What Goldman's Kyobo move means

How does Goldman''s move to buy 24% of Kyobo Life in Korea fit with the IPO of Samsung Life?

After the success of its investment in Kookmin Bank, Goldman Sachs is ready to take the plunge into Korean financial services again by buying 24% of Korea's second biggest life insurer (by assets), Kyobo Life. Market speculation suggests that Goldman will invest W300 billion ($256.5 million) to buy the stake, which is currently owned by Daewoo International.

A Daewoo official yesterday announced that Goldman's private investment arm will complete the acquisition within a month. Given that the parties have been talking for many months, the timing of this leak may not be a coincidence - especially if it is considered in the context of what is going on in the Korean life insurance sector as a whole.

As reported in last month's FinanceAsia magazine (August, page 48) this is a critical period for the life insurance industry in Seoul. The government is due to make a policy decision that will dictate whether or not the top Korean life insurance companies IPO.

These IPOs - should they happen - will transform the Korean capital market, and introduce major new stocks, with at least one of them likely to be a core holding for international investors. They will also allow Korea's life insurers to shore up their capital base and strengthen themselves.

The ultimate goal is to allow them to become national champions and use their position in the world's sixth biggest insurance market to later expand into China. However, the issue has turned into a powderkeg for Korea's new president.

There is a major problem.

Indeed, it is a problem that has been around since 1988 when Samsung Life first mooted the idea of listing. It is the issue that has shareholders and policyholders at each others throats and like most things comes down to who gets the money.

Policyholders think that the majority of the proceeds of the IPO should go to them. The life insurance company's current shareholders think that the proceeds should go to them and towards building the company's capital bases.

The debate fragments along two lines.

On a logical level, it comes down to a debate over whether the listing exercise constitutes a demutualization. On a political level, it comes down to whom the government favours.

The policyholders are broadly speaking, the 'ordinary people' and cannot be ignored because they are voters. Some of the shareholders, on the other hand, are Korea's rich chaebol families, and the government is keen to break up their power.

The swirling IPO debate principally affect Samsung Life and Kyobo - the insurer Goldman is looking to invest in. That's because they are the only two life insurers that currently meet the listing criteria of five years of profit and a full solvency margin.

They are also the two biggest. In terms of assets, Samsung Life is top followed by Kyobo. In terms of premium income, Samsung Life's market share is 40%, with Korea Life second with 20% and Kyobo third with 16%.

Beyond the big three, Allianz has a 5% market share, Hungkuk a 2% share, while the up and comers are Dong Yang, Shinhan, Prudential (of the US) and ING. The top 10 control 95% of the market.

What is clear to everyone is that Samsung Life is the premier company by every measure. It not only has the biggest market share, but it also has the best quality customers, the most savvy staff and is the most aggressive in importing foreign technology and ideas.

It has $58 billion worth of assets and ranked 15th in our AsianInvestor 100 list - indeed, the only institutions above it in the list were central banks and state pension funds. Its asset size is double that of Cathay Life in Taiwan (the nearest comparable) and it is unquestionably the biggest and best run life insurer in non-Japan Asia.

Kyobo's asset size is $24.3 billion.

After Samsung Life's IPOs the general consensus is that it will have a market capitalization of between $8-15 billion and will rank among Korea's top five listed companies. It will be an essential holding for any international fund manager investing in Korea or Asian financial services stocks.

The fact that it is controlled by the Lee family also makes it a suitable ideological rallying point for Korean policyholders who believe its IPO should benefit them and not an already rich chaebol family. The Lee family has resisted listing Samsung Life since 1988 precisely for this reason.

It has been loath, as a shareholder, to see all the value from an IPO accrue to the policyholders. The argument of the policyholders basically runs like this.

They argue that Samsung Life started with $5 million and all the value created in the last 40 years has been made with their money. About 15 years ago the government introduced the 90/10 rule on participatory policies where dividends made from investment were split 90% to policyholders and 10% to shareholders.

This suggests to the Korean policyholders that the life insurers are really mutual life insurers and that they own 90% of the free estate (ie the unrealised value) sitting in the company which is worth many trillion of won. However, these companies are not mutual insurers - legally speaking - and the participatory policies mentioned above no longer make up the majority of the portfolio, which on a practical level undermines the view that these are mutuals.

A source in Korea says that the government's own advisory panel informed it there was no legal basis for giving IPO or sale proceeds to policyholders. Nevertheless, a local Korean newspaper reported that the FSC was due to deliver a verdict on September 5 that Samsung Life should pay W1.4 trillion to policyholders when it listed.

It got this number from estimating Samsung Life's market value and assuming 12% should go to policyholders. A similar principle would also apply to Kyobo.

This, of course, would mean that most of the proceeds from a W1.5 trillion Samsung Life IPO would go to policyholders, and not shareholders or to boosting the share capital. Samsung said no to this proposal, arguing it wasn't worthwhile for it to list.

When the Korean newspaper leaked all of this, the FSC then rescinded its September 5 deadline for giving a verdict on the issue. The government is currently thought to be putting pressure on Samsung Life to give cash to the policyholders.

Originally it had seemed that tax was a key point of leverage that the government could use against Samsung. That's because around seven years ago it set in motion a long term tax that allowed the life insurers to revalue their assets, but mandated that if they were not listed within seven years they would have to pay a hefty tax on these assets.

