Breaking up is hard to do for Korea's conglomerates

News Analysis: For Seoul's economic reforms to succeed, the chaebol must be dismantled
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The Independent Online
THE FINAL chapter opened yesterday in the astonishing rags-to- riches story of a street vendor who rose to become head of South Korea's second-largest corporation.

Creditors of Daewoo Group yesterday finalised plans to break up the debt- laden conglomerate and effectively end an era born from the embers of the Second World War.

Under the plan Daewoo will be dismantled into just six trading units, all connected to the automobile brand for which the group is best known in the UK. The remaining 20 or so subsidiaries will be floated off or sold.

For Kim Woo-choong, Daewoo's chairman, it will be an ironic end for the company he started with a $5,000 loan in 1967. But what is really at stake is the government's brave attempt to kill off these lumbering corporate dinosaurs and, in turn, cement in place the country's economic revival.

Daewoo, whose name means "Great Universe", began as a textile business, importing raw materials and exporting finished goods. As a boy, Kim Woo- choong sold newspapers on the streets of Taegu, the city to which his family fled in 1950 after being driven out by North Korean troops.

Just nine years after setting up Daewoo, the government handed him a failing shipbuilder and asked him to turn it around. His success led to him being sought out by the authorities to rescue a number of companies. Each time the expansion was funded by loans until by the end of the 1970s Daewoo had nine times as much debt as equity.

Daewoo - pronounced "day-oo" - is the second-largest of Korea's 21 chaebol, or family-owned conglomerates. It is typical of these giant entities, with subsidiaries spanning a huge range of sectors and trades, but it is heavily laden with debt. Its turnover represents 5 per cent of South Korean gross domestic product.

Daewoo is involved in the manufacture of everything from ships to cars, while its construction unit builds houses, skyscrapers and shopping centres. Its securities business is Korea's largest brokerage.

The fact that Daewoo is not alone means analysts and investors will be hawkishly watching the progress of the restructuring for any signs that the government will backtrack on its tough reform programme.

The break-up of the chaebol is seen as central to the final phase of the re-engineering of the Korean economy. Korea has been the region's prominent success story in the two years since the Asian financial crisis struck. In the past year the stock market has risen four-fold and is well above its pre-crash levels. The latest economic data - exports at a 17- month high and industrial output at an 11-year high - appear to support the bullish stance taken by most analysts.

Janet Henry, Asian economist with HSBC Markets in London, said the extent of the cyclical upturn in the economy had overshadowed initial disappointment with the pace of reform. "We have seen the upturn, and the figures will start to flatten out as last year's recession falls out of the comparison. The next stage hangs on the restructuring story," she said.

"What is important is that Daewoo is not the only chaebol that could face problems, which is why people are looking so closely at the extent to which the government will make them sell off their assets."

In other words, the markets have applauded the decision to force Daewoo to divest itself of all but six units, but will punish any signs of backsliding. So far the Korean authorities speak with one clear voice. In his keynote Liberation Day address yesterday, President Kim Dae-jung said: "The market no longer accepts the chaebol as they are. To survive the era of ever- intensifying global competition, Korea's chaebol should be dismantled and reborn as smaller groups or independent entities."

The president believes the very structure and operation of the chaebol are a drag on economic development. They are typically controlled by founders and their family members, who wield almost absolute power over managerial affairs through cross-shareholdings among subsidiaries. To build their empires, the conglomerates resorted heavily to borrowing via loan guarantees from their affiliates.

Top of the list is Hyundai, the largest chaebol with 39 subsidiaries, which has announced plans to split into five separate businesses by 2003 and slash group debts to $37.9bn (pounds 23.5bn) from $66.2bn by the end of the year. Samsung, the third-largest group with 89 trading units, yesterday gained some breathing space after its principal creditors agreed to delay imposing financial sanctions indefinitely. LG Group and SK Group are next in line. All five have debt-to-equity ratios of between five and three to one, but are committed to getting that to two to one.

It is easy to see why reform of the chaebol is central to achieving a step change in the economy. Their complex networks of cross-shareholdings and subsidiaries allowed them to raise huge volumes of debt - so they have actually grown fatter rather than thinner in the two years since the Asian crisis.

The scale of their debt portfolios made them highly vulnerable in the crash. As the currency, the won, collapsed, foreign-held debts became impossibly expensive to service, while interest-rate rises aimed at supporting the currency made domestic debt costly.

The government has set five targets - chaebol chiefs to be more accountable for performance; boosting managerial transparency; improving the chaebol's financial health; focusing on core businesses; and eliminating loan guarantees between affiliates.

But, as with all fragile economies, the danger is political. If the break-up of the chaebol leads to mass redundancies, there will be a large political fall-out for the current administration, now one-third of its way through its tenure.

Even as analysts took in the toughness of President Kim's message, Lee Ki-ho, his chief economic adviser, tried to deflect potential criticism that the government was intervening excessively in the private sector.

"The President meant that the chaebol should make self-reforms because they cannot attain competitiveness under the current structure," Mr Lee said. "The government never planned to force a change in the current ownership system of the chaebol." Or, as the Korean car maker's UK slogan puts it - "That'll be the Daewoo".