International Trade/Offshore Manufacturing/Sourcing/Export/Import/Consulting Pass the Kimchee By Mark Towery About six years ago, not long after getting into the management consulting business, I traveled to Seoul to introduce my company to a longtime Korean business associate who has a senior position in a Korean chaebol. As we savored the Korean seafood stew at a restaurant near Namdaemoon, he chewed his fish meditatively and summed up my new career choice succinctly. "You are kimchee," he informed me with finality that literally closed our conversation on the subject until we reopened it this August. The point my friend was making was extremely telling at the time. When you are served at a Korean restaurant, along with the main entree you automatically receive a number of small dishes as part of the "service." Most notable among them are various types of kimchee or pickled and fermented spicy vegetables such as cabbage, radishes and lettuce. You never order or pay for kimchee separately, but no meal is complete without it. It is part of the whole product-service offering and is expected to be included. Until recently, Korean companies viewed management consulting services in much the same way. There was never a question that market research and a sound strategy were important. The idea of paying for such as service as a line item from an independent third party, however, was as inconceivable as paying for kimchee as a separate menu item. After all, market intelligence and strategic recommendations were supposed to be included in the services provided by banks and other business partners, or simply "cooked up" internally. From my somewhat parochial viewpoint, this is at least a contributing factor to why many Korean firms were blindsided by the change in their external environment. A couple of months ago, this same business associate (with whom getting an appointment used to take several hours of telephone calls), drove six hours to have dinner with me upon my arrival in Seoul. Our kimchee still came with the meal, but we were able to select from a special "IMF" menu where two dinners could be ordered for the price of one. We talked about strategy and focusing on core competencies, and used words previously alien to the Korean vocabulary, like "mergers, acquisitions, and divestitures." Times are changing in Korea and it's about time. As the current crisis forces Korean companies to adopt global best practices, the long-term result can only be positive. In the short-term, there is opportunity for the foreign investor in the midst of the chaos. How Korea Got Into Deep Kimchee Thirty years ago, Korea's economy was ranked just above Ethiopia's. In early 1997, it was the 11th largest economy in the world. Such an environment of perpetual growth fostered complacent patterns of lending and investing. The government stimulated industrialization in the mid-1960s by channeling sovereign loans to strategic industries through privately held conglomerates via the national banking system. This method of financing was used as a way to accelerate the formation of capital without "selling out" to foreign investors. This system worked well when the economy was small enough to be managed by a few technocrats, the domestic economy was protected and the chaebols were allowed to dominate the most promising industry sectors to build up enough critical mass for international expansion. The unfortunate result of these policies is that the banking system never developed sophisticated techniques of making loans based on a realistic valuation of the net present value of future cash flows. They loaned to industries the government suggested were favored. The chaebols themselves diversified into all fields Ð from semiconductors to shoes - and grew uncontrollably from their favored domestic position into global players. They remained privately held and managed, however, which meant their equity was patient, allowing them to accept razor-thin margins and finance their unquenchable hunger for market share at the expense of profitability. To suggest the idea of an acquisition to a privately held conglomerate was tantamount to stating that management was a failure and the business was being taken over by a hostile rival. With more than 85 percent of the economy controlled by private conglomerates, mergers and acquisitions were virtually unheard of. When the domestic market began to be liberalized in the 1990s, these companies began to face real competitive pressures. At the same time, liberalization of currency controls permitted practically unregulated international borrowing. With a strategic plan of growth at all costs, many of these companies even used short-term debt to finance aggressive long-term investments. Every decision was based on an assumption of continued growth. When the global competitive pressures slowed this growth, and the won suffered the effects of the regional currency crisis, the free-fall began, and there existed few financial controls to mitigate the severity, nor precedents for managing in such an environment. On the positive side, the crisis precipitated a 180-degree shift in government policy regarding foreign investment, forced a recognition of the need to develop a world class banking and financial system and, for the first time, fostered an actual eagerness by Korean companies to accept foreign investment. The depressed currency and devalued assets make such investments even more attractive. Most importantly, this short-term pain will force the reforms that the Korean economy needs to sustain long-term growth. Fire in the Belly Koreans have been understandably humbled by the current financial crisis, but not disheartened. While it is true that a shell-shocked type of denial prevails throughout the corporate psyche, in general, Koreans have met the challenge head on. Kim Dae Jung's government has not only set the tone, but led the charge by actively encouraging foreign investment and implementing sweeping legislative reforms that virtually open up 100 percent investment by foreigners into most business sectors, including the previously almost entirely protected real estate market. Korean companies are now actively seeking foreign investment, and are eager to partner with U.S. companies when the synergies are there. Contrast these actions with Japan, whose financial bubble burst in 1991, but has done less to address the problem in seven years than Korea has in seven months. Or compare to Malaysia, where currency controls, panicked political posturing and ranting rhetoric are used to divert attention from the fundamental economic shortcomings of the economy. Unlike much of Southeast Asia, Korea has a fundamentally strong economy, an abundance of human and technical productive assets, world-class technology in some sectors, and companies with strong global market positions. They are simply