Improve Korea Proposals to the Korean National Pension Service - - PowerPoint PPT Presentation

Improve Korea

Proposals to the Korean National Pension Service

Jan 2019 Page 1

IMPORTANT DISCLOSURES

This presentation is published by Dalton Investments LLC solely for informational purposes and is not, and may not be construed as, investment, financial, legal, tax

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In respect of the information and materials which have been prepared by us and contained herein, in the event of any inconsistency between the English language version and the Korean language version, the meaning of the English language version shall prevail.

Jan 2019 Page 2

IMPORTANT DISCLOSURES

This document is provided for informational purposes only, and does not constitute a solicitation of any shares in any investment vehicle managed by Dalton Investments LLC. Such solicitations can only be made to qualified investors by means of the private placement memorandums, which describe, among other things, the risks of making an investment. Additionally, this presentation does not constitute investment advice of any kind. All of the information in this document relating to Dalton Investments LLC or its affiliates (collectively, “Dalton” or the “Firm”) is communicated solely by Dalton, 1601 Cloverfield Boulevard, Suite 5050 N, Santa Monica, CA 90404, regulated by the U.S. Securities and Exchange Commission (SEC). SEC registration does not imply SEC endorsement. No representation or warranty can be given with respect to the accuracy or completeness of the information, or with respect to the terms

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returns/results detailed herein. No representation is made that any results/returns indicated will be achieved or that all assumptions in achieving these returns have been considered or stated. Additional information is available on request. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on market conditions. Unless otherwise indicated, figures presented are preliminary, unaudited, subject to change and do not constitute Dalton’s standard books and records. Any estimates, projections or predictions (including in tabular form) given in this communication are intended to be forward-looking statements. Although Dalton believes that the expectations in such forward-looking statements are reasonable, it can give no assurance that any forward-looking statements will prove to be

• correct. Such estimates are subject to actual known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from

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Jan 2019 Page 3

17%

Korea National Pension Fund Domestic Equity Others

The National Pension Service (NPS) is one of the largest shareholders of Korean stocks and Steward of Korean people’s pensions

Source: Korea National Pension Service Investment Management; Meritz Securities *As of Oct. 31, 2018

• $97B invested in domestic equity
• Representing 7% of Korean stock market
• Ownership > 5% in 340 companies
• Ownership > 10% in 130 companies

NPS total assets $570B*

Jan 2019 Page 4

Proposal 1: Global Standards Conforming, Sustainable Changes

• I. Focus on ensuring any changes (e.g., payout increase) are measuring up to

global standards and are sustainable

• Most Korean companies improve their payout very gradually, comparing themselves
• nly to Korean peers. The NPS should encourage companies to benchmark their

payout policies to global standards

• The NPS also should encourage changing the compensation and performance

structure of the Korean companies’ executives to align their interests with those of all shareholders (including minority shareholders)

Jan 2019 Page 5

Align Interests of Management with Those of Shareholders

• Set core key performance indicators for management evaluation and compensation,

including long-term “economic value added”, return on capital, total shareholder returns (share price appreciation + dividend + share repurchase & cancellation)

• Compensate management primarily through performance based compensation with >

50% of performance based compensation in the form of stock or option awards

• Target management ownership of shares at > 5x annual salary
• Tie management’s performance based compensation to long-term share price changes

The goal is for management to have “skin in the game”

Jan 2019 Page 6

Proposal 2: Active Exercise of Shareholder Rights

• II. Actively exercise shareholder rights as steward of the people’s capital by:
• Maintaining independence from the Government and other institutions
• Hiring highly-qualified professionals and experts in the investment field
• More actively exercising shareholder rights, particularly in light of the severely

distorted nature of the Korean equity markets

Jan 2019 Page 7

Proposal 3: Focus on Capital Allocation

• III. Focus on overall capital allocation and planning of companies to

maximize long-term “economic value added” for all shareholders by:

• Pressing companies, as a large shareholder, to focus on maximizing long-term

“economic value added”

