Korean Preference Shares: The 'New' Japanese Net-Nets

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Includes: AMPCF, CJRPF, HYMPY, LGEAF, LGHHF, SSDIY, SSNLF
by: The Value Pendulum

Summary

Korean preference shares represent a compelling investment opportunity for deep value investor, in a similar fashion with Japanese net-nets.

Investors in Korean preference shares don't enjoy voting rights, but benefit from significant discounts to the common stock equivalent and possibly higher dividends.

The opportunity set comprises roughly 140 Korean preference shares.

In September last year, I wrote about Japanese net-nets in an article titled "Seeking Japanese Net-Nets As Deep Value Investment Opportunities" where I highlighted the significant number of net-nets that can be found in Japan and how these stocks are generally of higher quality than their U.S. counterparts in terms of profitability, financial strength and capital return to shareholders. Japan is not the only Asian stock market where such mispricing opportunities exist. In fact, in my article, I mentioned that Warren Buffett bought a basket of Korean net-nets for his personal portfolio, as confirmed. Alice Schroeder, the author of Snowball: Warren Buffett and The Business of Life, in a live Q&A discussion hosted on Reddit. One deep value mispricing deep value investment opportunity that has gained attention in recent years is Korean preference shares.

Background On Korean Preference Shares

It is important to make a clear distinction between Korean preference shares and U.S. preferred stocks which readers will be more familiar with. I will leave the job to Mr. Daniel Tudor, the Economist's Korea correspondent and author of the book "Korea: The Impossible Country." In an article written by Daniel, which was reproduced on Groove Magazine, Korean preference shares are defined as follows (my emphasis):

Then there are "useon-ju" ("preference shares" where I come from, otherwise known as preferred stocks). Many chaebol issued these preferred stocks, which are just like normal stocks, but without voting rights - this was to raise money without losing control over the company. They have the same economic value as ordinary shares, and you receive the same dividends (or even a little more) at the end of the year. But because they don't issue so many of them, they have the same problem that small companies have - big institutions can't buy them in any meaningful amount.

The pros and cons of Korean preference shares are quite evident from the definition by Daniel. On one hand, Korean preference shares are rather illiquid and do not offer voting rights. On the other hands, investors are "compensated" with a cheaper entry price (discount to common stock equivalent) and possibly higher dividends. The lack of voting rights is much less of an issue than perceived, since most investors are unlikely to accumulate significant shares to make a difference in largely family-controlled Korean and Asian companies and the fact that shareholders holding common stocks will still have voting rights. Research by Korea Investment & Securities indicated that the average relative price of preferred stocks compared to common (for the top 20 preference shares in terms of market capitalizations) has ranged from 30% to 70% historically between 1993 and 2013. Improving corporate governance, repurchases (and subsequent cancellation) of preference shares by companies and the increased investor interest are among the factors that have and will narrow the discount between preference shares and their common shares equivalents.

In my article on Japanese net-nets which I made reference to at the start, I highlighted institutional investors like Monish Pabrai and well-known investment writers such as Geoff Gannon and Oddball Stocks' Nate Tobik among those who have gotten their feet wet with Japanese net-nets. Similarly, the idea of investing in Korean preference shares is not just an academic exercise. In April 2013, Weiss Asset Management started Weiss Korea Opportunity Fund which "invests primarily in listed preferred shares issued by companies incorporated in South Korea." According to its 2015 Annual Report, Weiss Korea Opportunity Fund delivered a cumulative total return on net assets of 40.7% since inception (inclusive of dividends), while the reference MSCI Korea 25-50 Index lost 4.4% over the same period. At the 18th Annual Sohn Investment Conference in New York held on 8 May 2013, famed investor Li Lu of Himalaya Capital presented on Korean preference shares. In an interview with SumZero in April 2016, Emerging Value Capital Management's fund manager Ori Eyal mentioned that he started investing in a basket of Korean preference shares since 2013 (or 3 years ago) and "the basket has doubled already." More importantly, Mr. Eyal thinks that there is still upside, adding that "I think there's another double to go, so it'll be 4x by the time it's done." Norman Rothery, who writes for his blog Stingy Investor and The Global And Mail, tells the story of how Keith Smith, a managing director of a business and financial valuation consultancy by day and a value investor by night, invested in three Korean preference shares due to a "big discount to its common stock due to a lack of voting rights and liquidity" and "bigger dividends."

Seeking Korean Preference Shares As Deep Value Investment Opportunities

For readers interested in investing in Korean preference shares, Weiss Korea Opportunity Fund's top 10 holdings (reproduced below) as of December 31, 2015, accounting for 73.25% of the portfolio's net assets, can be a good starting point.

  1. Samsung Electronics Co Ltd (OTC:SSNLF) Preferred Shares
  2. LG Electronics Inc (OTC:LGEAF) Preferred Shares
  3. Hyundai Motor Company (OTC:HYMPY) 1st Preferred Shares
  4. Hyundai Motor Company 2nd Preferred Shares
  5. CJ Corporation (OTC:CJRPF) Preferred Shares
  6. LG Household & Healthcare (OTC:LGHHF) Preferred Shares
  7. Amorepacific Group (OTC:AMPCF) Preferred Shares
  8. CJ Cheiljedang 1st Preferred Shares
  9. Hyundai Motor Company 3rd Preferred Shares
  10. Samsung SDI Co Ltd (OTC:SSDIY) Preferred Shares

Separately, Ori Eyal revealed in his interview that the opportunity set comprises "140 of these preference shares, and about 100 companies in South Korea have both common stock and these preference shares that are roughly equivalent." At the launch of the Weiss Korea Opportunity Fund in April 2013, there were approximately "145 issues with a market capitalisation of £17 billion." As a bonus for my subscribers of my premium research service, they will get access to the complete list of Korean preference shares, their discount to common stock equivalents and dividend yields in a separate bonus watchlist article to be published in the next few days.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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