Korea Event-Driven and Corporate Governance, DewPoint Research

Yeaseul Lim

Korea Event-Driven and Corporate Governance

Independent Equity Research Provider - South Korea

DewPoint Research

At DewPoint, we aim to convey a clear understanding of a company’s approach to capital allocation. As a matter of corporate governance, capital allocation reflects whose interests a company prioritizes when making management decisions. Given the Korean context, it comes down to a question of whether the company undermines the interests of minority shareholders for private benefits of controlling shareholders. This is what we focus on as a fundamental starting point in our research.
 
Capital allocation principles and practices provide the foundation for a company’s sustainable value creation. Thus, investors need to be alert to any possible distortions in capital allocation, especially when they take a long-term perspective. They also want to find safe stocks with committed management, no separation between ownership and control, and robust business models. We seek to fulfill such needs in a disciplined manner.
 
We also work as a representative of foreign investors who are willing to exercise active ownership in their investee companies. Our service may include identifying stocks that are fundamentally strong but vulnerable to activist attacks.

Equity Bottom-Up

<p><strong>On January 6, 2020, <a href="https://www.smartkarma.com/entities/hanwha-chemical-corp" target="_blank" data-smartkarma-citation="entities:8656:1" rel="noopener">Hanwha Chemical (009830 KS)</a> finalized a merger of its wholly-owned subsidiary (Hanwha Q Cells &amp; Advanced Materials) into the company and renamed it to "Hanwha Solution".</strong> Hanwha Q Cells &amp; Advanced Materials was created through a merger between Hanwha Q Cells Korea and Hanwha Advanced Materials in August 2018. While the latter was a Hanwha Chemical's wholly-owned subsidiary, Hanwha Q Cells Korea was held 60% by private companies owned by controlling families. </p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/118/471/original/Hanwha_ownership.png?1581996684" class="editor-image img-responsive" data-smartkarma-image-id="118471"></figure>
<div class="content-caption">Hanwha Group's Ownership Structure (Simplified version)</div>
<p>A week later, local news reported that Hanwha Solution began the process of issuing corporate bonds worth 200 billion won to pay off its maturing debt carried over from the merged subsidiary. <strong>As seen below, Hanwha Chemical's</strong><strong> debt-to-equity ratio increased from 52.3% to 92.7% (of Hanwha Solution) after the merger. </strong>The debt-to-equity ratio of Hanwha Q Cells &amp; Advanced Materials was higher than 500% mainly due to its large amounts of long-term debt (745 billion won) of which Hanwha Q Cells Korea had contributed 91% (680 billion won).</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/118/512/original/Hanwha%20Chemical_debt%20burden.png?1581999092" class="editor-image img-responsive" data-smartkarma-image-id="118512"></figure>
<div style="text-align: left;" class="content-caption">*We used the 3rd quarter financial results to calculate debt-to-equity ratios and estimate financial debt burden of Hanwha Chemical before the merger. Hanwha Q Cells &amp; Advanced Materials was recently established, so the latest financial statements are not available. The filings for the merger do not include specific numbers about its financial position. So, we roughly calculated its estimated amounts of debt by a summation of Hanwha Q Cell Korea's debt and Hanwha Advanced Materials' debt as of December 31, 2017 (before they were merged with each other)</div>
<table class="table table-striped">
<colgroup> <col> <col> <col> <col> <col> </colgroup>
<tbody>
<tr>
<td style="width: 140.889px;">
<p>Financial Position (unit: 100 million won)</p>
</td>
<td style="text-align: left; width: 131.111px;">Hanwha Chemical (As of Sep 31, 2019) </td>
<td style="text-align: left; width: 126.667px;">
<p>(A) Hanwha Q Cells Korea (As of Dec 31, 2017)</p>
</td>
<td style="text-align: left; width: 126.667px;">
<p>(B) Hanwha Advanced Materials</p>
<p>(As of Dec 31, 2017)</p>
</td>
<td style="text-align: left; width: 115.111px;">(A+B) Hanwha Q Cells &amp; Advanced Materials </td>
</tr>
<tr>
<td style="width: 140.889px;">Short-Term Debt </td>
<td style="text-align: right; width: 131.111px;">3,828</td>
<td style="text-align: right; width: 126.667px;">1,149</td>
<td style="text-align: right; width: 126.667px;">2,241</td>
<td style="text-align: right; width: 115.111px;">3,390</td>
</tr>
<tr>
<td style="width: 140.889px;">Long-Term Debt </td>
<td style="text-align: right; width: 131.111px;">134</td>
<td style="text-align: right; width: 126.667px;">6,804</td>
<td style="text-align: right; width: 126.667px;">650</td>
<td style="text-align: right; width: 115.111px;">7,454</td>
</tr>
<tr>
<td style="width: 140.889px;">Corporate Bonds </td>
<td style="text-align: right; width: 131.111px;">13,370</td>
<td style="text-align: right; width: 126.667px;">2,483</td>
<td style="text-align: right; width: 126.667px;">1,043</td>
<td style="text-align: right; width: 115.111px;">3,526</td>
</tr>
<tr>
<td style="width: 140.889px;">Cash and Cash Equivalents </td>
<td style="text-align: right; width: 131.111px;">2,174</td>
<td style="text-align: right; width: 126.667px;">975</td>
<td style="text-align: right; width: 126.667px;">46</td>
<td style="text-align: right; width: 115.111px;">1,021</td>
</tr>
<tr>
<td colspan="5" style="width: 140.889px;"><em>Source: Company data</em></td>
</tr>
</tbody>
</table>
