Kyobo Life: The mother of all puts
Put options amount to threats seldom acted upon. By demanding that the chairman of Korea’s third-largest life insurer buy back their shares, a group of investors has taken Asian PE into uncharted territory
If an investment has not gone according to plan; if performance targets have not been reached or a pre-agreed exit timeline has not been adhered to; if all other avenues to assert influence over a company’s operations have been exhausted – a PE firm might take the nuclear option and demand that the founder and majority shareholder buy back its shares.
These put options are not supposed to be exercised. They constitute leverage, a means of encouraging a founder to engineer a turnaround or push for an IPO. Some investors and advisors negotiate hundreds of downside protection clauses during their careers without ever enacting a put. On those occasions when one is required in Asia, the sums involved are usually relatively modest: the aim is to recoup a position amounting to tens of millions of dollars, not billions.
And then there’s Kyobo Life, where the nuclear option has been triggered with around KRW1.85 trillion ($1.6 billion) in equity on the line. This unprecedented situation features six investors – including a Canadian pension fund, a Singapore sovereign wealth fund, and two of the largest Asia-based GPs – that have waited up to 11 years for one of Korea’s big three life insurers to go public. Their patience exhausted, they want the company chairman to provide an exit.
“The chairman is like an ostrich with its head in the sand. He thinks he can get away with it by stalling and he is surrounded by yes men who don’t have the courage to tell him the truth,” says one investor in the company. “He should have gone public four years ago. He could do a trade sale today and leave with $2 billion. How could anyone say no to that and risk losing everything? Only a guy who has no sense of reality.”
Those involved are wary of speaking on the record, citing the fact that the situation is far from resolved. As it stands, Affinity Equity Partners, Baring Private Equity Asia, IMM Private Equity, GIC Private, Ontario Teachers’ Pension Plan (OTPP) and Standard Chartered Private Equity (SCPE) have exercised their puts against Chang-Jae Shin, the chairman who holds a 33.8% stake in Kyobo Life. Corsair Capital, the earliest PE investor in the company, has yet to reveal its intentions.
Downside protection is not uniform across the investor group. Shin is about to enter arbitration with Affinity, Baring, IMM and GIC over a requirement to buy back their shares at the cost of investment plus a certain return or at fair market value, whichever is higher, in the absence of an IPO. They came in at KRW245,000 per share and a Deloitte appraisal found they should be taken out at KRW409,000 per share, putting Shin on the hook for around KRW2 trillion. He disputes this assessment.
The process has been engulfed by rumor and intrigue. Investors claim much of it is misinformation circulated by associates of Shin who is looking for a way out but has yet to make any meaningful proposals. According to a Kyobo Life spokesperson, Shin stands by the exit scenarios he has already presented to investors and remains open to negotiation. The main sticking point is the put price, which he and Kyobo Life believe is unreasonable.
Shin is not the first controlling shareholder to rail against a put and a variety of stalling tactics might be employed in these situations. Sometimes there is genuine hope that it amounts to more than just delaying the inevitable. “If a company has failed to achieve an IPO in five years, there might be a strategic buyer in the background or a potential flip to another PE investor, which means everyone is in the money,” says Steven Tran, a partner at Mayer Brown.
But no one is comfortable making predictions about the outcome for Kyobo Life. It is a family business – founded by Shin’s father in 1958 – that has morphed into a behemoth with KRW101.5 trillion in assets. Playing for stakes this high, when will the chairman blink?
Belt and braces
Downside protection generally comes in the form of a redemption against the company or a put against the founder. Sometimes it is a combination of the two. For example, an investor might subscribe to redeemable convertible preference shares issued by the company – allowing it to recover its principal, convert into ordinary shares, and get preferential access to dividends or to cash on exit – and a standalone put against the founder. If the company runs out of money, there is still the option of targeting assets held by the founder.
An investor can take action for all manner of material breaches, from audit irregularities to falling short of performance targets. Failure to achieve an exit, typically an IPO, within an agreed timeframe is the most common. And the threat of the put tends to bring parties to the negotiating table. Marcia Ellis, a partner at Morrison & Foerster, can recall only two situations in more than 20 years where puts have been exercised. In both cases, the circumstances were unusual.
