one else would.ö

Today, KEB has been fully resuscitated, and actually gets more valuable by the day. That is thanks to the accumulation of gains KEB is making from equity stakes sold in formerly distressed companies such as Hynix and Hyundai Engineering & Construction (see FinanceAsia magazineÆs November 2006 cover story for more on this).

It will be interesting to see how KoreaÆs Blue House reacts to the current debacle. Lone StarÆs decision to abandon the sale deals a serious blow to KoreaÆs image, and given that Kookmin was the major beneficiary of the sale, it also damages the financial sector. On the other hand, next year is a presidential election year, and the hard line that has been taken with Lone Star has played well with the average voters.

ôAs things stand,ö says one local banker, ôthe Korean public feels that foreigners have made too much money at their expense, and that assets were sold on the cheap.ö

We can only wait and see what turn this drama takes next.
¬ Haymarket Media Limited. All rights reserved.
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