• Checking capital allocations that prioritize the interests of affiliates and corporate

groups over those of company’s shareholders

• Reviewing capital efficiency through the separation of actually-employed capital and

unemployed capital

• Assessing the appropriate level of total payout by companies to shareholders

Jan 2019 Page 8

Proposal 4: Cash Capacity

• IV. Focus on cash capacity to improve ways to identify companies that need

to increase total payout

• Rather than focusing on whether the recent dividend payout ratio and dividend yield

are below the minimum level, the NPS should focus on a company’s idle cash accumulated over the past years and its ability to generate cash

Jan 2019 Page 9

Companies with Excessive Cash Yet to be Targeted by the NPS

0% 100%

Net Cash* / Total Equity Estimates (As of 1H ’18, Consolidated)

Source: Korea Financial Supervisory Services DART – Quarterly Reports

50%

*Net cash estimated excluding stake values in key subsidiaries (e.g., for group ownership) and including net cash portion of stakes in subsidiaries

Only these companies seem to be targeted; many

• ther potential candidates

Jan 2019 Page 10

Proposal 5: Share Buybacks/ Cancellation

• V. Where appropriate, recommend share buybacks/cancellation over

dividend payouts

• If the share price of a company is significantly lower than its intrinsic value, a share

buyback is more effective than dividend payouts

• Share buyback without cancellation, however, is not a direct return to shareholders

(See Appendix for illustration of share buybacks with cancellation and without)

Jan 2019 Page 11

Warren Buffett on Conditions for Share Repurchase

“Charlie and I favor repurchases when two conditions are met: 1. A company has ample funds to take care of the operational and liquidity needs of its business 2. Its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.” Warren Buffett “Shareholders should have been supplied all the information they need for estimating that value. Otherwise, insiders could take advantage of their uninformed partners and buy out their interests at a fraction of true worth.” Warren Buffett

Source: Berkshire Hathaway Shareholder Letters

Jan 2019 Page 12

Appropriate Share Repurchases Demonstrate Pro-Shareholder Attitude

“ A manager who consistently turns his back on repurchases, when these clearly are in the interest of owners, reveals more than he knows of his motivations.” “By making repurchases when a company’s market value is well below its business value, management clearly demonstrates that it is given to actions that enhance the wealth

• f shareholders, rather than to actions that expand management’s domain but that do

nothing (or even harm) shareholders” Warren Buffett “The reason why Korean management don’t do share repurchases or cancel treasury stocks even after repurchases might be because they believe the companies’ money is theirs and don’t want to share it with minority shareholders.” Industry Expert

Source: Berkshire Hathaway Shareholder Letters

Jan 2019 Page 13

Despite Low Valuations, Share Buybacks are Much Less Common in Korea than in Other Countries

1% 1% 2% 3% 17% 19% 28% 57% Korea China Taiwan ASEAN Japan Europe World US

• Avg. annual share repurchase ratio from 2011 to 2017 by

MSCI Indexes

Source: Factset, MSCI; Bloomberg

Jan 2019 Page 14

Korean Companies that Buyback Shares Do So on a Small Scale

Korean Companies (Estimates)

• Samsung Electronics repurchased ~9% since ‘15
• SK Innovation repurchased ~$1B (5%) in ‘18
• SK Hynix repurchased ~$1.6B (3%) in ’18
• Hyundai Motors repurchased ~3% of common stocks

since ’15

• Naver repurchased 2.4% since ’15
• SK Telecom repurchased 2.5% since ’15
• Hyundai Mobis repurchased 1% since ’15
• Samsung Life Insurance repurchased ~5% since ’15
• Samsung SDI repurchased ~5% since ’15
• Samsung Fire & Marine repurchased 3.5% since ’15
• Kia Motors repurchased 1.7% since ‘15
• NC Soft repurchased 3% since ’15
• CJ Corp repurchased ~$40M (~1%) of common stocks

since ‘15

• Hyundai Department Store repurchased $50M (1%)

since ‘15

• Dongsuh repurchased $8M (0.3%) since ‘15
• Hyundai Home Shopping repurchased $15M (1.3%)

since ‘15

Source: Bloomberg; CNBC; Korea Financial Supervisory Service DART – Public filings; Company websites.

