The Coming Week in Asia: Mayday at the Hyundai Group

HONG KONG -- Next week may shed more light on what is turning into one of Asia's all-time great corporate and family sagas: the revolt by son against father at South Korea's largest conglomerate, the Hyundai Group. But beyond the boardroom soap opera, the Hyundai story is about the improvement of corporate governance in Korea.

Credit Suisse First Boston said late Friday of the Hyundai story that "we expect this to dominate trading next week in Korea." Over the past two weeks, "the decline because of the Hyundai worries was more than 150 points on the Kospi index, and only half of that has been made back," CSFB added.

At issue within Hyundai is the question of family control. When in May two of the conglomerate's subsidiaries didn't get their debt rolled over by their biggest creditor, Korea Exchange Bank, the market trembled, afraid of a repeat of the 1997 financial crisis when ballooning debts in Korea threatened the entire financial system.

Instead, crisis has been averted for now. In exchange for more credit and a restructuring plan, founder Chung Ju Yung rocked Korea by saying this week that he and his two sons would resign from their positions within Hyundai.

That was fine with younger son, Chung Mong Hun, but not with his older brother, whom the younger Chung had overthrown in March as successor to their father. The eldest son in the family, Chung Mong Koo, refused to step down from his position at head of Hyundai Motor, and confusion reigned.

The big issue: Will Hyundai continue to be ruled by squabbling relatives or get the professional management the market thinks it needs?

"We are at a watershed mark for Korea today and it is make-or-break time: Either companies pay attention to shareholders or the equity market as a viable source of long-term capital will dry up and long-term growth will disappear for corporate Korea," wrote Jardine Fleming's Korea analyst Eugene Chung in his Friday morning note.

The problem with Hyundai is that, like other large Korean conglomerates, known as chaebol, it has far too much debt. While Hyundai has lowered its debt-to-equity ratio from more than 400% before the financial crisis to less than 200% today, it's done it not through asset sales and debt repayment, but rather by raising mountains of equity.

When the stock market was booming, that worked fine. Today, there is hardly a foreign investor interested in Hyundai companies -- even the sound and profitable ones. Because Korea's financial sector is still in need of billions of dollars to recapitalize after decades of unprofitable, politically dictated lending, the country's companies are sorely dependent on raising equity capital if they are determined to hold on to their assets. Hence the power of Hyundai's bankers to wrest this week's stunning resignations from the Chung family.

Given that, according to Bigdough.com, no U.S. mutual fund owns any Hyundai group stock, why should Hyundai matter? The answer is that outside a few market darlings in Korea preferred by foreign investors, what is going on at Hyundai is emblematic of the pace of reform, nation-wide, in the world's 11th-largest economy.

"We seem to have encountered a degree of inertia with regard to the furthering and deepening of the financial reform agenda," said Ray Jovanovich, institutional portfolio manager at Indocam Asset Management in Hong Kong. Add in the fact that Korea is again running a current account deficit and that interest rates are rising in an already very tight credit market, and you have the ingredients of further troubles on the equity markets.

What the markets want to see is a halt to the age-old practice of cross-subsidies among chaebol companies, in which good companies bail out lousy ones. At Hyundai Marine, for instance, analyst Brook Vinicchayakul at UBS Warburg said this week that the level of corporate governance is "worse than we previously anticipated. The company continues to make unsound equity investments, via cash injections, in sister companies." UBS has no underwriting relationship with the company.

Now, the Hyundai group is promising to sell more than 3.7 trillion won ($3 billion) in assets and trim investment by $2 billion, to try to reduce liabilities of more than $50 billion. It sounds good, but so did the announcement that the three Chungs were stepping down.

If one of them is insisting on sticking around, the market may wonder how much to trust the plans for asset sales.