The sale of Korea Aerospace Industries (KAI), which is expected to accelerate next month, could prove a need for clearer M&A guidelines and regulatory standards in the defense industry as there are many points where the government can step in and slow the progress, sources and lawyers said.
KAI is considered the largest defense company to be sold through a public auction. Once the fiscal year 2011 annual report is released next month, a financial advisor is likely to be hired and the sale process will begin in earnest, a deal source said.
The scope and timing of government intervention in the KAI sale is not clear and could potentially stretch the timetable as well as affect bidding strategies, sources following the deal said. Deals involving defense makers usually receive approval within one to two months, but the KAI sale could take longer, lawyers said.
The standard review period is 15 days and allows another 15 days for an extension.
More specific sale guidelines could help the sale process and encourage consolidation in Korea’s defense sector as a whole, some felt.
The National Defense Industry Law Article 35 says the Ministry of Knowledge and Economy (MKE) must approve any change in the control of Korean defense companies. The Foreign Investment Promotion Law also requires approval by the MKE whenever a foreign investor acquires more than a 10% stake in a defense company that represents a minimum 100 million won investment.
However, these regulations are “abstract” for M&A practices, and involve a large amount of room for government judgment, Kim Ki-Young, partner at law firm Yulchon, said.
Potential bidders will have to pass a national security test but since the defense sector is not a perfectly competitive market, antitrust will not be a major issue. The financial capacity to run operations and produce products on time will also be a key factor, the lawyers pointed out.
In the event of consortium bids between foreign and domestic bidders, the foreign investors would have to hedge the political risk before joining a bid, Shin Hyun-Sik, partner at law firm Shin & Kim, said.
Complicating things more is an official regulatory filing requirement after the signing of an agreement with a nominated buyer but a “mutual consensus” between the seller and the government from national security prospective as required by the relevant laws would be needed before selecting a preferred bidder, Shin at Shin & Kim said.
Daewoo Heavy Industries and Daewoo International have already been sold through a public auction process, but they were only partially focused on the defense industry and sold to domestic buyers designated as national defense product suppliers. So they may provide limited scope for guidance, Shin added.
An official at the MKE agreed more specific guidelines could be required to proceed with the KAI sale but the establishment of new regulations was unlikely. Discussions around additional guidelines, however, could take place during the process, he said.
Shareholders have recognized the importance of the government’s role, and have already reached out to the relevant authorities, the deal source said.
KAI’s largest shareholder is state-owned Korea Finance Corporation with a 26.75 percent stake while Samsung Techwin , Hyundai Motor and Doosan Group each holds a 10 percent stake. KAI supplies a whole range of aviation weaponry to the Korean armed forces but 30 percent of its business comprises private airplanes.
Hyundai Motor, Samsung Techwin, and Hanjin Group and Boeing have repeatedly been reported as potential bidders.
Korean defense makers expect to obtain a stable, high-tech component supply chain and opportunities to join overseas projects by brining foreign strategic investors, according to a Seoul-based sector analyst.
In addition to the attractiveness of Korean’s growing defense sector, KAI’s technologies add value despite a high 30x price/earnings ratio, the analyst said.
The South Korea government has raised the 2012 defense budget to 32.95 trillion won from 31.3 trillion won in 2011, accounting for 10 percent of the entire national budget.
“Acquiring KAI is like investing in an automotive business in the 70s, we don’t know exactly how the potential value will grow further,” the analyst noted.
KAI expects to record annual sales revenues of 1.2 trillion won, the highest figure among Korean defense makers, with an operating income margin ratio of 8 percent. The annual capex is 150 billion won, the analyst said.
KAI has a market capitalisation of 3.2 trillon won.
by mergermarket reporter Kate Kim in Seoul
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