Foreign Companies (Estimates)

• Apple (US) repurchased $220B (26%) since ‘12
• Softbank (Japan) repurchased $5.6B (~10%) in ‘15-’16;

announced to repurchase $5.5B (~7%) in 2019

• Starbucks (US) announced to repurchase $14B (~20%)

from ‘19 to ‘20

• Nestle (Swiss) announced to repurchase $21B (~10%)

from ‘18 to ‘20

• Boeing (US) announced to repurchase $18B (10%)

from ‘18 to ‘20. It has repurchased 39% since ’99

• Shell (Netherlands) announced to repurchase $25B

(~10%) from ‘18 to ‘20

• AutoZone (US) has repurchased 81% of shares from

‘98 to ‘17

• Home Depot (US) announced to repurchase $15B

(7%) from ‘18 to ’20. It has repurchased 50% since ‘03

• CK Asset (Hong Kong) has repurchased $1.1B (~5%)

from ‘16 to ‘17

• Cisco (US) announced to repurchase $25B (13%) from

‘18 to ‘19. It has repurchased 37% since ‘02.

• Micron (US) announced to repurchase $10B (16%)
• Merck (US) announced to repurchase $10B (7%)
• Amgen (US) completed repurchase of $10B (7-8%)
• Qurate Retail (US) has repurchased 55% since ‘06

Typically, less than 1% of issued shares are repurchased per year 2~7% of issued shares are repurchased per year and over many years

Jan 2019 Page 15

Most Korean Companies Do Not Cancel Repurchased Shares, Eliminating the Direct Benefit to Shareholders

Share Repurchase Effect Other Problems of Non-Cancellation

• Increased ownership through share count reduction
• If one maintains his share count but the overall share count decreases then the
• wnership increases
• Due to share reduction, EPS (Earnings Per Share), BVPS (Book Value Per Share), DPS

(Dividend Per Share) and other per share value could increase

• Share repurchase requires share count reduction (cancellation) to have direct effect

and return value to continuing shareholders. Share repurchase without any cancellation is not a direct return

• Creates overhang worry
• Markets factor in the possibility of treasury shares coming back to market and hence

ignore repurchase

• Worry of treasury share abuse to benefit majority shareholders
• Korean congressmen have raised issue of abusing treasury shares (magic of treasury

shares) by companies to benefit only majority shareholders over minority shareholders

Jan 2019 Page 16

0% 10% 20% 30% 40% 50% 60%

# of Treasury Shares / # of Issued Shares Estimates (As of 1H ‘18, Common Shares, KOSPI)

Many Korean Companies Hold Significant Amounts of Treasury Shares

Source: Bloomberg

Jan 2019 Page 17

Share Buyback Effects Should be Considered Over the Mid to Long-Term

Source: Korea Financial Supervisory Service DART – Public filings; Berkshire Hathaway Shareholder Letters; Manual of Ideas Global *William Thorndike is the author of “The Outsiders”, an acclaimed book that covers eight CEOs who excelled at capital allocation

“Effectiveness of buybacks need to be measured over 5-10 years. Henry Singleton repurchased for 6-8 years and the share price didn’t move. But afterwards, it is estimated to have created mid-40% IRR.”

Frequently Cited Reason for Share Repurchase by Korean Companies

“To enhance shareholder value through stabilizing share price” “Now, repurchases are all the rage, but are all too often made for an unstated and, in our view, ignoble reason: to pump or support the stock price…”

Warren Buffett’s Comment on Share Repurchase William Thorndike*’s Comment on How to View Share Buyback Effects Share buyback should not be about propping up the short-term share price. It should be about mid to long-term investment performance.

Page 18

Appendix

Jan 2019 Page 19

Illustration of Share Buybacks (with Cancellation) at Bargain Prices

Illustration of Share Repurchase (w/ cancellation) Effect

$83.3 $83.3 $83.3 $33.4 $100 $50 $100 $100 Intrinsic Value: Market Value:

Company

Intrinsic Value: Stock Price:

A B C $33.3 $33.3 $33.3 $33.3 $33.3 $33.3 33.3% 33.3% 33.3%

Time 1 Time 2 Time 3 Time 4

A B C $33.3 $33.3 $33.3 $16.7 $16.7 $16.7 33.3% 33.3% 33.3% A B C $41.7 $41.7

• $16.7

$16.7

• 50%

50%

• A

B C $41.7 $41.7

• $41.7

$41.7

• 50%

50%

• A company has intrinsic

value of $100 and is valued at $100 in the market. Company has 3 shareholders who each on 1 share of the company. Company’s market value drops to $50. Company repurchases the share from shareholder C at this price ($50/3) and cancels it. Company’s intrinsic value drops by $16.7 as company used that amount for

