Hyosung's Transformation into a Holdco + Four Subsidiaries
I published this article back in 2018. There have been a lot of interest on Hyosung Group related shares, especially Hyosung Corp and Hyosung Heavy Indutries. This article should provide better background. Free to read.
Hyosung Corporation (004800 KS) announced on January 3rd that it will transform into a holding company and four subsidiaries. The company will spin-off four business units, including textile, heavy industries, industrial materials, and chemical. The Holdco will own a 39.3% stake in the new entity while the four subsidiaries will hold a combined 60.7% stake in the new entity. The potential change of Hyosung Corp into a Holdco structure has been speculated for many months but this was the first time that Hyosung has officially stated that it will change into a Holdco structure.
Overall, we believe this transformation into a Holdco and four subsidiaries structure will likely to have a POSITIVE impact on Hyosung Corp since it will enable a greater corporate transparency and investors will be able to better value the separate businesses. Although there could be some short term selling from investors that are playing the “buying on rumor, sell on news” (of the conversion to the Holdco), the Hyosung Group is likely to benefit from this change to a Holdco structure in the long run.
This transformation is very reminiscent of the breakup of Hyundai Heavy Industries Group to Hyundai Robotics (267250 KS) (Holdco) and its subsidiaries Hyundai Heavy Industries (009540 KS), Hyundai Electric & Energy (267260 KS), Hyundai Construction Equipment Corporation (267270 KS).
The following are the five new entities (including the split ratios) that will be created for Hyosung Group in this reorganization:
Hyosung Corp - Holding company (0.3928)
Hyosung TNC - Textile & trade (0.1232)
Hyosung Heavy Industries - Heavy industries and construction (0.2655)
Hyosung Advanced Materials - Materials related (0.1276)
Hyosung Chemicals - Chemicals (0.0908)
The current shareholding structure of Hyosung is as follows: Cho Hyun Joon (born in 1968) - 14.27%; Cho Hyun Sang (born in 1971) - 12.21%; Cho Seok Rae (born in 1935) - 10.18%; and Other family/relatives - 0.81%.
Cho Hyun Joon (first son) became the CEO of Hyosung on July 20th, 2017, replacing his father Cho Seok Rae who became the honorary chairman. The insiders have been increasing their stakes in Hyosung in the past year. For example, Cho Hyun Joon increased his stake from 13.8% at end of 2016 to 14.27% at end of 3Q17. Likewise, Cho Suk Rae increased his stake from 10.15% at end of 2016 to 10.18% at end of 3Q17.
Hyosung Business Breakdown
Hyosung provides a breakdown of its businesses by sales, operating profit, assets, liabilities, and equity on a quarterly basis.
In 1Q-3Q17, industrial materials, trade, heavy industries, and textile business units represented 20%, 18.3%, 17.2%, and 17.1% of its sales, respectively.
In 1Q-3Q17, textile, industrial materials, chemical, and construction business units represented 31.8%, 26.2%, 16.1%, and 11.1% of its operating profit, respectively. The bulk of the company’s business value is in the textile, industrial materials, and chemical businesses with these three units representing 74% of the company’s total operating profit in 1Q-3Q17. However, these three units represented just 49% of its total sales in 1Q-3Q17.
Hyosung Balance Sheet; Pre & Post Company Split
In the table below, you could see the balance sheet of Hyosung (pre & post split), on a non-consolidated basis. Post company split, Hyosung (Holdco) will have the strongest balance sheet, with a current ratio of 224% and net cash position. Post company split, Hyosung Chemical will have the worst balance sheet, with a current ratio of 35% and net debt to equity ratio of 229%.
Key Factors to Consider in the Conversion to a Holdco Structure in Korea
The following five factors below are probably among the most important factors to consider when analyzing a Korean company that is trying to convert to a Holdco structure.
Complex to simple structure is better - If the conglomerate has more complex business and ownership structures, this is better than if a company has simple business and ownership structures since a conversion to a Holdco structure can improve value of a conglomerate by making the business structure more transparent and easier to value on a separate basis. For example, the transformation of Hyundai Heavy Industries Group into Hyundai Robotics Holdco involved going from “complex’ to “simple” in terms of business organization structure. However, this was not the case for the Holdco conversion of BGF Retail. For Hyosung, we think the company is going from “complex” to a more simplified business structure and in this sense, this is a POSITIVE.
