Why a horse named Vitana V might be good news for Korean equities

You’d have got good odds on a horse positively influencing South Korean corporate governance, something that now appears increasingly likely.

You may have read about the scandal under which a number of South Korea’s family-dominated conglomerates (‘chaebols’) are alleged to have made material contributions to Choi Soon-sil, a close friend of President Park Geun-hye in return for political influence (including buying a £660,000 horse, Vitana V, for her equestrian loving daughter!)

What is, however, less well known is that this will hopefully accelerate the much-needed restructuring of the dominant chaebols and accelerate the existing steady improvement in minority rights in Korea.

As Matthew Vaight pointed out in his recent blog things were already changing with dividend payments rapidly growing from low levels compared to other international markets and increasing signs of regulatory pressure.

This latter point appears to have been accelerated by the scandal given the degree of public outrage. Whilst President Park has been suspended, the chaebols are also viewed with growing frustration leading to a slew of proposed bills related to corporate governance with a goal of ‘economic democratisation’.

The proposed bills will address a number of areas of minority shareholder frustration

  • To limit controlling shareholders’ access to corporate capital at the expense of minority shareholders.
  • To reinforce the fiduciary duty and the expertise of the National Pension Service Investment Management (which is the largest investor in South Korean, the third largest pension fund in the world, managing £350bn of assets).
  • To reform the Board of Directors to enhance their independence.

These changes should positively impact in a number of ways. Firstly through encouraging fundamental corporate restructuring such as the abandonment of the typical sprawling cross-shareholding structures of the likes of Samsung Group into a more normal dual-layer holding company.

The second impact could be just as material – a major reappraisal of corporate governance. In many cases Boards of Directors have not been protecting minority interests. According to the Korean Corporate Governance Service, 25% of proposed independent directors were inappropriate due to potential conflicts of interest and a remarkable 25% of nominated directors have been Non-Executive directors for 20 years. Whilst international investors have been pushing for change for some time they might finally start getting support from domestic investors as well. In the 2015 AGM season, only 1.5% of proposals were voted against by domestic institutional investors, while foreign pension funds voted against 11%.

This matters because Korea still trades at a 20% valuation discount to the rest of Asia, largely due to concerns over corporate governance and minority shareholder protection. If investors start to believe there is real change there is a significant opportunity. Valuation matters – just look at Samsung Electronics – it’s hard to think of a company with worse headlines over the last 12 months with the disaster over their exploding batteries in their Note 7 phones through to their alleged involvement in the contributions to Choi Soon-sil. However since 1 January 2016 the shares are up over 50% and yet still trade on a P/E of less than 10.

As Korean corporate governance practices improve we should see a reduction in the market’s traditional valuation discount. What would the odds have been of a horse taking centre stage in the chaebol restructuring saga? Long doesn’t come close, but incredibly there seems more than an outside chance that a horse named Vitana will succeed where countless politicians and investors failed before.