Second heavy hitting Korean M&A in as many days

Why is Doosan Heavy prepared to pay so much for Daewoo Heavy?

If Korean M&A were a game of cricket, a couple of sixes would have been hit in the first 'over'. StanChart's $3.3 billion acquisition of KFB on Monday, was followed yesterday by Doosan Heavy's $1.8 billion announced acquisition of 51% of Daewoo Heavy at a 220% premium to its current stock price. Barely 10 days into 2005, Korea's M&A volume has already broke through the $5 billion mark.

To be fair, the Daewoo Heavy Industries & Construction deal has hardly blindsided anyone. The government's desire to sell the company first came to light in the middle of 2003 when CSFB was hired to write a feasibility study. CSFB was officially mandated in December 2003 to sell both KDB and Kamco's combined 51% controlling stake and has been managing the sale ever since.

The company had obvious attractions for buyers, especially since old economy companies have come into vogue again. Daewoo Heavy has a strong, global presence in construction-related equipment manufacturing, and good market shares in the US and European markets. But perhaps more important, it has forged a very strong presence in the fast-growing China market. For example, it has the leading market share in China for sales of excavators.

Two issues complicated matters for CSFB and led to delays in the sale. The first was the fact that this was Kamco's first M&A transaction and as with any debut deal it inevitably takes longer.

But perhaps more important was the fact that Daewoo Heavy was not a straightforward industrial company. In spite of its name, about 20% of its revenues come from its defense business, which produces missile guidance systems and next generation armoured vehicles among other things. Due to the sensitivity of this business a raft of approvals had to be sought and eventually the Korean Ministry of Defense ordained that this particular part of Daewoo Heavy could not be sold to foreigners for reasons of national security.

CSFB therefore had to organize an auction process that ran along three different tracks. This led to seven local firms bidding for the defense business, three foreign entities bidding for the non-defense business (including private equity firm, Carlyle), and four domestic players bidding for the entire business.

Meanwhile, the publicly-stated preference of Daewoo Heavy's union was for the company to be sold to one bidder since it did not want to see the company split up. It gained sufficient commitments (from its perspective) to ally with Pantech, a mobile phone handset manufacturer and support its bid for the company - a move that put some pressure on local politicians.

Also keen to bid for the whole entity was Hyosung, a mini-chaebol specialising in the motorcycle and construction businesses.

However, the eventual victor was Doosan Heavy, part of the Doosan Group - a company that must rank as one of the more interesting in Korea today thanks to the speed of its transformation.

Indeed, one might draw comparisons between Doosan and Nokia. The Finnish company that has today become synonymous with mobile phones and technology, used to be a forestry company and succeeded in reinventing itself through a few bold corporate gambles.

Similarly, the Park family behind Doosan had made their name in the beer business (through the OB brand). But after the financial crisis the present generation decided to reinvent the company in the belief that Korean beer would never become a global export and thus had limited growth potential.

They sold a controlling stake in OB to Interbrew and sold their whisky business outright. Meanwhile the Park-controlled Doosan bought Korea Heavy Industries from the government in what became a transformational piece of M&A.

Korea Heavy's acquisition gave Doosan several nuclear power plants, a business that produced turbines and boilers for power plants, a thriving desalination business and some defense businesses and construction machinery manufacturing. The business had a strong focus on Asian and Middle Eastern markets, but was widely viewed as being mismanaged by the government. Under Doosan's stewardship the business experienced a turnaround that was impressive.

Then over the past two years the management of Doosan surveyed the landscape for the next transformational M&A deal to add to their new heavy industry portfolio. Bankers say the company looked at over 700 companies (and hired Boston Consulting Group) before finally concluding that Daewoo Heavy (now also government-controlled and for sale) was the perfect fit. Daewoo Heavy offered both product diversity as well as geographic diversity and was almost the same size, meaning the company would effectively double in size after the deal.

Indeed, put together the two would have W7-8 trillion of revenues and rank Doosan among Korea's 10 biggest companies. Returning to the Nokia analogy, that is quite a jump from 1996 when Doosan was just inside the top 30. The family has certainly come a long way from 1896 when it opened a corner shop in Baeogae, Seoul.
Indeed, while going from beer to nuclear power plants makes one think of Homer Simpson, the achievement of the Park brothers is undeniable and their bold reinvention is a corporate lesson for any Asian company.

Their desire to gain control of Daewoo Heavy was palpable from the outset, and Doosan was advised by Morgan Stanley on achieveing their goal. All of the bidders were given four weeks in the data room but Doosan quickly emerged with preferred bidder status and was allotted a further four weeks to finalise its bid. Some complications led to the preferred bidder status being extended for almost a month but Doosan retained poll position thanks to its "killer bid" strategy.

Indeed, in a move that has some investors and analysts not entirely convinced, Doosan has paid W22,150 a share for Daewoo Heavy, versus the company's market price of W8,150 - ie it has paid a 220% premium. You don't see many 220% premiums in the Asian markets which is one reason why the price has raised eyebrows. Indeed, comparisons might ironically (given the beer connection) be drawn with the deal last year where Anheuser-Busch bought control of Harbin Brewery in a bidding-war at a price that equated to 50 times historical earnings and made many suspect the US firm had overpaid.

However, there are two things about the Doosan "killer" bid that may give pause for thought. First is that the company was keen to make a bid that would win beyond a shadow of a doubt, so as to head off at the pass any political controversy with the labour unions. Second, one must look at its track record. When Doosan bid for Korea Heavy the company paid twice the market price (in an auction) and was again accused of dramatically overpaying. The company merely believed it had done superior due diligence. The company's success with Korea Heavy has vindicated that view. Doosan is asking the sceptics to have the same belief in its due diligence this time around as well.

It will finance the acquisition through W800-900 billion of cash and through a local syndicated loan facility. Additionally, the Military Pension Fund may also buy 10% of the company (from Doosan) in a purely passive investment, ie not interfering with its management control.

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