Is the core business being undervalued because it is “mixed” with other less profitable businesses? The company’s core business is in advanced materials and textile and there is a case to be made that these businesses are not adequately receiving their appropriate valuations since they are mixed with other businesses with lower valuation multiples such as trade, construction, and heavy industries. As such, with respect to this factor, we think it is POSITIVE, as there is an opportunity for extra alpha as more investors maybe willing to attach higher valuation multiples on its core textile and advanced materials business units. Notice how the company’s industrial materials business unit represented 26.2% of total operating profit of the company in 1Q-3Q17, up from 15.8% in 2015.
Transition stage from father to son ownership - Some of these Holdco conversions are made in a period when there is a definite transition stage from the “father” to “son” ownership & control of the company. Hyosung fits this bill and on this factor as well, it is a POSITIVE. A key argument would be because there would be less “incentives” by the owners to keep the share prices lower due to inheritance tax issues.
Is there an opportunity to better use its cash/treasury shares? Hyosung has treasury shares representing 5.3% of shares outstanding. There is an opportunity for a potential cancellation of this treasury shares which could have a positive impact on the shares but it remains to be seen how the company will use its treasury shares. In this respect, the treasury shares factor is NEUTRAL.
Market cap limits - Some of the institutional investors have market cap restrictions when investing in stocks. As such, the companies with bigger market caps that convert into Holdcos have less problems with dealing with this factor. Hyosung Chemical and Hyosung TNT could face market cap restrictions from some institutional investors post company split. As such, we think this is NEGATIVE.
Key Products of the Company’s Business Units
Textile - Major products include spandex, polyester, and nylon. The company has the largest market share of spandex yarns globally. Rash guards have been selling very well in many parts of Asia such as Korea and Japan in the past few years. Rash guards are made of spandex, nylon, and polyester. Hyosung is one of the key beneficiaries of the increasing demand of rash guards in Asia. For a more detailed analysis, see our report,Hottest Selling Apparel Item in Korea This Summer - Rash Guard.
Industrial/Advanced Materials - Tire cord is a major product of this business unit. It also makes airbags. The company expects additional capacity of 36k tons pa of tire core to be built in Vietnam by end of 1Q18. The company has about one third of the global tire cord industry market share. The company also makes advanced materials such as carbon fiber and aramid fiber.
Chemicals - Major products include NF3, PP, TPA, and PDH. The company is raising its capacity of PP and PDH by 0.6m tons pa in Vietnam, which is likely to be fully operational in 2020. About 0.3m tons of PP capacity is expected to be operational by end of 2018. It is expected that nearly 800 billion won in annual sales is expected from these new capacities once they are completely built. NF3 is used mainly for cleaning substances generated during making IT products such as semiconductors and LCDs.
You could see from the expansion of the company’s tire cords, PP, and PDH capacities in Vietnam. Hyosung has a major presence in this country and is one of the beneficiaries of the continued economic development in this country.
Source: Hyosung
Source: Hyosung
Potential Sale of its Subsidiaries
One of the catalysts with Hyosung share price is a potential sale of its subsidiaries. Additional sale of these subsidiaries should help to improve its balance sheet and further simplify its organizational structure. In order to complete the company’s Holdco conversion process, Hyosung will need to sell its subsidiaries including:
Hyosungitx Co Ltd (094280 KS) - Mkt cap of 157 billion won; Hyosung has a 27.99% stake.
Chin Hung International (002780 KS) (also called Jinheung Enterprise) - Mkt cap of 274 billion won; Hyosung has a 48.2% stake.
Shinwha Intertek Corp (056700 KS) - Mkt cap of 74 billion won; Hyosung has a 15.3% stake.
Other financial affiliates
Korean Companies That Have Announced/Completed into Holdco Structure in 2017
2017 was a big year of many Korean companies announcing/completing their organizations into Holdco structures, including the following companies:
Hyundai Robotics/Hyundai Heavy Industries/Hyundai Construction Equipment/Hyundai Electric & ENergy Systems
Lotte Holding Company/Lotte Confectionery/Lotte Chilsung Beverage/Lotte Food/Lotte Shopping
Orion Holdings/Orion Corp
BGF Retail/BGF
Hyundai Development Co./HDC Holdings
SK Chemical/SK Chemical Holdings
Maeil Dairy Industry/Maeil Holdings
Crown Confectionery/Crown Haitai Holdings
It appears that many more Korean companies, including Hyosung will revamp their organization structures into a Holdco structure as well in 2018. Among the large cap companies, we have mentioned SK Telecom as one of the top candidates that could potentially change its organization structure into a Holdco model in 2018.