over-diversified, over-leveraged and overexposed in many cases. Unlike Japan, Korea has the political and corporate will to address the problems that face its economy, and is taking swift action. The opportunities are clearly unprecedented. Korea is certainly the best investment bargain in Asia. Korea's economy will likely recover first and emerge stronger, and the time to act is now. So where is the catch? Korean companies may be open to investment, but they have no experience in such transactions or even how to behave in anything other than a growth economy. They are unsophisticated about valuing their companies, and often have unrealistic expectations about both what investors should be willing to pay and the near-term economic outlook for the Korean economy. The government has the right ideas, but bureaucracies move slow, and many question if the banking system will be reformed timely, and if weak companies will be allowed to fail so stronger ones can thrive. For these reasons, many U.S. financial investors who flocked to Korea in early 1998 hunting for bargains returned frustrated. Although the situation is improving, many of these same issues remain. It Takes a Strong Stomach A good example is the real estate market. As of June 26, 1998, this sector, which was practically closed to foreigners in the past, was completely opened. There is now virtually no distinction between a Korean and a foreign investor according to the law. Yet, when I met with the owners or manager of six office buildings in Seoul, only one even presented a financial statement. When I asked about cash flow, I was shown the health club in the basement. When I asked about price, I was told what they had paid for the construction eight years prior. The fact that the economy was deflating, interest rates were rising, and tenants were moving out was not a part of the conversation. Partly because of the 30-year history of perpetual economic growth and asset appreciation, there is an oriental mindset against selling short. Investments in real estate were made for the almost certain appreciation in their asset value, not cash flows. A friend likes to tell the story of buying some imported American wine on the black market. Bristling at the fact that one bottle of a particular brand was $6, he pointed to a dirty bottle of the same brand on a back shelf, and asked how much (certain it would be cheaper). He was told that it cost $8 because the proprietor had paid more for it six months earlier. This mentality prevails in many of the board rooms. Another issue that faces many healthy Korean companies is the fact that by not allowing weaker competitors to fail, the government is, in effect, preventing companies that have made good business decisions from getting on with their business expansion plans. Consider, for example, the fact KIA motors, which has been technically bankrupt for two years, is still operating. A senior executive at a major textile company lamented that his weaker competitors were dumping cheap products at below market prices, forcing his better-managed company to respond in kind. In doing so, his profitability suffers and expansion plans must be put on hold. The natural instinct of Koreans to protect the status quo must be challenged. In many cases however, things progress more smoothly. The most difficult part of a negotiation is first getting a true valuation of the company and then bringing the Korean owner's expectations in line with market realities. Real estate presents the best opportunity for a financial investor. For the strategic investor, manufacturing opportunities fall into three basic categories: The best scenario is when a large conglomerate is spinning off a healthy business that is not part of its core business for strategic reasons. Obviously, the investor pays a premium for such companies when they have no pressing financial difficulties. The second is when a relatively healthy and profitable company has short-term financial problems, due to high interest rates or bad borrowing practices. Such a situation can be an opportunity for a firm in the same industry to take an equity position and leverage the Korean partners' assets and market position to enhance worldwide competitiveness and market coverage. Such an arrangement is often a win for the Korean firm, as well. The third scenario involves a truly distressed company. In this case, if management is weak, only an investor experienced in the industry with management expertise to provide should consider such an investment. Difficulties in properly valuing the company and uncovering hidden liabilities are multiplied. The third case can be the best bargain for the sophisticated strategic buyer, but is certainly the most risky. In all cases, it is also important to thoroughly research the domestic competitive market situation as part of the due diligence process. Having met with a number of Korean companies seeking investment recently, I often feel like they all want $10 million U.S in investment regardless of their size, have no specific plan for what it will be used for, have valued their assets at over three times their market worth, want to relinquish little equity, and want an option to buy it back in two years. This is obviously an over-exaggeration, but indicative of the generally unrealistic expectations that prevail. Fortunately, many of these companies have now met with a number of potential investors that have asked the same hard questions and are becoming more realistic in their expectations and sophisticated in their preparation. Patience and persistence are still the keys to a successful deal. Most Koreans still refer to the economic downturn in their economy as the "IMF" crisis, as if the International Monetary Fund created their problems. In spite of the temptation to point out the distinction, the best way to counter this mindset is often with a non-threatening approach that emphasizes a win-win scenario in the interest of the Korean company as well as the foreign investor. Unless you have a management team to put in place, you will need a committed partner after an acquisition. It is not advisable, therefore, to take undue advantage of his short-term distress. It also helps to approach a potential target with less emphasis on typical financial analysis, such as EBITDA, and more on EABS or "earnings after the bad stuff." Timing is critical, in that as the economy begins to stabilize, the best deals will be gone. The time to act is while the outlook is still bleak. After all, as any Korean can tell you, the more sour the kimchee, the better stew it makes. Mark Towery is managing director of GeoStrategy Partners, an Atlanta-based firm with affiliate offices in the Pacific Rim, Europe and elsewhere that assist companies in developing overseas sales and marketing strategies. E-mail Advertise on this site Put your company on this site!