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By George Wehrfritz
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It was hardly a triumphant homecoming for the leading corporate chieftain of Korea Inc. Sitting in a wheelchair with his right knee in a cast, Samsung chairman Lee Kun Hee ended a five-month absence on Feb. 4 with a rare press conference at Gimpo International Airport near Seoul. Parked before a gaggle of reporters, the embattled head of the country's largest conglomerate, or chaebol, took time to ask for forgiveness. "I'm sorry for the stir I caused last year," he intoned in a low, somber voice, referring to twin scandals that rocked the Samsung Group and sent him abroad. "And I think I'm fully responsible."
Message delivered, Lee rejoined his phalanx of bodyguards, boarded a limousine and returned to his life of seclusion. But his efforts didn't stop there. On Lee's third day back, Samsung announced that it would donate $1 billion "to society," the bulk from Lee family assets. The conglomerate also dropped its legal campaign against pending legislation that could effectively split Samsung in two.
The company and its chairman obviously needed some good publicity. The 64-year-old tycoon originally left South Korea last September when it looked as if he might be indicted in connection with political donations during the 1997 presidential campaign. (Samsung says Lee left for a medical checkup in the United States; prosecutors dropped the charges for insufficient evidence and because the statute of limitations had passed.) Prosecutors are still examining Lee's role in a second case, involving the questionable use of tax-saving bonds in the transfer of a controlling stake in Samsung to his four children a decade ago.
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There is unease inside the House of Samsung, where Lee and his kin now face the most serious challenge to their business empire since the Asian financial crisis in 1998. This time the fight is personal, and the stakes include the family's control of Asia's most valuable high-tech company, Samsung Electronics. In 2005 the share price of Samsung Electronics rose 46 percent, making it the region's second largest manufacturer by market cap, behind Toyota. The company has become the pride of post-crisis South Korea for surpassing archrival Japan's Sony Corp. as the most valuable name in consumer electronics, and for becoming a global model of modern management and innovation. What the scandals bring home, however, is that Korea has a love-hate relationship with its brightest star. On the one hand the country is deeply proud of the company's achievements. But it is also suspicious of its power and eager to cut it down to size.
The Samsung Group is a classically complex and murky family conglomerate in the old Korean style, in which Samsung Electronics is just one cog. Indeed, in a nation known for intense industrial concentration, Samsung is now the most powerful chaebol ever, with 63 companies and 135,000 workers at home, accounting for 20 percent of South Korean exports.
The Lee family fortune is tied to the Samsung Group as a whole, not its star division, and is underperforming as a result. The clan's fortune has more than doubled in the last five years, to $4.3 billion, ranking the Lees 16th on the Forbes list of Asia's richest tycoons. But over the same period, the market value of Samsung Electronics has increased some twentyfold to more than $100 billion, or the fifth largest in Asia. Some analysts attribute the family's underperformance to a strategic blunder: failing to increase its own stake in the group's star asset while its shares were still a bargain. Others say that the Lee family had little choice but to keep its stakes small, given South Korea's anti-tycoon regulatory environment and societal antipathy to the rich. The contrast to Asia's most freewheeling tycoon turf, Hong Kong, home of Li Ka Shing (second on the Forbes list, with a net worth of $13 billion), could not be more stark. "South Korea has an almost communist attitude: if you have mon-ey, then you stole it from somebody," says Seoul-based investment consultant Tony Michell. "We have no idea what the Lees would have done if they were the Hong Kong Lis and not the Korean Lees."
Indeed, it is hard to imagine another Asian country that would move to break up an undisputed corporate star. Yet Samsung has become not just an icon for other Korean firms, but the prime target of lawmakers and powerful pressure groups aiming to untangle the weblike cross-shareholding structures that allow Korean clans to control public companies through unlisted group affiliates. The Lee family, for example, owns just 3.3 percent of Samsung Electronics (compared with some 60 percent now held by foreign investors). But it effectively controls the firm through other arms of the Samsung empire.
