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Q&A: NPS embroiled in Korea’s political scandal over Samsung units’ merger

Nov 29, 2016 (Gmt+09:00)

South Korea’s National Pension Service (NPS), the world’s third-largest pension scheme with $460 billion in assets under management, is engulfed in one of South Korea’s biggest influence-peddling scandals which has gripped the country for more than a month and led lawmakers to seek to impeach President Park Geun-hye. On Nov. 29, Park said in a nationally-televised address that she would follow parliamentary decisions on her presidency, including shortening her five-year term which is set to last through early 2018.


It is the first time for the NPS’ fund management department to be involved in prosecutors’ investigations since it was launched in 1999, paralyzing its organization and delaying the planned revamp of the department, including hiring a deputy CIO in charge of private markets.

Division heads and other senior officials of the pension fund, who are under scrutiny by state prosecutors, refrain from meetings with outsiders. And it is known that its investment committee meetings are being put off or replaced by written reports.

The following is a summary of the allegations surrounding the pension fund. See chronology of Samsung-NPS scandal.

Q: What are the allegations?

A: NPS is alleged to have voted for the proposed merger of two Samsung units in July 2015 under pressure from the government. In this connection, Samsung Group is alleged of donating 3.5 billion won ($3 million) to a close confidant of President Park, Choi Soon-sil, who has been under arrest on allegations of influence-peddling over state affairs and embezzlement. Both NPS and Samsung dismissed the allegations as unfounded.

The question for NPS is what made it approve the takeover of Cheil Industries Inc. by Samsung C&T Corporation, despite recommendations from influential advisory firms such as Institutional Shareholder Service (ISS) and Glass Lewis & Co that Samsung C&T shareholders vote against the merger because of the unattractive merger ratio.

NPS was the biggest shareholder in Samsung C&T, a trading and construction firm, with a 11.2% stake as of Sept. 1, 2015 when the two Samsung units were combined. It also had a 4.8% stake in Cheil Industries, a fashion, textile and chemical unit of the Samsung Group. The state pension fund was believed to have a casting vote over the merger plan, after U.S. activist fund Elliot Associates opposed the tie-up and took legal actions to block the deal which a Seoul district court rejected later.

Q: Who are the targets of prosecutors’ investigation?

A: NPS Chairman Hyung-Pyo Moon, former NPS’ CIO Wan-sun Hong, and ex-NPS Chairman Choi Kwang showed up at a prosecutors’ office for questioning last week. State prosecutors also raided the head office of the NPS’ fund management department. Moon was the welfare minister at the time of the merger. The pension fund is under the ministry.

Choi was forced to step down in October 2015 under pressure from the welfare ministry, after he opposed a second term for then CIO Hong, saying that Hong lacked expertise and capacity to manage 500 trillion won in assets. Choi also had said: “It was a very inappropriate behavior for Wan-sun Hong to meet (Samsung Electronics) Vice Chairman Jay Y. Lee ahead of the investment committee meeting.”

The domestic equity division of the NPS was hit badly by the probe, because it supervises the exercise of voting rights over local shares. Further, many of those involved in the decision-making to vote for the Samsung units’ merger remain as senior managers in the division.

Q: What is the focus of prosecutors’ investigation?                                                      

A: △whether the Samsung Group illegally lobbied the presidential Blue House to win support for the proposed merger, △ whether the presidential office exerted pressure on the NPS to vote for the merger, and △ whether the NPS cast a vote for the tie-up against its interests because of pressure from the presidential office.

Q: What fueled speculations about NPS’s implication in the scandal?

A: Personal relationships between former NPS executives and top government officials were behind market speculations that the presidential office might have pushed the NPS to support the merger.

Ex-CIO of the pension fund, Wan-sun Hong, is an alumnus of Kyung-hwan Choi who is close to President Park and served as finance minister until late last year.

Questions for Hong are why he met with Samsung Electronics Vice Chairman Jay Y. Lee as CIO, along with other senior NPS officials on July 7, 2015. The meeting was arranged just three days before the NPS held an internal committee meeting to determine its stance on the proposed merger, and 10 days ahead of a Samsung’s shareholder meeting to vote on the tie-up. There was no meeting between Hong and Elliot Associates ahead of the merger.

Another question for NPS is why its decision to approve the merger was made by its internal committee, not through a voting committee under the welfare ministry. By contrast, the NPS’s decision earlier in the year to approve a tie-up between two units of the SK Group was made at the welfare ministry’s voting committee.

Q: What was at issue over the Samsung-Cheil merger?

A: The 1:0.35 merger ratio, under which 0.35 Cheil Industries share is exchanged for every Samsung C&T share, was seen as detrimental to Samsung C&T shareholders’ value by many analysts. Since rumors on the merger circulated early last year, Samsung C&T shares had declined, while Cheil shares advanced.

For the Samsung family that had more shares in Cheil than those of Samsung C&T, higher valuations of Cheil would help it secure more shares in the combined entity.