<p>Most local media presented positive views on this latest merger, saying that Hanwha Group was focusing efforts on chemical and solar businesses. Although this might be partly true, <strong>we rather think that this merger can be interpreted as a signal warning investors about the underlying misalignment of interests facing Hanwha Solution (Hanwha Chemical).</strong></p>
<hr>
<h2><strong>Why Hanwha Solution Is More Vulnerable To Governance Risks</strong></h2>
<p>H-Solution, which is a family-owned private company, is the most important key to implementing succession plans for Hanwha Group. Controlling families are interested in increasing the value of H-Solution such that they can secure enough control over the Group by merging H-Solution with <a href="https://www.smartkarma.com/entities/hanwha-corporation" target="_blank" data-smartkarma-citation="entities:10619:1" rel="noopener">Hanwha Corporation (000880 KS).</a> H-Solution has held a majority stake in many different private companies directly or indirectly, such as Hanwha Energy, Hanwha General Chemical, and Hanwha Q Cells Korea. <strong>Among large-sized publicly-listed firms within the Group, Hanwha Solution (Hanwha Chemical) is apparently most suitable for being taken advantage of to support H-Solution and other private companies. Here are some reasons why. </strong></p>
<div class="content-highlight">
<ul>
<li>
<p><strong>A Separation between Ownership and Control:</strong> Controlling families hold indirect ownership (cash flow rights) of only 11.8% in Hanwha Solution but are able to effectively exercise control over management. Meanwhile, the families hold 100% cash flow rights in H-Solution and Hanwha Energy. </p>
</li>
</ul>
<ul>
<li>
<strong>Business Portfolios (Compared to Hanwha Aerospace):</strong> Controlling families' cash flow rights in <a href="https://www.smartkarma.com/entities/hanwha-aerospace-co-ltd" target="_blank" data-smartkarma-citation="entities:504:1" rel="noopener">Hanwha Aerospace (012450 KS)</a> is also only about 11%. However, the key difference between Hanwha Aerospace and Hanwha Solution is that the latter has been heavily involved in internal transactions with affiliates (non-subsidiaries). Hanwha Solution runs chemical raw materials and solar businesses. The company also has processing and distribution business segments. Hanwha Energy, Hanwha General Chemical, Hanwha Total, and Hanwha Q Cells Korea, which are (or were) indirectly owned by controlling families, have been engaged in relevant businesses to varying degrees. The amounts of raw materials Hanwha Solution bought from those affiliates for the fiscal year of 2018 accounted for nearly 45% of its total COGS. Meanwhile, <a href="https://www.smartkarma.com/entities/hanwha-aerospace-co-ltd" target="_blank" data-smartkarma-citation="entities:504:1" rel="noopener">Hanwha Aerospace (012450 KS)</a> operates in three segments: aviation and defense, security, and industrial equipment. The company runs those businesses mostly through wholly-owned subsidiaries and has negligible amounts of internal transactions. Such that, Hanwha Aerospace is less likely to face alleged unfair trade practices.</li>
</ul>
</div>
<h2><strong>Hanwha Solution's Capital Allocations And Ongoing Risks</strong></h2>
<p>We found out three types of value-destroying capital allocations that Hanwha Solution (<a href="https://www.smartkarma.com/entities/hanwha-chemical-corp" target="_blank" data-smartkarma-citation="entities:8656:1" rel="noopener">Hanwha Chemical (009830 KS)</a>) has done over the years. </p>
<ul>
<li>
<strong>Self-dealing transactions with Hanwha Q Cells Korea:</strong> In the Detail Section, we provide detailed information about how those transactions have had an adverse impact on <a href="https://www.smartkarma.com/entities/hanwha-chemical-corp" target="_blank" data-smartkarma-citation="entities:8656:1" rel="noopener">Hanwha Chemical (009830 KS)</a>. However, the relevant risks seem to be disappearing as Hanwha Q Cells &amp; Advanced Materials was finally merged into Hanwha Chemical, though Hanwha Solution (the post-merger company) incurred large amounts of debt that came along. </li>
<li>
<strong>Sales transactions with <a href="https://www.smartkarma.com/entities/han-express-co-ltd" target="_blank" data-smartkarma-citation="entities:19441:1" rel="noopener">Han Express (014130 KS)</a>:</strong> Hanwha Solution has been a major client of Han Express, which is held 47% by siblings of Kim Seung-yeon, Hanwha Group Chairman. This seems problematic but is not directly linked to an issue of raising the value of H-Solution.</li>
<li>
<strong>Selling raw materials to Hanwha Energy:</strong> Hanwha Energy buys raw materials from Hanwha Solution and its subsidiaries. Hanwha Energy is a wholly-owned subsidiary of H-Solution. The company has also seen a dramatic improvement in credit ratings after selling off its indirect stake in Hanwha Q Cells Korea to Hanwha Chemical. Hanwha Energy is the last one left to be used by controlling shareholders to pocket some money and/or expand control over the Group. That is why we see that risks facing Hanwha Solution have not been resolved yet. </li>
</ul>
<p><em>In Detail, we will take a closer look at some historical patterns of unfair wealth transfer and identify risks that remain unresolved. While we mainly discuss Hanwha Solution (<a href="https://www.smartkarma.com/entities/hanwha-chemical-corp" target="_blank" data-smartkarma-citation="entities:8656:1" rel="noopener">Hanwha Chemical (009830 KS)</a>) here, we will cover </em><em>Hanwha General Chemical (2020 IPO candidate) and <a href="https://www.smartkarma.com/entities/hanwha-systems-co-ltd" target="_blank" data-smartkarma-citation="entities:28308:1" rel="noopener">Hanwha Systems Co Ltd (272210 KS)</a> in a separate insight with a focus on their money-making mechanisms.</em></p>