Despite its cutting-edge reputation, at home Samsung is under fire as the last of the corporate dinosaurs. The other top-tier Korean conglomerates were hit harder by the Asian financial crisis, and many have been taken apart by the government. That has produced truly independent and --now highly profitable companies like Hyundai Motors. In contrast, Samsung Electronics is a hot company still tied to an old-style chaebol. "Some Samsung companies are well run, but the whole [group] structure is hanging by some very thin threads," says James P. Rooney, CEO of the investment firm Market Force. "It's a dangerous position to be in."
Despite his homecoming, chairman Lee remains Korea Inc.'s most effective reformer and best-admired businessman. In less than a decade, he forged Samsung Electronics into a world leader in memory chips, cell phones and digital devices like flat-screen televisions. He cleaned up corporate governance to such an extent that pioneering shareholder-rights crusader Jang Hasung, dean of the Korea University Business School, sees "no significant problems" at the company today. Yet Jang still describes the Lee family as "a cloud that hangs over everything" because the group as a whole remains sprawling, unfocused and rife with potential problems. "[Chairman Lee] spun off companies, got out of noncore business and quietly laid off 28 percent of his work force [at Samsung Electronics], and that's why it rebounded so well," he says. "Now the entire Samsung Group needs to do the same thing."
Samsung's organizational chart evokes the mazelike circuitry of its semiconductors; companies own shares in one another and hold each other's debt in a tangled system utterly unlike the neat power pyramids familiar in London or New York. Conflicting interests are common. In one recent example, Samsung Credit Card was listed among the companies being sued by Samsung Motors' creditors. Yet it's also the second largest shareholder in the reconstituted auto company, now owned by Renault--giving it interests in both sides of the same case.
In economic terms, chaebol structures are grossly inefficient, blurring focus and lines of command and fostering cronyism. For all the right-angle turns on its organizational chart, real power at Samsung flows in a circle. At the top of the circle sits Samsung Everland, an unlisted amusement-park operator and real-estate developer that serves as the family's de facto holding company. It owns a controlling 19 percent stake of Samsung Life, an unlisted insurance company that is the largest single shareholder in group giant Samsung Electronics, itself a major investor in unlisted Samsung Credit Card, which in turn owns 25 percent of Everland. The Lees' power moves clockwise around the circle: via Everland, it controls Life, Electronics and the credit-card business. That allows the family to wield voting power for some 16 percent of Samsung Electronics shares, five times what it actually owns, and enough to control the board of directors. Yet the architecture has a major flaw: sever one link and the circle breaks.
The weakest link may be Samsung Life, which is threatened by a Lee family folly. In his biggest mistake as Samsung boss, chairman Lee sank at least $3 billion into an ill-fated auto venture on the eve of the Asian financial crisis. In 1999, only a year after Samsung Motors' first cars hit the road, the government forced Lee to sell his overleveraged project. To pay off some $2.5 billion in loans (now $4.7 billion with interest), Lee handed over 3.5 million shares of Samsung Life to creditors and pledged to take the company public by 2000 with a guarantee that the creditors would get at least $700 per share. The IPO still hasn't happened. Creditors, who sued Lee and 22 Samsung affiliates last December, now own 17.6 percent of Samsung Life, making them the second largest shareholder bloc, behind Everland.
Unlike in the old days, when deals often unfolded beyond public view in South Korea, Samsung Life's fate is now the subject of open warfare in a fast-changing business culture. Powerful civic groups and newly emboldened regulators argue that the proceeds from any share listing should go to policyholders, not shareholders, a move that would undermine the value of the stock Lee turned over to his creditors. And that's not the only threat. In informal trading, the market now values the private shares in Samsung Life at about $500 each. If the company went public at that share price, chairman Lee would owe Samsung Motors creditors an additional $650 million in principal and $2.3 billion in interest--enough, analysts say, to erase two thirds of the family fortune.
