Value Investing

Investing in Korea: Types of Mispricing – Net-Nets, Prefs, Holding Company Discount

Having covered the overview of the South Korean economy previously, we would be sharing of the 3 types of mispricing that is prevalent in South Korea.

Type 1: Net-Net

The traditional form of mispricing as identified by Graham. Doing a quick scan, there are 18 net-net companies in South Korea with most having a market capitalisation of less than USD100m. However, the discount to NCAV for these net-nets are not huge with some trading roughly equivalent to the NCAV.

Type 2: Preferred Stocks Discount

Over 100 South Korean public companies have listed both common and preferred shares. One has to understand that the preferred shares in South Korea are very much different compared to the ones we know in other countries such as in the US. The preferred stock in South Korea are virtually the same as common stock, where not only do they get a higher dividend, they have an equal claim on the company and preferred treatment in the event of liquidation, just that they are non-voting shares. To truly understand the reason for such preferred shares, it would date back decades ago involving the history of chaebols in South Korea.

Today, most preferred stock trades at roughly 50 – 70% discount to that of the common stock. While these shares were initially issued at a slight discount to that of common stock, the discount gap widened over the years and is close to its all time high.

The last time that Korean preferred stocks traded at such a wide price discount was after the IMF bailout in 1997. Investors who purchased Korean preferred stocks in 1997 tripled their money.

— Ori Eyal, Managing Partner of Emerging Value Capital Management LLC

To put it into context, imagine Company X having common shares that trade at 18x PE multiple. However, with the preferred shares, due to the discount we are able to purchase Company X at perhaps a 6x PE multiple.

Type 3: Holding Company Discount

As many Korean companies are IPO-ing their subsidiary companies, it results in the listed parent company to be a holding company. While we normally apply a 20% holding company discount, however, in Korea, we are able to discover opportunities whereby this discount is actually much larger than 20%.

Summary

Through research, one would notice that every country has its various forms of mispricing opportunities. Comparing between South Korea, Japan, Hong Kong and Singapore, we would notice that each mispricing opportunity is very much different. We find that studying such differences is what makes value investing so interesting and exciting. That said, while we admit entering the South Korean market has its difficulties, it is one market that we shall consider entering depending on the number of opportunities we are able to discover.

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Investing in Korea: Types of Mispricing - Net-Nets, Prefs, Holding Company Discount