In the case of Samsung Life, for example, this one-off tax hit is estimated at around $300 million this year. However, sources in Korea say that Samsung will be able to claim back this tax whenever it does eventually list.

So this fiscal 'big stick' may not suffice to persuade the Lee family to act. Indeed, driving the IPO are the Korean banks, who are creditors of Samsung Motors.

Back in 1998 when the financial crisis was at its worst, Samsung Motors got into serious trouble and to assuage creditor banks, Samsung's Lee family pledged shares in Samsung Life to the banks. These banks are keen to see an IPO so they can realise their gains on Samsung Life stock.

Not everyone on the government side is pointing the same way, however. There are elements of the bureaucracy that would rather see a strong life insurance industry, with big listed stocks boosting the local stock market.

The fear among this group is that giving in to the policyholders would be popular but not necessarily in the best interests of the companies or Korea Inc as a whole. They also know that this issue is capable of souring foreign investor sentiment.

Indeed, at a recent FinanceAsia conference in Seoul on the subject of the life insurance IPOs, James Rooney, who set up Templeton in Korea said the government was veering towards socialism and policies that made foreign investors very uncomfortable.

He asked: "What are we trying to do with these life insurance companies? Are we just trying to make a quick profit on the value of their shares? No, I don't think so. In fact, these are very weak companies. They are still fundamentally damaged from the past, they don't have strong balance sheets, most of them may not even be solvent on a technical basis. They still have a long way to go before they can become strong national champions and can compete and become capital providers within Northeast Asia.

"So when I hear all these arguments about whether or not policyholders should get some of the capital, I'm rather shocked. I'm very concerned if we do that we'll make these companies too weak [to confront] the future."

Rooney added that the role of the life insurance companies "was to provide a safe place for your mother to put her money. Mrs Park, Mrs Kim, Mrs Lee, the mothers of Korea have placed their money in trust with these companies and want their money to be safe.

"They provide long term retirement saving, and cover your family situation against the risk of death. So your mother put her money there for a very specific purpose, so it is safe and she can have a predictable future. I never heard anybody put their money into a life insurance company so they could gamble on a future IPO."

The risk of loss from bad investments, he further noted, was borne by the shareholders, not by the "mothers of Korea". If a life insurer makes a dud loan to a dud company, it is the shareholders who have to put more capital in to cover the position or risk losing their ownership.

He concluded: "Let's not kid ourselves. These companies are weak, they need this capital and if they get the right amount of capital, they have great prospects for the future. But if we limit that amount of capital, by dividing it up between the company and the policyholders, then there is no incentive for the market to give them capital. And instead of being worth 100, they may end up being worth nothing, or just 10. You can do that, but forget about your insurance industry in the future. So I hope we realise that this sort of crippling approach will do us more damage."

Against this backdrop, the bureaucrats who oppose the government's more populist tendencies will be glad to see Goldman Sachs arrive on the scene. Firstly, if Goldman's acquisition of the Kyobo stake proves successful it will set a precedent.

The W300 billion it will pay will not go to the policyholders. Hence, you could ask, why should the proceeds of an IPO? Both are sales of stock.

Secondly, when Kyobo eventually IPOs, the government knows it will find it more politically difficult to push Goldman Sachs around than a domestic Korean company. This, after all, is an investment bank that seems to be permanently donating senior staff to the US Treasury department.

And the Korean government is very sensitive to spats with the US government. Goldman may or may not be fully aware of the role it is playing in this powerplay.

But for Goldman it forms part of the principal investment team's shift back - under Henry Cornell's leadership - into big investments. After a few years of shoddy dotcom blow ups, the principal investment department has returned to the philosophy that a smaller number of big bets are better than a lot of small ones.

And financial services in Asia is where it has been most successful. Its investment in Ping An Insurance in China has gone well, and its investment in Kookmin is worth three times what it paid. Thanks to Kookmin it also has a good understanding of the Korean financial services world.

Goldman will also be able to help Kyobo on the liability management side. Indeed with low interest rates, Korean life insurers are crying out to buy derivatives and Goldman can assist it in this area. Indeed, provided Goldman can eventually exit via a listing in the coming years, it is not hard to see why the US bank views this as Kookmin Part II.

When it made its investment in Kookmin, the Korean banking sector was a mess, and on the cusp of recovery. Arguably, Korean life insurers are at a similar stage of the cycle. The price is also arguably attractive, being close to book value.

Once cleaned up and reinvigorated, there is no reason why Kyobo - with its market power and clout in one of the world's most exciting insurance markets - might not be worth at least $3 billion in three years, which would again see Goldman tripling its money (or better). There is also the possibility that Goldman could up its stake and buy 14% from KAMCO.

As to timing, the statement by Daewoo about a deal getting signed by the end of the month looks unrealistic. An MOU perhaps. But should the deal get signed before year end, it will definitely play into the hands of Samsung's Lee family, which will then hope to IPO their 53% owned life insurer in the first quarter.

At this point the government's stance on whether policyholders should receive W1.4 trillion or not may have been modified by Goldman's entry into Kyobo. One thing is certain: would Goldman be buying into Kyobo if it thought it was going to have to give away the spoils (to policyholders) when the IPO eventually happened?

If Goldman thought that would be the outcome, one can imagine it wouldn't put $250 million on the line.

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