Who Will Benefit From Global Fiscal Crisis?

SEOUL, South Korea, Oct. 30, 2008 — -- While the global financial markets fall and South Korea's economic growth dwindles, the country's business conglomerates, known as "chaebols," may be some of the few companies worldwide that stand to gain from this crisis.

One reason is the chaebols largely avoided taking on excess risk after being forced to clean up their balance sheets and accounting during the Asian financial crisis of the 1990s.

"They've learned their lesson back then," said Kim Kyeong-won, senior vice president of Samsung Economic Research Institute.

Through aggressive corporate reform in the last decade, "the chaebols are not only safe in this turmoil but have indeed saved enough ammunition to start buying up strong companies abroad," said Kim.

Rhee Zu-sun, the director-general of Korea Economic Research Institute, said: "The big players are on top of a very healthy financial structure and looking for companies to buy up. There's potential for lots of M&As especially of foreign companies, in the near future."

Chaebols such as Samsung, Hyundai and LG have played a major role in the South Korean economy since the 1960s. These family-controlled firms have grown into big business conglomerates assisted by the government's export-driven policies.

In many cases, the chaebols grew during the years of Korean economic boom of the '70s and '80s because they could channel funds from the nationalized banks by winning favors from the ruling governments.

Profitability was not necessarily their priority, but expansion was. When the Asian financial crisis hit in the mid-'90s, some debt-ridden chaebols went belly up while others were forced to downsize and spit up their operations.

Today's chaebols each still own a broad range of businesses. For example, Samsung's interests range from electronics, heavy machineries and financial services to medical centers, amusement parks and museums. Samsung Electronics is also the largest maker of memory chips in the world. LG Electronics is the world's fourth largest mobile phone maker and Hyundai Motor ranks the world's fifth largest in automaking.

The chaebols were a major factor in South Korea's economic implosion in the 1990s. As foreign reserves hit rock bottom in November 1997, foreign lenders halted credit and urged debtors to repay existing loans, which forced South Korea to borrow millions of dollars from the International Monetary Fund to keep bankruptcy at bay. The banks, then nationalized, had for decades been lending heavily to chaebols though the firms were suffering from poor management and lagging investment.

From the triggering force of the 1997 financial crisis, these chaebols have now transformed into businesses that could lead the rebound from this current turbulence.

"At the moment, ironically they [the chaebols] are financially sound, very strong, and good, contributing to the resilience to the level of crisis," said Kim Dong-soo, first vice minister of Korea's Ministry of Strategy and Finance, at a news conference jointly held with representatives from the Bank of Korea and the Financial Services Commission on Monday.

The officials say the current situation is quite different from a decade ago when the International Monetary Fund bailed the country out.

Back then, the crisis was a result of corporate insolvency but today's turbulence originates from outside the country. Foreign currency reserves were just $8.9 billion then compared with $239.7 billion now -- the sixth largest foreign reserves worldwide.

Of the total reserves, 90.6 percent are highly rated bonds, rated AA or higher. Corporate debt to equity ratio, a measure of how much debt companies have taken on, in late 1997 was 424.6 percent and now it's 106.5 percent. That's a big decrease, but still a fair amount of debt compared with other multi-national firms.

The impressive drop in debt was largely due to restructuring efforts to improve capital structure, transparency and corporate governance by the Korean conglomerates. While many went belly up, the survivors had to pay a hefty price. That meant not only cutting ties with the traditional way of doing business, but also an overhaul in the mindset of the founders and owners.

"In an export-driven economy in the '70s and '80s, the big players believed that they were too big to fail. For them, bankruptcy risk was almost near zero because even if they screw up, the government will come right to rescue," said Lim Won-hyuk, director of the Korea Development Institute.

But since then, economists say the conglomerates have become smarter, leaner and more creative. On the back of China's growth -- a market where South Korea sells a quarter of its total exports -- the chaebols enjoyed a booming economy in the last decade, significantly improving their balance sheets.

But when it came to reinvestment, many of the companies were reluctant to expand.

"It's been all about profits and cash flow," said Han Sang-won, chief manager of Hyundai Research Institute.

While being conservative in expanding business, chaebols like POSCO and Hyundai Mobis have chosen to aggressively reinvest in research and development, with the goal of becoming a world leader in at least one industry, rather than second in many.

For example, Samsung Electronics, which focuses on technology-intensive industries, has now upped its R&D ratio to 9.4 percent of sales. Since the 1997 crisis, Samsung has continued tp transform itself from a me-too manufacturer to a world leader in innovation and market share.

The bailout by the IMF also compelled South Korean companies to become more transparent in their finances and accounting.

"Before the crisis, it was vague or fake. The companies could mask transactions and claim anything," said the Samsung Economic Research Institute's Kim. "But now, Korea is implementing the toughest accounting standard system in the world, far stricter than Japan."

As a result, economists say the chaebols are sitting on a large cash flow, waiting for the financial tsunami to pass.

Of course there's no telling if or when the chaoebols will use their buying power given the severity of the current financial crisis, which has frozen credit and pushed many economies into recession.

Some analysts and market watchers caution that if the crisis drags on, the chaebols will not be immune. "We're seeing ordinary economy players who have nothing to do with the source of crisis, starting to get impacted," warned James Rooney, CEO of Market Force, a consulting firm in Seoul. "Over the next months, Korean companies, whether small or big, will confront negative impacts of a huge domestic liquidity crunch."

The challenge, analysts say, is whether chaebols can find a way not to overstretch or open their checkbooks just for the sake of adding another big international brand name under their umbrella.

"Yes, the debt ratio has drastically fallen from IMF bailout. But the current 106 percent average is not enough compared to other multinational companies that maintain around 50 to 60 percent level, depending on their business sectors," said Lee Hyuk-Jin, fund manager at Hi Asset Management.

Jessica Kim, Qree Yon and Youmi Kim contributed to the reporting of this story.