[Intl-tobacco] Going Public: Korea KT&G gets ready for privatization. (fwd)

[Robert Weissman]

Going Public: Korea KT&G gets ready for privatization.
by Clive Turner  =20
Source: Tobacco Reporter, Saturday, 1/8/00

Korea, =93Land of the Morning Calm.=94 Well, it might be peaceful atop the
mountains and out in the beautiful countryside, but in Seoul? Flashing
cinematic posters astride tall buildings; salarymen sloshing and scurrying
through the pavement puddles from five in the morning; a ceaseless flow of
speeding traffic and hotel lobbies full of businesspeople glued to their
mobile phones, even at the breakfast table. Morning Calm? I don=92t think
so!

But calm and order was certainly the environment I experienced when
talking with Ahn Chung-Ho, executive vice president of Korea Tobacco and
Ginseng Corporation (KT&G). Precisely on time he welcomed me, with an
interpreter and an aide in a spacious office befitting a man whose
responsibility is overseeing the KT&G=92s emerging privatization.

Much speculation has surrounded this highly significant move, but within
minutes it was obvious that for KT&G, the issue is considered clear-cut
and eminently sensible. KT&G is confident it will succeed.

The privatization is now completed in legal terms. It=92s been planned over
the past two years with the intention of selling 35 percent of the
government=92s ownership to private investors, including large institutiona=
l
buyers. The sale is expected to take place before the end of the year,
but, by the end of June, no price had been determined, and the lead
investment bank management had not yet been announced. The listing will
appear in September.

Ahn explained that between 15 and 20 percent of the shares are expected to
be sold domestically, with the balance later going internationally,
raising between us$500 million and $600 million in depository receipts.
=93The take up,=94 he said, =93will be quick and widely welcomed given the =
price
is acceptable.=94

A SOLID FUNDAMENT.

KT&G, founded in 1899 as a small ginseng management division under the
control of King Kojong, has a remarkably healthy, if not enviable,
financial status. Cigarette production actually began in 1921, and today
the company enjoys a very low debt-to-equity ratio and ample cash flow.
This has seen to it that the state-owned KT&G was a top candidate for
foreign investment and privatization among state companies.

KT&G=92s track record speaks for itself. In 1998 the company posted more
than $255 million in net income, a 35 percent increase over 1997. This was
on sales of $4 billion. Even with the difficult economic times, tobacco
sales, which represent by far the majority of the corporation=92s income,
rose to $3.9 billion in 1998 from $3.42 billion in 1997.

At the end of last year KT&G=92s debt-to-equity ratio stood at 24.8 percent=
,
a fraction of what is common among other major Korean companies. The
company had a liquidity ratio of more than 500 percent, or four and a half
times more cash flow than Korea=92s largest electronics company.

The Korean cigarette market has been open to foreign competition for a
decade, but KT&G has retained 95.1 percent of the market through 1998.
Philip Morris came in second last year with a market share of 2.3 percent
compared with 6.9 percent in 1997 when KT&G slipped to 88.8 percent.

Consumer preferences for foreign brands had been steadily growing at the
expense of domestic brands. But then during the economic downturn,
consumers shifted to domestic products because the foreign brand retail
prices leaped due to the weak currency.

However, many observers predict that foreign brands will gain ground once
more when Korea=92s economy strengthens. =93Well, we shall see,=94 says Ahn=
=2E

STREAMLINING OPERATIONS.

KT&G=92s 1998 performance was due not only to economic factors. It saw to i=
t
that the company maintained relatively low cigarette manufacturing costs
through reducing the size of its production and management structure.
During the economic crisis, KT&G trimmed its work force from almost 8,000
to 6,000 and plans to have only 4,500 workers by the year 2000. Also, some
new machines will cut back the number of factories from eight to four or
five. If new production is needed, then the present one-shift arrangement
would be increased to two shifts. Depending on what happens ahead, a new
factory might be in the cards, but the decision about when and where will
not be made until next year.

Meanwhile, any cutbacks and redundancies required which are not met by
natural attrition will be largely paid for by financial resources becoming
available through in- creased production. And, said Ahn, =93I can assure yo=
u
that proper and reasonable compensation will be paid to those who have to
go because of company requirements.=94 He mentioned that one advantage of
such a situation will be to bring through and give more responsibility to
younger people.

