Better Judgement Reigns at Hyundai Heavy
This morning, Yonhap reported that Hyundai Heavy is no longer considering a bid for a 15% stake in Hynix, a Korean computer chip manufacturer. When it was rumored that Hyundai Heavy was considering a purchase of the Hynix stake, this blog suggested that this was an ill-conceived idea in the first place. It has been interesting that there has been feedback/comments made to me which defended the initial idea. I couldn’t agree less.
You Are The Best Decision-Maker
This will take a short explanation. The idea is still that specialization, not generalization, is a superior approach, unless there was a specific set of skills or knowledge that will create advantages over time. Economist Joseph Schumpeter called this creative destruction. It is the use of a developed set of skills to create a new company or industry. When companies expand because there are opportunities, it makes complete sense to do so if the company had complementary skills, such as large-scale manufacturing. However, simply diversifying business lines for its own sake isn’t, generally speaking, efficient.
When you use the word efficient in financial terms, you simply mean getting the optimal return on investment, given your risk tolerance and objectives. Conglomerates (or chaebol) are, largely, quite inefficient. Why is that? Lets say you have 100 dollars. The theory is that you, and not the conglomerate (let’s call it General Electric), should be able to invest your 100 dollars in any way you like. Perhaps you want 50% technology and 50% manufacturing. Perhaps it is 70% technology and 30% manufacturing. Let’s say that you change your mind after a year. If you invested 100 dollars in GE, then you are locked in: GE determines the allocation of your 100 dollars, not you. So, unless you completely believe in GE, and its decision-making instead of yours, you are in the better position by making the allocation decision by yourself. In Korean conglomerates’ cases, this is particularly important.
Korea’s Checkered Past
A long time ago (actually not really), Korean conglomerates faced nearly universal extinction. What happened? The chaebol over-borrowed, pure and simple. Sometimes, they borrowed in foreign currencies. Well, the Asian financial crisis hit, and the Korean Won plunged to over 2,000 KRW to the US dollar. The weaknesses of the above paragraphs became apparent, as the different subsidiaries basically borrowed from each other, and guaranteed each others’ debts. So, when one subsidiary suffered, the entire group suffered. Investors were, in short, screwed. They could not simply get out of the failing subsidiaries and keep the relatively-healthy ones. Even the venerable Hyundai Heavy was threatened, as the indebtedness, combined with family infighting pushed Hyundai Group to the brink. Samsung Motor is no longer Korean owned: it is owned by Renault-Nissan, which bought the bankrupt Samsung Motor. Samsung Group had no choice to jettison its new, failed foray into the automobile market.
The concepts above are not new. I didn’t dream them up without academic backing and real-world examples. As Korea develops, these concepts will need to be adopted. Investors can move money around the globe (including Korean ones). They are doing so now. Those investors will reward those companies that are allocating their capital efficiently, and punish those that do not. Above, General Electric is mentioned. Many will know it is a very reputable US company. Nevertheless, the returns to investors have been very, very dissatisfying.
Below is a graph over the past 5 years which compares GE’s stock performance compared to the market as a whole (S&P 500). For those of you that do not know, the S&P 500 is the index used by investment professionals. You can see that GE, even at best, is only equal to the S&P 500. Over the past 5 years, GE has underperformed the S&P 500, quite dramatically. Now admittedly, some of this has to do with the fact that GE is involved in finance, via the General Electric Credit Corporation (GECC). However, that illustrates the value of being able to dis-invest independently, rather than allowing a company to make those decisions for you. When Korean chaebol announce mergers where the buyer purchases a company or subsidiary where there are no synergies, the Seoul Gyopo Guide will be casting a suspicious eye. If Korean chaebol want to expand, then perhaps that is capital better spent abroad on companies or subsidiaries in foreign countries, that are related to the core capabilities of the chaebol itself.