Heard in Asia: Korea Tobacco Is Solid, But Pros Aren't Swayed (fwd)

[Robert Weissman <rob@essential.org>]

Heard in Asia: Korea Tobacco Is Solid, But Pros Aren't Swayed
by JASON BOOTH / Staff Reporter of THE WALL STREET JOURNAL
Source: The Wall Street Journal Interactive Edition, Thursday, 9/30/99


When Korea Tobacco & Ginseng lists its shares next week, it will be the
eighth-biggest company on the Korean stock exchange with a near-monopoly
in the domestic cigarette market, one of the world's largest.

Some other attractions: It will be the only major, publicly-traded Korean
company that is free of debt; it's already a hit with local investors who,
according to the underwriters, oversubscribed by a ratio of 57 to 1 for
the 15% stake offered. Trading in the shares begins Oct. 8.

Yet overseas fund managers say they will be hesitant to invest until the
government, which owns 99% of Korea Tobacco -- either directly or through
state-run banks -- makes it easier for the company to raise prices and
import tobacco.

Price Factor

"Unless we get better transparency on prices and the arrangement with
farmers, I don't think people will be paying a premium for this stock,"
says Alfred Ho, fund manager at Invesco Asia in Hong Kong. "At its current
level, we will not be participating in a big way."

The 15% stake was sold at 28,000 won ($23.02) a share. "Under the current
earnings structure, we think the company is fairly valued at 26,000 to
27,000 won," says Y. Jinnie Lee, who covers Korea Tobacco for Samsung
Securities, one of two firms underwriting the initial public offering. Ms.
Lee says the stock likely will rally after it starts trading and "then
will look for its fair value."

The government plans to sell a further 10% to 15% stake to international
investors by the end of the year in the form of depositary receipts, the
company says. But foreign interest could wane if the stock takes off in
the first several weeks after its listing. In fact, according to the
underwriters, the stock has been quoted at more than 50,000 won per share
on the gray market, where stocks are informally traded before their formal
listing.

"The list price is attractive given that they still have a monopoly," says
Adrian Fu, fund manager at Investec GF Asia in Hong Kong. But if the stock
price rises to 40,000 won before the depositary-receipt issue, the
government will have to find another way to attract interest, such as
relaxing cigarette-price restrictions or raising the limit on foreign
investment, he says. The government is expected to raise the current 5%
limit on foreign ownership.

Political Pressure

What also bothers many foreign fund managers is that the company's bottom
line often is influenced as much by politics as by economics. Korea
Tobacco must get government approval before it can raise its cigarette
prices. Although Seoul has indicated it will allow prices to rise to help
keep the company profitable as the local cigarette market opens wider to
foreign competition, analysts predict the government could reverse its
stance under political pressure.

"One way the government controls inflation is to maintain low prices for
high-demand items, such as cigarettes," says Henry Morris, director of
Industrial Research and Consulting in Seoul. "So the company's earnings
stream may be dictated by the government."

Analysts say the ability to raise prices is crucial to Korea Tobacco's
profitability, because while South Koreans smoke about 100 billion
cigarettes a year, that figure is expected to remain stable or decline in
the coming years. South Korea is the company's primary market, although
former Soviet republics such as Kazakstan have become export markets.

The company is also weighed down by other restrictions in the national
interest: Korea Tobacco is required to buy Korea's entire tobacco crop
each year, even though local tobacco tends to be higher in price and lower
in quality than imports. But it would require a vote by the National
Assembly to change the policy. While farmers make up only a small portion
of Korea's population, Mr. Morris notes that they wield a good deal of
political clout and garner widespread public sympathy. The policy isn't
expected to change in the foreseeable future.

Both Korea Tobacco and government officials declined to comment, citing
the quiet period imposed before the company's listing.

Size Does Matter

To be sure, there's bound to be foreign interest in the stock simply
because of its size, fund managers and analysts say. Because it is one of
Korea's 10 largest companies, many foreign fund managers who want to track
the benchmark stock index will be obliged to buy some of IPO shares.

And while Korea Tobacco isn't seen as a growth company, its size, net cash
position and domestic market share of more 90% might make it a safe
investment in an otherwise volatile market. Indeed, the company saw an 11%
increase in earnings per share in 1998 when Korea was in the middle of a
deep recession. The strong performance was due to increased sales as
smokers switched from imported cigarettes to cheaper local brands. At the
same time, rising interest rates allowed Korea Tobacco to earn more money
from its large cash hoard.

But being large and safe won't justify paying a premium for Korea Tobacco
over other tobacco companies in Asia, fund managers say. At 28,000 won a
share, the company carries a price-earnings ratio of 21 for the year,
according to forecasts by Samsung Securities. If the stock does surge to
50,000 won, the P-E ratio will rise to nearly 40. That compares with an
average P-E of around 17 for publicly traded Asian tobacco companies,
Samsung Securities estimates.

Write to Jason Booth at jason.booth@wsj.com1

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