It has been reported in recent days that the Hyosung Group has received an approval of its plans for the split-off of Hyosung Corporation (004800 KS) by the Korea Exchange. This spin-off involves splitting Hyosung Corp into holdco (Hyosung Corp) and four other operating companies including Hyosung T&C (textile and trading), Hyosung Heavy Industries (shipbuilding and construction), Hyosung Advanced Materials (industrial materials) and Hyosung Chemical.
The following are the five new entities (including the split ratios) that will be created for Hyosung Group in this reorganization:
Hyosung Corp - Holding company (0.3928)
Hyosung TNC - Textile & trade (0.1232)
Hyosung Heavy Industries - Heavy industries and construction (0.2655)
Hyosung Advanced Materials - Materials related (0.1276)
Hyosung Chemicals - Chemicals (0.0908)
For further details on this split-off, see our report, Hyosung’s Transformation into a Holdco + Four Subsidiaries (Part 1). This method is dividing up the company is reminiscent of similar split-up of other major chaebols in 2017 including the Hyundai Heavy Industries Group and the Lotte Group. (See our report, Its All About Hyundai Robotics).
The split-off of Hyosung Corporation is expected to be completed by June 1st and the shareholders’ meeting to vote on this matter will be held on April 27th. The newly formed companies will start trading on July 13th.
A Lot of Controversy on This Stock
On the bright side, the Chairman Cho Hyun-Joon has been buying a lot ofHyosung Corporation (004800 KS) shares. On March 13th, it was reported that Chairman Cho increased his stake in the company from to 14.52%, up from 14.27% at end of September 2017. His average purchase price for the shares he purchased this year is estimated to be about 136,510 won, which is higher than the current price of 127,000 won. The purchase amount is estimated to be about 12 billion won (US$11.2 million).
On the negative side, in January 2018, Hyosung’s Chairman Cho Hyun-Joon was indicted on charges of embezzlement and breach of trust. In the past five years, Chairman Cho Hyun-Joon has been on a brutal fight between his younger brother Cho Hyun-Moon who has accused his older brother of numerous improper business dealings. The following is a summary of this fight between the Hyosung Group’s Chairman Cho Hyun-Moon and his brother Cho Hyun-Moon:
In February 2013, Cho Hyun-Moon who was a Vice President of Hyosung Heavy Industries at that time resigned from the company. It was later found that Cho Hyun-Moon was very dissatisfied with the way his brother was operating Hyosung Corp. and this disagreement with his brother was a key reason for him leaving the company.
In January 2016, Cho Seok-Rae (the founder of the Hyosung Group; 83 years old now) was sentenced to a three-year imprisonment on charges of tax evasion and accounting fraud. He was fined US$110 million.
In December 2016, Cho Seok-Rae stepped down as the Chairman of the Hyosung Group, replaced by his first son Cho Hyun-Joon.
In January 2018, Cho Hyun-Joon, the Chairman of the Hyosung Group, was indicted by the Korean government (Seoul Central District) prosecutors on charges of embezzlement and breach of trust. In the past several years, Cho Hyun-Joon tried to help the local prosecutors by tryng to get some dirt on his older brother.
Hyosung’s Chairman Cho Hyun-Joon (left); His younger brother Cho Hyun-Min (right): (Source: Naver Images)
In addition, a well known civic organization called Solidarity of Economic Reform (SER) (http://www.ser.or.kr/main.html), which specializes in trying to protect the minority shareholder rights in Korea, has pointed out that despite Hyosung’s efforts to split off the company, it still has concerns regarding its corporate governance. SER’s major concerns about Hyosung’s corporate governance policies include a) the recent indictment of Hyosung’s Chairman Cho Hyun-Joon for embezzlement worth nearly 20 billion won and breach of trust and b) Hyosung’s reappointment of Choi Joong-Kyung, who is the Chairman of the KICPA (Korea Institute of Certified Public Accountants) as a member of its Board of Directors. This involves a conflict of interests, especially because there are some concerns about the potential accounting irregularities of Hyosung’s financials.
