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So, is Lone Star Ever Going to Make Any Money Off KEB?

If you haven’t heard the news, Korean financial regulators have “ordered” Lone Star to sell their remaining stake in Korea Exchange Bank to Hana Financial Group within 6 months.  So, the WSJ’s Evan Ramstad in his Korea Realtime blog asks if Lone Star is ever going to make any money.  Well Evan they are.

According to Evan, Lone Star has already made $3.3 billion in dividends.  So, let’s analyze that briefly.  Back in 2003, Lone Star originally put in a $2.5 billion investment into Korea Exchange Bank.  Since 2003, Lone Star has sold small pieces of the business and taken dividends that total about  $3.3 billion.  Hana Bank’s current offer on the table is $3.9 billion, thus if you add what Lone Star has already made, and add Hana’s offer, then that would equal to about $7.2 billion total.  Subtract the $2.5 billion invested back in 2003 and that comes out to about $4.7 billion in net returns.  So what is that in investment banker talk?  Assuming that Evan’s cash flow numbers are correct, an incremental ascending order of dividend payments over the past 7 years, and “J-Curve” return principles, then that would be an estimated internal rate of return (“IRR“) of about 21%.  Not bad.  Not great, but not bad as most U.S. private equity firms consider 20% a “good” IRR.

It could have been better.  In 2007 HSBC offered Lone Star $6 billion and that may have been as estimated IRR of perhaps 35-40%, which of course, would have been a lot better.  Any ways, here’s hoping this messy seven year drama in Korea’s foreign investment history be put to bed and be over with soon.

  • Wedge

    Lone Star: Proving that no good deed goes unpunished since 2003.

  • Andrew

    “KEB suffered heavily from the late 1990s financial crisis and even saw its insolvency ratio exceed the limit. The Korean government, which was the majority shareholder at the time, was having trouble finding a bidder, foreign or at home. Particularly, many of the local financial firms were up to their neck in their own problems and the Korean government had to look abroad.

    Lone Star, though, was not a financial institution but a private equity fund, and was the only bidder that showed an interest in buying KEB.”

    http://koreajoongangdaily.joinsmsn.com/news/article/html/358/2944358.html

    Without Lonestar, KEB wouldn’t exist!

  • ecorn

    The government’s order to sell the remaining shares within six months gives Lone Star a shitty negotiating position. While I’m sure there are some safeguards, essentially they have to take whatever Hana offers. How long is that $3.9 billion offer valid? Can Hana retract it and come back with an offer of $2.9 billion instead?

  • http://www.busanhaps.com Bobby McGill

    I don’t know…having a major influx of outside cash coming in, the complete reorganization of a flawed business model and then the driving of that business into profitability should be applauded. Not to mention all the jobs created, more credit options and a wider range of services.

    If they want to sell, they’ve earned that right —in a market guided by basic contract law and not public sentiment, of course.

  • http://www.xanga.com/wangkon936 WangKon936

    ecorn,

    Sad but true. What the regulators have wrought will give Hana a lot of leverage to ask for a haircut. Expect the IRR to dip below what’s projected.

  • http://adamsawry.wordpress.com Adams-awry

    AFAIK, Lone Star recently took out massive loans from Hana Bank, using their KEB stake as collateral. If Hana Financial try to lower the price, Lone Star could simply default on repayment. So, IMO, they have lost none of their bargaining power. Thoughts WangKon?

  • Koreansentry

    Comment deleted by moderator. Off topic or inappropriate comment.

  • http://www.xanga.com/wangkon936 WangKon936

    Adams-awry,

    The threat, by a private equity firm, to just default on repayment of loans is not a very credible one IMHO. The main reason is that PE firms need to maintain good relations with banks because 50 to 70% of the funds they use to buy companies comes from some form of debt financing. Establish a bad relationship with your lenders and it gets much harder to raise debt. In an industry as small as PE (and lenders to PE) one tends to run into each other quite often. A PE wants the banks to be their friends, not their enemies.

    I believe Lone Star gave Hana preferential treatment in bidding on KEB, and if true, one is inclined to believe that Hana will not abuse their position. Hana will ask for a haircut, but I’d be surprised if it’s a huge discount. I wouldn’t expect $3.9 B to be recut to say $2B, for example. A recut deal for perhaps $3.6 to $3.2 is more likely IMHO.

  • trebor

    Wangkon, didn’t Lone Star pay 1.3bn for its stake in KEB? How does that change your calculation?

    I would also deduct costs – legal bills. And that’s not over yet.

    The next issue is going to be tax. In order to follow through on its threat to tax whatever Lone Star makes from the sale, the government is going to have to violate its double taxation agreement with Belgium. I reckon they’ll take the tax and Lone Star will sue and eventually get it back.

  • hamel

    The threat, by a private equity firm, to just default on repayment of loans is not a very credible one IMHO. The main reason is that PE firms need to maintain good relations with banks because 50 to 70% of the funds they use to buy companies comes from some form of debt financing. Establish a bad relationship with your lenders and it gets much harder to raise debt.