One involved the 100% sale of a company, and a shareholder enforced the put because the contractually agreed price for the buyback was superior to that of the acquisition. The other came about because the majority shareholder wanted the investor to exit ahead of a listing. The put was utilized out of structural convenience. A bridge loan was extended to the majority shareholder by the investor, which ensured there was enough capital available to satisfy the put, and it was secured against shares in a separate listed company owned by the same shareholder.
“More often, what happens is we say we are going to exercise the put, we prepare a statutory notice that we issue if they don’t pay up, we put all the documents in front of the counterparty, and then we have a negotiation,” Ellis says. “If they don’t have much money, the put isn’t going to help much. But you could end up doing a different deal with them. Sometimes you sit there with a white board, list their assets and liabilities, and think about how they could be arranged so they can pay you. The last thing the fund wants to do is take a write-down on the investment.”
Investors specializing in highly structured transactions that come with intricate downside protection concur with this view. One GP observes that exercising a put turns the situation into a zero-sum game, whereas the reality is always more nuanced. Other considerations include the founder’s relationships within the industry and whether taking the nuclear option would negatively impact an investor’s ability to secure deals in the future.
The context in which a put is secured can also be important. Where there is competition for a deal, the founder can insist on a redemption, keeping his personal assets out of reach. A put, therefore, tends to feature in transactions that lie beyond the mainstream, usually because there are imperfections or complications. In these situations, the put is often triggered when problems cannot be rectified – but going after the founder doesn’t necessarily result in an optimal outcome.
“I’ve come across scenarios where the investors don’t exercise against the founder because they know it would bankrupt him. If he controls the business through a holding vehicle, they could make that insolvent, but then the founder loses his stake. That’s not good for the company if it means he quits, and an IPO is postponed indefinitely. Investors might get some shares in the company, but they are worth less than before and they cannot get any cash back because no one is willing to buy those shares,” says Bryan Koo, a partner at Clifford Chance.
Kyobo Life does not fit this profile. Together with Samsung Life and Hanwha Life, the company accounts for nearly half of overall industry premiums. While Kyobo Life trails the other two in terms of assets and premiums, it has produced a superior return-on-equity (ROE) in recent years. Several insurers have started issuing more debt to boost their capital buffers ahead of the introduction of stricter capitalization and accounting standards. Kyobo Life’s size should be of benefit in this changing commercial landscape, especially if the reforms drive industry consolidation.
In short, there would be plenty of takers if the company became available. “Likely buyers for insurance companies include other insurers and financial groups that want to diversify their operations by incorporating an insurance arm,” says Siew Wai Wan, a senior director for insurance ratings at Fitch Ratings. The latter were out in force when Orange Life was put up for sale last year, with Shinhan Financial Group ultimately prevailing. KB Financial Group was also linked to the asset.
Misplaced faith
There was considerable interest among investors when Kyobo Life sought external funding in 2007. Korean regulators had just announced that local life insurers could pursue IPOs, so the path to liquidity seemed clear. Corsair secured a 9.75% stake for KRW281 billion and then Standard Chartered paid $230 million for 5.4%. The global financial crisis complicated matters, but within two years, Tong Yang Life went public. In 2010, Samsung Life and Korea Life (now known as Hanwha Life) listed. Surely it was only a matter of time before Kyobo Life followed suit.
A second wave of private equity investment came in 2012 as Korea Asset Management Corporation and steelmaker Posco – which acquired positions in Kyobo Life from the wreckage of Daewoo Group – made their exits. OTPP agreed to buy 9.9% for KRW470 billion, though it ended up with 7.62%, and then Affinity, Baring, IMM, and GIC paid KRW1.2 trillion for 24%.
All were backing Shin to deliver an IPO, but some industry sources claim uncertainty about the chairman’s attitude towards PE pre-dates the first commitment. “We went to see him and said, ‘You need capital, we want to take a 30% position in your company.’ He told us there was one condition: we had to be passive and not bother him,” says one investor who looked at Kyobo Life. “He ended up going with an international consortium because he thought he would be left in peace.”
This tallies with accounts from GPs that ended up backing the company. To some, he typifies the old school chaebol chairman: an individual who is a law unto himself, retaining the habits he’s held for decades despite increased emphasis on corporate governance in Korea. Others describe him as “not an outgoing person” who has little interaction with the market.
According to one investor, Shin hosted large-scale lunches and dinners to which the private equity shareholders would be invited, but he didn’t have a one-on-one meeting with the chairman until after the put was exercised. Nothing was achieved at that encounter. Corsair and Affinity are the only investors with board-level representation, occupying two out of seven seats. Of the other five, three are management and two have historic affiliations to the company.