Overall, Hyosung Corporation (004800 KS) is an interesting stock with an opportunity to realize higher value through the split-off process. However, the company is facing some serious concerns regarding its corporate governance and potential accounting irregularities, which have helped to push down the share price.
This note provides an analysis about how the shares of Hyosung Corporation (004800 KS) and its four subsidiaries may trade once they start to trade again on July 13th. Our sum-of-the parts valuation of Hyosung Corp suggests an implied market cap of 6.6 trillion won, which is 39.9% higher than current market cap of 4.7 trillion won. Hyosung Corp shares have been suspended trading from May 29th to July 12th.
The following are the five new entities (including the split ratios) that will be created for Hyosung Group in this reorganization:
Hyosung Corp - Holding company (0.3928)
Hyosung TNC - Textile & trade (0.1232)
Hyosung Heavy Industries - Heavy industries and construction (0.2655)
Hyosung Advanced Materials - Materials related (0.1276)
Hyosung Chemicals - Chemicals (0.0908)
Most recently, Korea National Pension Service (NPS) increased its stake in Hyosung Corp to 10.63% (as of June 29th, 2018), up from 10.16% (as of March 30th, 2018). As we mentioned in our report, Hyosung’s Transformation into a Holdco + Four Subsidiaries (Part 1), the three key positives of this split-off include a transition from a complex to simple structure, potential for higher valuation of its core businesses, and a transition stage from father to son ownership. The negative factors include market cap limits of the split-off subsidiaries and potentially unwise use of treasury shares.
Balance Sheets of Hyosung Corp (Pre & Post Split) and its Four Major Split Off Companies
The table below shows the balance sheets of Hyosung Corp (pre and post company split) as well as its four major affiliates as of July 1st, 2018. Post the company split off, Hyosung Corp (holdco) has the strongest balance sheet as it was in a net cash position as of July 1st, 2018. Among the four major affiliates, Hyosung Chemicals has the weakest balance sheet, with net debt to equity ratio of 301% and total liabilities/equity ratio of 390% as of July 1st, 2018.
Sum-of-the Parts Valuation of Hyosung Corp and Its Affiliates Pre and Post Company Split
Our sum-of-the parts valuation of Hyosung Corp suggests an implied market cap of 6.6 trillion won, which is 39.9% higher than current market cap of 4.7 trillion won. Our valuation methodologies for the break-up value are as follows:
Hyosung Heavy Industries - We used Hyundai Heavy Industries, Doosan Heavy Industries, and GS E&C as comps. Taking the book value of Hyosung Heavy Industries as of July 1st and applying the average P/B multiple, we derived an equity value of 568 billion won for Hyosung Heavy Industries.
Hyosung Advanced Materials - We used Kolon Industries as the comp. Applying an estimated annual net profit of 134 billion won and applying a P/E of 11.1x (5% premium to Kolon Industries), we derived an equity value of 1,482 billion won for Hyosung Advanced Materials.
Hyosung Chemical - We used Lotte Chemical and Kumho Petrochem as comps. We applied a 20% discount to the average P/E multiple of these comps. Applying an estimated net profit of 95 billion won, this suggests an equity value of 414 billion won for Hyosung Chemical.
Hyosung TNC - We used Taekwang Industrial and Huvis as comps. We applied a 10% discount to the average P/E multiple of these comps. Applying an estimated net profit of 260 billion won, we derived an equity value of 2,606 billion won for Hyosung TNC.
Hyosung Corp (Holdco) - To derive the value of Hyosung Corp, we added all the market caps of the four affiliates and after applying a 30% discount and taking into account its ownership stake of 42.1% (this is ownership by 3 major shareholders + treasury shares; assuming that the Holdco will swap the shares sold by the major owners of the four affiliates) and adjusting for net cash , this resulted in a value of 1,515 billion won.
Hyosung Corporation (004800 KS) shares were trading at P/E of 13.8x (using 2017 earnings) and 10.3x (using 2018 consensus earnings estimates) prior to the company split. Hyosung Corp’s current market cap is 4.7 trillion won and the consensus net profit forecast is 459 billion won in 2018.
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