The following commentary was originally posted on FoolFunds.com, the website of Motley Fool Asset Management, LLC, on Feb. 25. With permission, we're reproducing it here in its original form.
As I hurtled from one end of South Korea to the other on a bullet train traveling in excess of 200 miles per hour, I had two thoughts: "These hodo kwaja are delicious, and this country sure doesn't look emerging to me."
Let me explain.
First (and more importantly), hodo kwaja are bite-sized walnut cakes -- usually filled with a red bean paste -- that are quite satisfying. For an extra treat you can wash them down with soju, the local firewater. In moderation, of course.
Second, MSCI Barra does not include South Korea among its 27-country list of developed markets, instead calling it emerging. This despite the fact that South Korea is right and truly emerged, with a fully industrialized, diverse economy and a per-capita GDP on par with Japan's and higher than Spain's, Italy's, or New Zealand's. If this makes you wonder what people are buying when they invest in emerging market ETFs, well … it should. Korea's no more an emerging market than Pittsburgh is a city on the Pacific.
Truth be told, even within Asia, South Korea flies under the radar. This country of nearly 50 million is the sixth-largest exporter in the world. It is perfectly situated between China and Japan, two of its largest trade partners, and it sports a debt-to-GDP ratio that the U.S. and many European countries can only dream of. Were it not for the fact that South Korea has the tendency to be shot at by its crazy neighbor to the north, at face value it would seem to be a dream market for investors.
Investing challenges lead to "emerging" tag
MSCI cites numerous reasons for Korea's categorization as "emerging" rather than "developed," including the lack of an "active offshore market" for its currency. We've experienced some other impediments to investing in Korea. Many Korean companies seem indifferent -- at best -- to attracting foreign investors. Among even the largest Korean companies, many only release their financial statements in Korean, creating significant barriers to foreign investors trying to find and analyze pertinent corporate information.
The Korean regulatory regime sets the tone: When we first launched the Independence Fund, we had to jump through myriad hoops just for the right to participate in the Korean markets. Of the markets where we are now able to trade, it was the most difficult nut to crack by far. Regardless, these obstacles are surmountable and what's more, once you get past them, I believe that the Rodney Dangerfield-esque quality of the Korean market hides some real opportunities.
And, of course, North Korea keeps things exciting.
Tensions rise before visit
In the weeks prior to our early-December arrival, North Korea shelled the island of Yeongpyong, killing several South Korean soldiers and civilians. Tensions were still quite high and while our Korean host insisted it was safe, she disclosed that several foreign firms had canceled visits. Nevertheless, from the moment Bill Mann and I arrived at Incheon International Airport, we found that it was business as usual wherever we went (and one company we visited, Woongjin ThinkBig, had its stylish headquarters in Paju, about 5 miles from the North Korean border).
While many of the Koreans we spoke to admitted being nervous in the immediate aftermath of the attack, all had returned to their regularly scheduled lives. In fact, the most common lingering sentiment was one of frustration at the South's government for appearing too timid in response. This spoke to a great miscalculation on the part of the North: For years they have been able to count on popular opinion in the South pressuring the government not to retaliate. This time around, we definitely got the impression that many South Koreans were sick of the North's provocations.
Another thing we found interesting: We spoke to several South Koreans who were openly hostile to the concept of even reuniting South Korea with the North. It makes some sense: Over the past 50 years North Korea has so totally cut itself off from the South that while older Koreans have family members with whom they'd love to reunite, many in the younger generation lack this direct emotional link. To them, North Koreans are as foreign as Bhutanese, with whom they have almost no contact and little in common.
Unease = Opportunity
We take no pleasure in human suffering, but sometimes investing isn't for the squeamish. The fact is that unease between the two Koreas can lead to investment opportunities. Despite the political concerns, South Korea's KOSPI index performed very well in 2010, gaining 22%. We have identified several worthy investment candidates in the country, including some, such as Posco, that represent long-term holdings for the Independence Fund.
One name that regular Declarations readers may recognize is Sung Kwang Bend Co. This pipe fitting manufacturer headquartered in Busan has been a staple of our Top 11 list for several months now. As is common among Korean companies, Sung Kwang Bend generates more than half its sales from exports. Our meeting with the company went well -- except for the part of the factory tour when I was almost run over by a forklift (it was probably my fault).
Apart from the industrial companies in Busan, we also met with several consumer-oriented companies in and around Seoul. We saw a diverse range of products, including cosmetics, snack cakes, textbooks, and ginseng extract. Many of these companies provide us a back-door play into China, deriving sales from the most populous nation while maintaining the corporate governance standards of a more mature market.
One example of this dynamic is Orion Corp. Not to be confused with dozens of other Orions around the world, this one makes Choco-Pies (full disclosure: I'm eating one right now) and other snacks; it also runs all legal sports betting in Korea, a synergy that surpasses my understanding. But sticking to just the confectionery segment, Orion earned half its 2009 revenue domestically and the other half overseas, mostly in China. Back in 2005, that split was 82% domestic. While Korean sales grew only 3% per year over the ensuing years, overall segment revenue expanded by 17% a year thanks to accelerating sales into China, Russia, and even Vietnam.
Catching the Korean Wave
Despite the formidable companies we met, the hottest export seems to be the so-called Korean Wave -- Korean TV, music, and film are increasing in popularity throughout the rest of Asia, and I must admit I found the pop music to be obnoxiously catchy. But the highlight of the trip may have been when Bill and I were simultaneously offended and delighted by the name of a restaurant in downtown Seoul -- Fat Panda: American Style Chinese Food. We asked our host about it and he said, "I love American-style Chinese food!" So what do we know?
For all of the obvious prosperity in Korea, it can be difficult finding small- and mid-cap companies in which to invest. This is particularly true because so much business in Korea operates through conglomerates, or chaebol. Americans will recognize the name Samsung, but apart from the electronics sold into North America, Samsung includes groups operating in the chemical, financial, and apparel industries, to name just a few. Other recognizable names include LG and Hyundai.
The last meeting of our trip was with Hyundai Mipo Dockyard, a publicly traded shipbuilder in the Hyundai chaebol. Hyundai Mipo is a subsidiary of Hyundai Samho Heavy Industries, a more diverse shipbuilding company. Hyundai Samho is itself a subsidiary of Hyundai Heavy Industries, which calls itself the world’s No. 1 shipbuilder, in addition to having a hand in countless other industrial projects. In turn, a large portion of Hyundai Mipo's assets are invested in shares of its parent, Hyundai Heavy. This type of intertwined ownership is not uncommon in Korea, and with a little digging can lend itself to undetected investment opportunities (or pitfalls).
Despite its hurdles, South Korea has established a rich and vibrant economy with strong growth, low unemployment, and plenty of opportunity. It has earned its stripes as one of the so-called Asian Tigers, and we believe it is still well-positioned for future growth. Many of our favorite Korean companies fly under the radar of the typical global investor, but with a patient eye we believe there will be plenty of values to uncover.
For further reading I suggest:
- Nothing to Envy: Ordinary Lives in North Korea by Barbara Demick
- Troubled Tiger: Businessmen, Bureaucrats and Generals in South Korea by Mark Clifford
- A Single Shard by Linda Sue Park
- Best English-language local news source: Chosun Ilbo
- Best English-language North Korean government news agency: Korean Central News Agency
- Favorite Korean song: So Nyeo Shi Dae, "Run Devil Run"
- Under the radar Korean restaurant: Haeun Maru, Busan
Editor's note: Tony Arsta is not able to engage in discussion on the boards or in the below comments section. Tony does not own shares of any companies mentioned.