    True, IF you believe you will do business with them again (multi-iteration game theory). But if you think this is a one shot deal, and you plan to get out of the country and never deal with that bank again (single iteration game theory), it is feasible.

    On a small scale, think of all the Korean companies and banks who won’t issue credit cards or cell phone contracts to foreigners based on the assumption, which unfortunately sometimes works out to be not unfounded, that sad foreigner will one day leave the country with a big phone/credit card bill and not repay it. (Of course, Koreans can do this trick too, but in the case of foreigners, our credit rating back home does not suffer, whereas Koreans either cannot come back, or need to stay away until their debts are forgotten or forgiven.)

  • dogbertt

    The main reason is that PE firms need to maintain good relations with banks because 50 to 70% of the funds they use to buy companies comes from some form of debt financing. Establish a bad relationship with your lenders and it gets much harder to raise debt. In an industry as small as PE (and lenders to PE) one tends to run into each other quite often. A PE wants the banks to be their friends, not their enemies.

    This is quite true, and not only for lending, but for all the many other services they need banks for.

    @hamel: The banks Lone Star are working with are not banks that only operate within Korea. Even if that were true, it would not be feasible, because if Bank A sees you are willing to fsck over Bank B, Bank A will think twice about dealing with you.

  • http://www.bcarr.com Brendon Carr

    There is also the possibility that Hana and Lone Star have colluded to arrange a “sale” of the KEB shares even though such sale was not permitted at the time of their deal. The loan may be a convenient cover for a non-permitted payment. In other words, Hana may have extended the loan on the explicit understanding that Lone Star would “default”.

  • hamel

    @ dogbertt:

    The banks Lone Star are working with are not banks that only operate within Korea. Even if that were true, it would not be feasible, because if Bank A sees you are willing to fsck over Bank B, Bank A will think twice about dealing with you.

    Thank you for pointing that out. Honest question, do things in the real world really work out that way? Do companies never burn their bridges with one bank and just move to another bank, but maybe at a higher interest rate and higher collateral?

    @ brendon carr: now that IS interesting. But if that is the case, and they do default (as per a secret agreement), wouldn’t this wreck their credit with other banks, as Dogbertt argues?

  • dogbertt

    @hamel: Never, not once, no, in my experience. For any one of a number of reasons — here are the two that first come to mind:

    – Most companies of any size rarely deal with only one bank for their banking needs. If they purposely screw one bank on a transaction, that may well cause a cross-default in their transactions with other banks, which would cause great harm to the company.

    – If a company screws over a bank by refusing to perform its obligations for basically any reason other than insolvency, the bank can and will retaliate legally to get what it’s owed and then some. This is what would happen to Lone Star if it screwed a Korean bank in your example, because unlike KT, which would not go to the time and expense to pursue a midnight runner English teacher over a $1000 unpaid phone bill, a Korean bank most certainly could and would spend the time and money to pursue Lone Star, in the U.S. if need be. That said, my strong _assumption_ is that Lone Star banks with banks that have a strong international presence and that it also engages in transactions with those banks other than those related to just its dealings with KEB.

    As an aside, the informal flow of information related to borrowers between commercial banks is quite robust

  • http://www.bcarr.com Brendon Carr

    But, dogbertt, surely you have heard of “limited recourse” or “non-recourse” loan agreements?

    The reason I think this is a possibility is that I’ve had personal experience working on loan agreements where it became pretty clear during the drafting that both the lender and the borrower had no intention of the loan being repaid, but instead must have intended that the collateral would be transferred in the event of a foreordained “default”.

  • dogbertt

    Yes, but that is different from the situation Hamel described.

  • hamel

    Yes, but that is different from the situation Hamel described.

    True. So if the lender agrees, for whatever reason, that the loan will not be repaid, is that enough to prevent the credit rating/reputation/whatever of the borrower from being adversely affected?

  • http://www.xanga.com/wangkon936 WangKon936

    “didn’t Lone Star pay 1.3bn for its stake in KEB? How does that change your calculation?"

    trebor,

    I’m using the numbers provided by Evan. It could mean that Evan is accounting for currency differences and fees. Don’t know. But if you are going to get some sort of consistency out of your calculations, you need to have consistency in your source of data.

    I’m not stamping a guarantee to my calcs. They are just estimates after all. Now if someone PAID me to analyze this and gave me detailed data, then I’d put some guarantee of accuracy behind my work.

  • http://www.xanga.com/wangkon936 WangKon936

    A few weeks ago I said,

    “I believe Lone Star gave Hana preferential treatment in bidding on KEB, and if true, one is inclined to believe that Hana will not abuse their position. Hana will ask for a haircut, but I’d be surprised if it’s a huge discount. I wouldn’t expect $3.9 B to be recut to say $2B, for example. A recut deal for perhaps $3.6 to $3.2 is more likely IMHO.”

    Then I read this:

    http://www.businessweek.com/news/2011-12-02/lone-star-set-to-reap-4-billion-after-cutting-korean-bank-price.html

    The recut deal is for $3.5 billion, well within my range of “$3.6 to 3.2B” that I had predicted.

  • Wedge

    Clap. Clap. Clap.

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