On January 6, 2020, Hanwha Chemical (009830 KS) finalized a merger of its wholly-owned subsidiary (Hanwha Q Cells &amp; Advanced Materials) into the company and renamed it to "Hanwha Solution". Hanwha Q Cells &amp; Advanced Materials was created through a merger between Hanwha Q Cells Korea and Hanwha Advanced Materials in August 2018. While the latter was a Hanwha Chemical's wholly-owned subsidiary, Hanwha Q Cells Korea was held 60% by private companies owned by controlling families. 

Hanwha Group's Ownership Structure (Simplified version)
A week later, local news reported that Hanwha Solution began the process of issuing corporate bonds worth 200 billion won to pay off its maturing debt carried over from the merged subsidiary. As seen below, Hanwha Chemical's debt-to-equity ratio increased from 52.3% to 92.7% (of Hanwha Solution) after the merger. The debt-to-equity ratio of Hanwha Q Cells &amp; Advanced Materials was higher than 500% mainly due to its large amounts of long-term debt (745 billion won) of which Hanwha Q Cells Korea had contributed 91% (680 billion won).

*We used the 3rd quarter financial results to calculate debt-to-equity ratios and estimate financial debt burden of Hanwha Chemical before the merger. Hanwha Q Cells &amp; Advanced Materials was recently established, so the latest financial statements are not available. The filings for the merger do not include specific numbers about its financial position. So, we roughly calculated its estimated amounts of debt by a summation of Hanwha Q Cell Korea's debt and Hanwha Advanced Materials' debt as of December 31, 2017 (before they were merged with each other)

      



Financial Position (unit: 100 million won)

Hanwha Chemical (As of Sep 31, 2019) 

(A) Hanwha Q Cells Korea (As of Dec 31, 2017)


(B) Hanwha Advanced Materials
(As of Dec 31, 2017)

(A+B) Hanwha Q Cells &amp; Advanced Materials 


Short-Term Debt 
3,828
1,149
2,241
3,390


Long-Term Debt 
134
6,804
650
7,454


Corporate Bonds 
13,370
2,483
1,043
3,526


Cash and Cash Equivalents 
2,174
975
46
1,021


Source: Company data



Most local media presented positive views on this latest merger, saying that Hanwha Group was focusing efforts on chemical and solar businesses. Although this might be partly true, we rather think that this merger can be interpreted as a signal warning investors about the underlying misalignment of interests facing Hanwha Solution (Hanwha Chemical).

Why Hanwha Solution Is More Vulnerable To Governance Risks
H-Solution, which is a family-owned private company, is the most important key to implementing succession plans for Hanwha Group. Controlling families are interested in increasing the value of H-Solution such that they can secure enough control over the Group by merging H-Solution with Hanwha Corporation (000880 KS). H-Solution has held a majority stake in many different private companies directly or indirectly, such as Hanwha Energy, Hanwha General Chemical, and Hanwha Q Cells Korea. Among large-sized publicly-listed firms within the Group, Hanwha Solution (Hanwha Chemical) is apparently most suitable for being taken advantage of to support H-Solution and other private companies. Here are some reasons why. 