An abiding KT&G strength has been its well-established distribution
network. As of 1998, it operates 159 regional offices and more than
165,000 retail outlets around the country.

This means that personal relationships be- tween distributors and store
owners have been formed over many years and are virtually impossible to
compete with on any kind of level playing field by even the best organized
international operation.

NATIONAL PRIDE.

This situation is compounded by the fact that the industry in Korea has
always been advantaged by the unusually strong nationalistic character of
Korean people. It has been seen as unpatriotic to buy foreign brands (of
any product category) when the economy demanded sacrifice and support of
domestic brands and products.

In the early 1990s there were instances of international tobacco company
points-of-sale and advertising material being torn down by nationalistic
activists=97by patriotic smokers who demonstrated a very marked dislike for
products they felt were hurting the domestic economy. Ahn recalled those
outbursts with displeasure and said that KT&G did what it could at the
time to discourage such behavior.

=93It should be explained,=94 said Ahn, =93that our farmers, particularly
tobacco farmers, are highly thought of by the community at large. It is
felt they do a hard job well in difficult circumstances, and enjoy meager
rewards. People feel they deserve support against what is perceived as
wealthy and intrusive foreign interests.=94 KT&G has contracts with no less
than 34,000 tobacco farmers, and the size of landholding is not a
discriminatory issue. All tobacco production is purchased and farmers are
partially paid in advance. Technical help is also available and freely
given to improve quality.

Some 9,000 to 10,000 farmers are wholly dependent on tobacco with the
larger balance growing other crops or working on a part-time basis. They
provide 15 percent of the country=92s GDP.

STRENGTHENING ITS PORTFOLIO.

Ahn said many changes had taken place over the years, with a rather
dramatic rationalization of brands in particular. =93At one time,=94 he sai=
d,
=93we marketed 123 brands, but today the figure is 30. In 1946 we produced
103 million packs. Last year it was 5.1 billion packs, with the leading
brand name being =91THIS=92.=94 Asked about the significance of such an unu=
sual
brand name, Ahn replied that it simply reflected a trend, like =9388=94 whi=
ch
came out at the time of the Olympics in Seoul and which proved a great
success.

=93THIS=94 means just what it says. =93Everyone knows the word and it took =
off.
It became a best seller in record time.=94 Other brand names reflect
traditional Korean names like =93Arirang.=94 One brand was named =93Seung R=
i=94
which means victory, and was launched immediately after independence in
1945. Another was =93Saemaeul=94 or =93new village,=94 which was a catch ph=
rase
for the government=92s modernization program in the 1960s.

I asked about North Korea and whether there was any industry cooperation
between North and South. =93Not really,=94 said Ahn. =93They have their own
operation and although the respective governments talk to each other when
appropriate, tobacco contacts North and South are inactive.=94

So what about the future after privatization?

Ahn would not be drawn to speculate other than to agree that one or more
of the major international companies would likely buy some shareholding
because they would regard it as the best way now to get some leverage
within the market. But since no shareholding can exceed 7 percent, we are
not going to see a phalanx of Philip Morris battalions moving in. JT, BAT
or anyone else, won=92t exactly send in the cavalry, either.

THE OUTLOOK.

This privatization has been very carefully planned and orchestrated. Korea
is not about to give up its domestic market to foreign competition even if
that foreign competition offers the earth, the moon and the stars in terms
of brand status, quality and desirability. But as the economy lifts, the
foreigners will make further incursion one way or another and
privatization may well be a spur, an opportunity, and a means to gain the
crucial distribution that makes the difference between success=97and a long=
,
painful, expensive and ultimately wasteful haul.

Ahn=92s fingers are not crossed=97they don=92t need to be. His elegant, gen=
tle
style, his company=92s obviously immaculate planning, and his air of quiet
confidence exhibit no concern that privatization will unduly damage the
domestic operation.

He sees the move as entirely sensible, profitable, probably offering the
consumer increased choice, and attracting widespread positive nodding of
heads throughout the industry worldwide. -TR