Even if the family got its asking price, an IPO threatens Samsung Life's role as a crucial shield and cash cow protecting the entire chaebol. An IPO would put Samsung Life's stake in Samsung Electronics under tighter scrutiny and shareholder --pressure. In addition, analysts say, Samsung Life has about $100 billion in assets, mainly the proceeds of insurance premiums, that would cease to be at the group's disposal to, for example, fight off corporate raiders targeting another Samsung company. "If someone wanted to take Samsung Electronics today, Samsung Life could step in," says a Western-trained financial adviser in Seoul, who asked to remain anonymous, due to his company's policies. "[Yet] once it is listed, that would trigger a class-action lawsuit [by Samsung Life shareholders]."
In the United States and Europe, this couldn't happen. It is illegal for financial companies to control industrial companies, precisely to avoid such conflicts of interest. The government of President Roh Moo Hyun wants to enact a similar ban in South Korea, and the main target is Samsung. Under a bill pending in the legislature, financial companies could not hold more than 5 percent of an industrial company, which would force Samsung Life to shed a third of its 7.25 percent stake in Samsung Electronics. The proposed measures aim to prevent a repeat of the 1997-98 crash, in which most Korean banks collapsed as a result of overlending to manufacturing companies.
At the least, the Lee family is shifting tactics in the face of mounting attacks. Concern about the dominance of a company that, for example, sponsors not only every team but every professional sports league in the nation is summed up in a growing debate over how South Korea became the "Republic of Samsung." Public opinion began to turn on the Lees last year, due to the scandal over the 1997 presidential-campaign donations, now resolved, and the one that still simmers over the passing of the mantle in the Lee empire. The basic facts are not in dispute: in 1996 chairman Lee transferred a controlling stake in Everland to his son and three daughters at a tenth of its market value through an issue of tax-advantaged convertible bonds. Last October a Seoul court found the transfer legal, but said the bond sale constituted "a breach of trust" and found two Samsung executives guilty of betraying their fiduciary duties to benefit the Lee family. Prosecutors are still investigating chairman Lee's role and have not ruled out summoning him for questioning. Samsung has said the transaction was handled in accord with the law.
The donations announced last week were crafted to mute growing criticism of the Lee family. At the same press conference, Samsung invited scholars and NGOs to join a new independent ombudsman to oversee its operations and vowed to downgrade its powerful Group Reformation Headquarters, described by a company spokesperson as the chaebol's "control tower," in order to render affiliates more independent. Samsung vice chairman Lee Hak Soo (no relation to the founding family) said chairman Lee and top managers prepared these measures "with regret over [our] wrong practices in the past," and said Samsung would abandon attempts to block new chaebol-reform laws. In the future, he pledged, Samsung would "consider public opinion and comply with people's expectations... rather than argue who's legally right or wrong."
To some, it sounds as if the Lees are now prepared to accept the forcible breakup of Samsung. Admirers of chairman Lee say he rescued Samsung Electronics by making unconventional reforms, and may be willing to break up his empire be-fore surrendering it to his intelligent and impressive but still-untested son, 38-year-old Jae Yong. That would entail splitting the conglomerate into a financial company led by Samsung Life and an industrial company led by Samsung Electronics, selling noncore businesses and surrendering family control over part of the empire. Lee Eunjung, an accounting expert at the Center for Good Corporate Governance in Seoul, argues that the pending regulatory changes make the long-run outcome certain, whether or not chairman Lee participates willingly. "Samsung Life will be listed sooner or later," she says. "Then the whole group structure will break up."
If engineered with the precision of a new Samsung gadget, separation could allow the Lees to increase their stake in Samsung Electronics, making them richer and less vulnerable--which is to say more like the Hong Kong Lis and less like other Korean chaebol families that have seen their sprawling empires crumble over the past decade. "Eventually every chaebol family gets to a stage where it doesn't want to be as close to management of the group," says Henry Morris, Korea adviser for GAM Hong Kong Ltd., which runs more than 300 investment funds. "You could hope [that the Lees have reached it]. But it's a huge bridge for them to cross, and the chairman isn't sure what's on the other side."
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