South Korea takes aim at zombie companies

South Korea is bracing for a wave of tough corporate restructuring as the government finally gets serious about targeting zombie companies, alarmed by slowing economic growth and ballooning losses in major export industries.

The problem of companies that fail to service debt with income and instead stay afloat on cheap state loans has long plagued South Korea, but the need to address the issue has become urgent in the face of intensifying competition from lower-cost China and cash-rich Japan.

Exports from the north Asian country dropped 15.8 per cent in October, their 10th straight month of decline and the sharpest fall in more than six years, sideswiped by the economic slowdown in China, South Korea’s biggest export market.

Signs of stress were further highlighted by the Won3.8tn ($3.2bn) of net losses racked up this year by Daewoo Shipbuilding and Marine Engineering, the world’s largest shipbuilder by orderbook. Those losses were particularly egregious but not unique: other industrial groups including Samsung Engineering and steelmaker Posco have also fallen into the red.

“There are not many Korean companies that are actually making money,” says Kim Sang-jo, economics professor at Hansung University. “The mounting losses at the so-called zombie companies are threatening the country’s economic stability.”

The country is one of a handful where corporate debt has continued to pile up since the 2008-09 global financial crisis, even as most other developed economies have deleveraged.

Generous government subsidies have kept ailing companies in business as Seoul has delayed restructuring, fearful of denting economic growth and of the potential job losses. The number of companies unable to cover interest expenses with operating profits for three years rose last year to 15.2 per cent, from 12.8 per cent in 2009, according to the Bank of Korea.

“Distress levels which were once concentrated on certain industries have now dispersed across all industries in Korea,” says Yung Chug, managing director at AlixPartners. The business advisory firm estimates that 11 per cent of South Korean companies have “high risk” distress levels, compared with 2 per cent in Japan, 4 per cent for Europe, Middle East and Africa, and 7 per cent for the US.

Spooked by the huge Won6.3tn in combined net losses this year at the country's top three shipbuilders, the government is finalising a roadmap for consolidation in industries also including steel, shipping and petrochemicals. It has set up the country’s first restructuring firm, backed by eight state and private lenders, to overhaul debt-laden companies.

In addition, regulators are pressuring creditor banks to tighten screening of corporate loans, and have earmarked 175 small and mid-sized companies to be liquidated or placed under the creditor-led debt-workout programme.

With the Federal Reserve expected to raise US interest rates as soon as next month, many troubled South Korean companies sustained by low interest rates will come under pressure from higher financing costs.

At Seoul’s urging, state-run policy lender Korea Development Bank is looking to sell off 91 of its 118 non-financial units — acquired through serial bailouts — within three years.

Corporate Korea “is full of examples of companies where repeated capital aid was used but ultimately never succeeded and lost value,” says Mr Chung.

Some industry officials are sceptical about the government’s commitment to the restructuring push, pointing to KDB’s recent decision to provide a Won4.2tn lifeline to Daewoo Shipbuilding — whose debt-to-equity ratio was 650 per cent as of end-June versus an average of 123 per cent for Kospi-listed companies. There are also doubts over how aggressive it will be ahead of parliamentary elections in April.

Nevertheless, the drive is significant as the previous administration, preoccupied with economic growth, did not prioritise corporate restructuring.

There are some signs Korea Inc is responding. Samsung sold its chemical and defence units to Lotte and Hanwha to focus on more competitive areas, and Posco is offloading non-core businesses. But many second-tier chaebol companies accustomed to reckless expansion remain reluctant to sell their loss-making businesses.

Those “chaebol should change their mindset. They need to increase their operating leverage through consolidation,” says Michael Na, strategist at Nomura. “Without economies of scale, those in the old economy will increasingly find it difficult to survive.”

Barriers exist even for those willing to downsize. With the country’s feisty labour unions up in arms over anticipated job losses, Samsung was forced to offer big payouts to striking workers to push through the chemical units sale. There is also simmering labour unrest in the shipbuilding sector, where some 10,000 workers are expected to be laid off over the next three years.

“Restructuring will inevitably accompany short-term social and economic costs,” says Mr Kim. “But the Korean economy would face a bigger crisis if it delays corporate restructuring.”