• repurchase. But shareholder

A & B’s intrinsic values went up due to bargain repurchase

Shareholders: Company repurchases the share from C at $16.7

Stock price and market value eventually normalize and reflect the intrinsic value 3 shareholders 2 shareholders

Continuing shareholders enjoy higher intrinsic value and stock price

• $16.7 =

Ownership:

Jan 2019 Page 20

Illustration of Share Buybacks (with Cancellation) at NON- Bargain Prices

Illustration of Share Repurchase (w/ cancellation) Effect

$50 $50 $50 $75 $100 $150 $100 $100 Intrinsic Value: Market Value:

Company

Intrinsic Value: Stock Price:

A B C $33.3 $33.3 $33.3 $33.3 $33.3 $33.3 33.3% 33.3% 33.3%

Time 1 Time 2 Time 3 Time 4

A B C $33.3 $33.3 $33.3 $50 $50 $50 33.3% 33.3% 33.3% A B C $25 $25

• $50

$50

• 50%

50%

• A

B C $25 $25

• $25

$25

• 50%

50%

• A company has intrinsic

value of $100 and is valued at $100 in the market. Company has 3 shareholders who each own 1 share of the company. Company’s market value increases to $150. Company decides to repurchase the share from shareholder C at this price ($150/3) and cancels it. Company’s intrinsic value drops by $50 as company used that amount to

• repurchase. Shareholder A &

B’s intrinsic values went down due to expensive repurchase.

Shareholders: Company repurchases shares from C at $50

Stock price and market value eventually normalizes and reflects the intrinsic value 3 shareholders 2 shareholders

Continuing shareholders see value decrease

• $50 =

Ownership:

Jan 2019 Page 21

Illustration of Share Buybacks (WITHOUT cancellation)

Illustration of Share Repurchase (w/o cancellation) Effect

$100 $100 $100 $50 $100 $50 $100 $100 Intrinsic Value: Market Value:

Company

Intrinsic Value: Stock Price:

A B C $33.3 $33.3 $33.3 $33.3 $33.3 $33.3 33.3% 33.3% 33.3%

Time 1 Time 2 Time 3 Time 4

A B C $33.3 $33.3 $33.3 $16.7 $16.7 $16.7 33.3% 33.3% 33.3% A B (D) $33.3 $33.3 $33.3 $16.7 $16.7 $16.7 33.3% 33.3% 33.3% A B D $33.3 $33.3 $33.3 $16.7 $16.7 $16.7 33.3% 33.3% 33.3% A company has intrinsic value of $100 and is trading at $100 in the market. Company has 3 shareholders who each own 1 share of the company. Company’s market price drops to $50. Company repurchase the share from shareholder C at this price ($50/3) but doesn’t cancel. Company’s intrinsic value doesn’t drop because of treasury shares. Shareholder A&B’s intrinsic values don’t increase yet due to possibility

• f potential new shareholder

D (overhang)

Shareholders: Company repurchases shares but doesn’t cancel

New shareholder D pays $16.7 to acquire treasury shares from Company. 3 shareholders 2 shareholders 3 shareholders

Ownership:

No change in value for Shareholders

Jan 2019 Page 22

Warren Buffett on Share Repurchases

“When companies…find their shares selling far below intrinsic value…, no alternative action can benefit shareholders as surely as repurchases” “…if a fine business is selling in the market place for far less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price?” “The companies in which we have our largest investments have all engaged in significant stock repurchases at times when wide discrepancies existed between price and value.” Warren Buffett

8 Excellent Capital Allocators

Source: Berkshire Hathaway Shareholder Letters; The Outsiders by William Thorndike, Harvard Business Review Press, 2012

Name Company 30%+ Share Repurchases

Tom Murphy & Dan Burke ABC Capital Cities √ Henry Singleton Teledyne √ Bill Anders General Dynamics √ John Malone TCI √ Catherine Graham Washington Post √ Bill Stiritz Ralston Purina √ Dick Smith General Cinema √ Warren Buffett Berkshire Hathaway —