New York-based hedge fund Elliot Associates LP, then No.2 shareholder with a 7.12% stake in Samsung C&T, raised issues about the timing of the tie-up decision. It argued that it was unfair to combine the two companies at a time when Samsung C&T shares were significantly undervalued compared with its intrinsic value, whereas Cheil Industries were overvalued. (See Elliot's presentation)

The market value of Samsung C&T was 8.1 trillion won ($6.9 billion) around the time when the company announced a decision to absorb Cheil on May 26, 2015. It is far below Samsung C&T’s net asset value of 13.7 trillion won including its shares in subsidiaries. By contrast, Cheil Industries’ market cap of 19 trillion won was more than a double its net asset value of 8.7 trillion won.

Second, Elliot argued that the expected merger synergies the Samsung executives had suggested were “highly speculative and unsupportable.” Samsung had forecast that the combined entity would earn 4 trillion won in operating profit on sales of 60 trillion won by 2020. The U.S. hedge fund refuted it, saying the forecast is just “blue-sky projection” and should they fail to reach the target, Samsung C&T shareholders’ value will be significantly diluted.

Q: Background of the merger?

A: Samsung Group had planned to combine Cheil Industries and Samsung C&T to make the merged entity a de-facto holding company.

Samsung C&T, which owned a 4.1% stake in Samsung Electronics Co. Ltd, is at the center of the cobweb-like ownership structure of the Samsung Group. A control of the trading and construction unit would lead to a greater control of its crown jewel Samsung Electronics, and eventually a smooth transfer of leadership to junior Lee, son of ailing Samsung Chairman Lee Kun-hee. Because of the high share price of the world’s biggest smartphone maker, the Lee family had found it difficult to increase its shareholding in Samsung Electronics in the market.

Junior Lee and his family had a mere 1.6% stake in Samsung C&T, far less than their 43.5% stake in Cheil. After the merger of the two Samsung units, junior Lee and his family has secured a 39.9% stake in the combined firm.

Q: Rationale behind the merger ratio?

A: The 1:0.35 ratio was set in accordance with the country’s capital market act: a merger ratio should be based on the arithmetic mean of △ the average closing share price of the last one month, △ the average closing price of the last one week and △ the closing price the day before a board meeting.

(Ironically, the rule was introduced with an aim to stamp out the practice of South Korean family-run conglomerates to set merger ratios in favor of their family members.)

Q: What happened at NPS committee meeting and Samsung shareholder meeting in July 2015?

A: At the NPS’ committee meeting on July 10, 2015, eight of the 12 committee members voted in favor of the merger.

At the July 17 shareholder meeting of Samsung C&T, 83.57% of shareholders turned up: Samsung won 69.53% of the votes, which represented 13.81% more votes than the 55.71% (two thirds of those present) it needed to win to push ahead with the merger. But if NPS had decided to veto the merger, it seemed highly likely that many other institutional investors might have followed suit.

Q: NPS’ response to the allegations?

A: NPS said that although the 1:0.35 merger ratio was disadvantageous for Samsung C&T shareholders, it was set legitimately in accordance with the Capital Market Act. “Considering that we had shares of Samsung C&T and Cheil Industries in similar quantities and their weight in domestic stock portfolio, we concluded that expected benefits from the merger would offset the disadvantageous merger ratio, so we reached a final decision of “approval,” NPS said in a statement on Nov. 23. For Cheil shareholders, advisory firm ISS recommended they vote in favor of the merger.

Before the merger, NPS’ stakes in Samsung C&T and Cheil were valued at 1.22 trillion won and 1.18 trillion won, respectively.

NPS also had taken into consideration the share value of Samsung BioLogics held by Cheil. According to the minutes of an NPS meeting released to media recently, NPS put the value of Samsung BioLogics at 6.6 trillion won, in line with estimates of South Korean brokerage companies.

Considering that Cheil owned 46.3% of Samsung BioLogics, its shareholding was worth about 3 trillion won. It compared with the 2.02 trillion won estimated by ISS which had put the shareholding value at 1.5 trillion won previously.

Currently, Samsung BioLogics, listed on the Korean stock market on Nov. 10, 2016, has a market cap of 10.4 trillion won. Cheil’s shares in the biotech company are now worth 4.8 trillion won. Before the merger, Samsung C&T owned a 4.9% stake in the drug-making unit.

Separately, ex-CIO Hong told reporters that NPS refers to the welfare ministry’s voting committee only for matters on which its internal committee finds it difficult to reach an agreement, and the meeting with Samsung’s Lee in July 2015 was a normal procedure as a major shareholder.

NPS Chairman Moon denied involvement in the merger process.

Q: What’s next?

A: A special prosecutor is likely to be appointed soon to take over the investigations into the political scandal.

Samsung’s Jay Lee was summoned to a parliamentary hearing due on Dec. 6 as a witness, together with eight other top conglomerates’ chairmen. According to media reports, NPS chairman Moon, ex-CIO Hong and other NPS officials may be called to the hearing next month.

By Chang Jae Yoo

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