Several sources – investors in Kyobo Life and those familiar with the industry – question whether Shin ever took the notion of an IPO seriously, noting that he wasn’t keen on being subject to oversight by public shareholders. It is generally accepted that a listing should have happened several years ago when the market was more accommodating to insurers. Indeed, it is unclear whether an IPO today would achieve a valuation sufficient to meet investors’ minimum return requirements.
Whenever he was pressed on the matter at shareholder meetings, Shin simply said it wasn’t a good time to list. His position changed towards the end of last year, when it became apparent that the put would be exercised. A proposed IPO won board approval in December and a filing was made in March. That month, Shin said he was striving to deliver a successful IPO, underlining his desire to “preserve Kyobo’s 60-year history and identity.”
A listing is unlikely while the parties remain in arbitration. The stock exchange’s assessment criteria include a “management stability” test and applicants are required to disclose any potential change of control scenarios. A local banker observes that a legal dispute between a company’s largest shareholder and financial investors holding a put over a substantial minority interest is enough to trigger an IPO veto.
Meanwhile, Kyobo Life’s labor union – a vocal advocate for Shin – has filed a petition with Seoul Prosecutors Office regarding the validity of the put options. It calls for executives from Affinity and Kyobo Life to be charged with fraud and negligence, respectively. The crux of the argument is that Shin is unfamiliar with IPO processes and was not informed of the existence of the put options when he signed the investment agreement.
The private equity investors dismiss the petition as a ploy to delay an arbitration ruling – although the arbitration process and separate legal case could run concurrently. They question how someone who has spent his entire career in the upper echelons of Korea’s financial services sector, running a life insurance business, could claim ignorance of such crucial details.
“If somebody wants to be a chairman or CEO of a company where the nature of the business is selling long-term contracts, he should be able to read contracts himself. Chairman Shin didn’t sign just one contract, he signed them with multiple investors. Now he is basically saying that he didn’t read the contracts, or someone lied to him,” says one investor. “I’ve been investing in chaebols for more than a decade and no one has dishonored a contract of this magnitude.”
The road ahead
Shin has suggested three ways out for the investors: issuing asset-backed securities to them secured against unspecified Kyobo Life assets; the sale of their stakes to third parties; and an IPO followed by additional compensation if the valuation is lower than anticipated. One of these may yet form the basis of an agreement, but the investors claim there is insufficient detail to work from. Their lack of faith in the chairman is also a hindrance.
Assuming the arbitration, which is being heard at the Korea branch of the International Chamber of Commerce, proceeds and finds against Shin, he would have to come up with the money. This would probably involve leveraging personal assets or even giving up some or all of his stake in Kyobo Life.
In these situations, the gap between exercising the put and receiving payment can be drawn out. Some contracts allow for a remedy period of 30-60 days in which the company may try to resolve the problem that led to the put. There might even be an escalation process whereby every time a resolution cannot be achieved the negotiations move up a level in terms of the seniority of the participants, with 30 days allocated for each round. If an agreement still can’t be reached, they move to arbitration.
Where the grounds for triggering the put cannot be contested – for example, a company does not go public within an agreed timeframe – there might be a dispute over the pricing, especially if it based on fair market value, or whether the put notice has been properly issued.
“These processes can drag on for quite a while, depending on the circumstances,” says Maurice Hoo, a Hong Kong-based managing partner at Morgan Lewis. “The timing might also be pushed out if the founder is out of jurisdiction and you cannot serve process on them. Meanwhile, if you know the founder is dissipating assets in their home jurisdiction, what can you do? An investor should think through how to exercise, and possibly enforce, such a put option at the time it is granted, rather than wait until it is necessary to take action.”
Through strategies based on prevarication, obfuscation and frustration, a founder or controlling shareholder might hope to wear down an investor to the point that a compromise solution is more appealing than a protracted legal fight. But several of the PE players with stakes in Kyobo Life are willing to be patient.
“If we were talking about any other chairman or owner, I would expect them to make us a counter-offer. Based on my experience of this chairman, that’s not going to happen. And if it’s just another promise, without any tangible solution, no one will believe him,” says one. “We may end up going to court and seeking a settlement, and that process might take two years. But we’ve already been waiting for much longer than that.”
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