A Separation between Ownership and Control: Controlling families hold indirect ownership (cash flow rights) of only 11.8% in Hanwha Solution but are able to effectively exercise control over management. Meanwhile, the families hold 100% cash flow rights in H-Solution and Hanwha Energy. 




Business Portfolios (Compared to Hanwha Aerospace): Controlling families' cash flow rights in Hanwha Aerospace (012450 KS) is also only about 11%. However, the key difference between Hanwha Aerospace and Hanwha Solution is that the latter has been heavily involved in internal transactions with affiliates (non-subsidiaries). Hanwha Solution runs chemical raw materials and solar businesses. The company also has processing and distribution business segments. Hanwha Energy, Hanwha General Chemical, Hanwha Total, and Hanwha Q Cells Korea, which are (or were) indirectly owned by controlling families, have been engaged in relevant businesses to varying degrees. The amounts of raw materials Hanwha Solution bought from those affiliates for the fiscal year of 2018 accounted for nearly 45% of its total COGS. Meanwhile, Hanwha Aerospace (012450 KS) operates in three segments: aviation and defense, security, and industrial equipment. The company runs those businesses mostly through wholly-owned subsidiaries and has negligible amounts of internal transactions. Such that, Hanwha Aerospace is less likely to face alleged unfair trade practices.


Hanwha Solution's Capital Allocations And Ongoing Risks
We found out three types of value-destroying capital allocations that Hanwha Solution (Hanwha Chemical (009830 KS)) has done over the years. 


Self-dealing transactions with Hanwha Q Cells Korea: In the Detail Section, we provide detailed information about how those transactions have had an adverse impact on Hanwha Chemical (009830 KS). However, the relevant risks seem to be disappearing as Hanwha Q Cells &amp; Advanced Materials was finally merged into Hanwha Chemical, though Hanwha Solution (the post-merger company) incurred large amounts of debt that came along. 

Sales transactions with Han Express (014130 KS): Hanwha Solution has been a major client of Han Express, which is held 47% by siblings of Kim Seung-yeon, Hanwha Group Chairman. This seems problematic but is not directly linked to an issue of raising the value of H-Solution.

Selling raw materials to Hanwha Energy: Hanwha Energy buys raw materials from Hanwha Solution and its subsidiaries. Hanwha Energy is a wholly-owned subsidiary of H-Solution. The company has also seen a dramatic improvement in credit ratings after selling off its indirect stake in Hanwha Q Cells Korea to Hanwha Chemical. Hanwha Energy is the last one left to be used by controlling shareholders to pocket some money and/or expand control over the Group. That is why we see that risks facing Hanwha Solution have not been resolved yet. 

In Detail, we will take a closer look at some historical patterns of unfair wealth transfer and identify risks that remain unresolved. While we mainly discuss Hanwha Solution (Hanwha Chemical (009830 KS)) here, we will cover Hanwha General Chemical (2020 IPO candidate) and Hanwha Systems Co Ltd (272210 KS) in a separate insight with a focus on their money-making mechanisms.

Hanwha Solution (Hanwha Chemical): Misalignment of Interests, Wealth Transfer, and Ongoing Risks

Korea / Special Sits, Pairs, Index Rebalancing, Clepsydra Capital

Sanghyun Park

Korea / Special Sits, Pairs, Index Rebalancing

Event-Driven

<p>Kumho Industrial officially confirms Asiana Airlines controlling stake sale in a regulatory filing. KDB is said to have accepted this revised self-rescue measure. Sale process will commence immediately. Several local conglomerate names are being tossed around as a likely buyer. They are SK, CJ, Aekyung and Hanwha.</p>

Kumho Industrial officially confirms Asiana Airlines controlling stake sale in a regulatory filing. KDB is said to have accepted this revised self-rescue measure. Sale process will commence immediately. Several local conglomerate names are being tossed around as a likely buyer. They are SK, CJ, Aekyung and Hanwha.

Asiana Airlines Stake Sale: Deal Conditions & Potential Buyers

South Korea

Han Express Co., Ltd. provides land transportation services.  The Company specializes in transporting petroleum and frozen products.  Han Express also offers logistics services, warehousing services, and real estate rental services.  In addition, Han Express manufactures and sells specialty vehicles, such as concrete mixers.

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Han Express (014130 KS)

Hanwha Solution (Hanwha Chemical): Misalignment of Interests, Wealth Transfer, and Ongoing Risks

On January 6, 2020, Hanwha Chemical (009830 KS) finalized a merger of its wholly-owned subsidiary (Hanwha Q Cells & Advanced Materials) into...

DewPoint Research

Asiana Airlines Stake Sale: Deal Conditions & Potential Buyers

Kumho Industrial officially confirms Asiana Airlines controlling stake sale in a regulatory filing. KDB is said to have accepted this revised...

Sanghyun Park

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