This article was first published on Lexis®PSL on 9 July 2015. Click for a free trial of Lexis®PSL.
Corporate analysis: What is the significance of the action taken by a US hedge fund to try and block a merger of Samsung companies? Richie Clark, head of corporate at Fox Williams LLP, explains the background to the case and considers the legal questions raised.
Samsung faces legal challenge over takeover, LNB News 10/06/2015 15
Daily Telegraph, 10 June 2015: US hedge fund, Elliott Associates is to seek an injunction in South Korea to prevent a merger between Samsung companies which is designed to ensure control of the conglomerate passes to the grandson of its founder. Elliott Associates is the third-largest shareholder in Samsung Construction & Trading, part of the Samsung group.
What does the merger Samsung proposes entail and what are its claimed objectives for such a move?
The proposed merger between South Korean companies Samsung C&T (C&T) and Cheil Industries Co (Cheil) is in essence an effective takeover by Cheil of C&T in an all-share deal which values C&T at around US$8 billion.
While C&T’s principal business is in construction, it also owns interests in other Samsung group companies including those of Samsung Electronics Co, the undisputed jewel in the crown of the Samsung empire with its eponymous world-leading smart phones.
Cheil and C&T have defended the rationale for the merger as delivering synergies to the construction business and that the price agreed was a fair one based on the relative market prices of the two companies – which according to Korean law is the method which is required be followed for all-share deals.
However, the timing of the transaction was noteworthy in that the deal was announced when C&T’s shares were trading at close to a five year low while, in contrast, Cheil’s shares were trading at near a five year high.
As the merger would give Lee Jae-yong, the grandson of Samsung founder Lee Kun Hee, an effective 16.5% stake in the combined entity, this has led to suggestions that the deal is an opportunistic way for the Samsung founding family’s influence to be consolidated over Samsung Electronics Co.
What is the approval process for the merger?
The merger requires two thirds majority vote at the C&T EGM to be held on 17 July.
According to regulatory filings, the Lee family and affiliated Samsung entities own close to 14% of C&T. Since Elliott Advisors, the activist hedge fund founded by American billionaire Paul Elliott Singer which holds over 7% of C&T, publicly opposed the merger, it became clear that it will be hotly contested.
Both sides are therefore keen to influence how other shareholders will vote at the EGM by resorting to a range of tactics with a view to winning what is typically known as a ‘proxy battle’.
In addition to the extensive use of the media, and court processes, a key battleground is seeking to convince research analysts, proxy advisory and shareholder protection agencies of the merits of their respective cases, as the reports they publish can be very influential on voting decisions, particularly with institutional investors. Indeed, reports by leading proxy advisory agencies ISS and Glass Lewis have recommended that C&T shareholders vote against the merger, giving added backing to Elliott’s campaign.
Once Elliott’s opposition surfaced, C&T took the inflammatory step of selling treasury shares representing a 6% stake in C&T to KCC Corp., an historic ally of Samsung which also has a significant shareholding in Cheil —these shares would not otherwise have been counted as part of the EGM vote.
The proxy battle has also put into focus the role of institutional investors and whether they are properly stewarding the interests of the companies in which they have an interest. For example, the Korean National Pension Service, which is notoriously apathetic in its willingness to oppose management’s wishes, holds almost 12% of C&T, having recently acquired an additional 1.7%. It is likely that Cheil will have taken this into account when assessing its chances of success.
For its part, Elliott’s activist campaign appears to have engaged a large group of retail investors, as well as the Dutch pension fund APG Groep NV, who have publicly sided with Elliott.
Why are Elliott Associates seeking an injunction to prevent the merger?
Elliott filed two injunctions in the Korean courts with a view to preventing the merger going ahead..
The first is to block the merger as being unlawful in itself—based largely on the inadequacy of the US$8 bn price, when C&T’s interests in other Samsung entities alone are reportedly valued at almost US$11bn. Elliott’s argument is essentially that Cheil is benefitting from an illegal transfer of value from C&T.
On 2 July, the Korean court rejected Elliott’s claim, pointing to Korean law’s requirement that relative market prices be used to set the price on all-share mergers. However, in a move virtually unprecedented in activist situations involving Korean companies, Elliott has appealed against the court’s ruling. It is unclear whether the court will rule on the appeal prior to the 17 July date of the EGM.
The second injunction seeks to block the recently acquired treasury shares from being allowed to vote on the resolutions to approve the merger. It is anticipated the court will deliver its decisions on the injunction applications in early July.
Why do investors believe the merger may be an unlawful move to give the founder’s grandson influence over Samsung Electronics Co?
Given the cross-holdings of the Lee family in both Cheil and C&T, concerns are certainly raised as to whether the C&T board acted independently in the interests of all shareholders to obtain the best price, and what steps it took to do so.
In addition, the brazen sale of the treasury shares to ensure they vote in favour of the merger raises serious corporate governance concerns.
At a much higher level, the proposed merger has created a tremendous amount of media interest in Korea for a number of reasons.
Korea does not have a long history of shareholder activism. As such, the perceived aggressive tactics of a well-known American activist investor makes it easy for the media to seek to protect what is an iconic if not strategic brand for Korea.
While this inevitably breeds some protectionist sentiment, it has come in the midst of a perfect storm in Korea as there has been a willingness by some to question the perceived privileged position that Korea’s leading industrial class—known as the chaebol—have enjoyed over the years.
It has put into the spotlight the fact that these chaebol-influenced corporate governance weaknesses have contributed to the systemic underperformance of Korean stocks from a valuation perspective when compared to the global markets.
While historically this privileged position enjoyed by the chaebol tended to mask the significant corporate governance concerns, this value spread plays into the hands of a typical activist investor’s strategy and Korea is clearly no longer off limits for activists.
What has been the Korean government’s position on the merger?
While the government’s competition regulator has not voiced any objection to the merger, the government itself has taken a perhaps surprisingly neutral position on the transaction.
The government’s ambivalence on this matter may be down to not wanting to discourage foreign investors from continuing to provide capital to South Korean companies.
It may be that the time is finally right politically to allow market forces to hold the chaebol to account when they fall short of international corporate governance best practices, without government intervention which may have occurred in the past.
How would such a merger affect international markets?
Coming close on the heels of the highly publicised activist battle at British investment giant Alliance Trust, where Elliott successfully brokered a deal to restructure the board of Alliance Trust in advance of its AGM, Elliott’s battle with C&T will have an impact on global markets whether successful or not. The C&T merger is further evidence that activist investors are scouring the globe for corporate governance abuses which undervalue companies in which they feel they can increase shareholder value.
Whatever the result, the proxy battle may inspire more Korean shareholders and institutional investors to become more engaged and active themselves in the companies in which they have an interest, following the growing trend in most Western economies.
What is the likely outcome of the challenge to prevent the merger?
There is very little precedent in Korea for these types of situations and, therefore, it is difficult predict the outcome.
The court proceedings are just one of the weapons being used by Elliott to seek to prevent the merger in what is a much larger activist campaign. Even if Elliott loses the battle in court (which, after the initial ruling, appears likely), its war with C&T is far from over. The heightened awareness created by the campaign has engaged both retail and institutional shareholders in C&T, many of whom have come out in opposition to the merger—it is far from certain that the merger will be approved at the EGM on 17 July 2015.
One potential outcome could be a negotiated settlement—as was the case in Elliott’s recent battle with Alliance Trust—to obtain Elliott’s (or at least other investors’) support ahead of the meeting. This would be likely to involve any or all of a higher merger price, board changes, improved corporate governance practices and a commitment to distribute C&T’s shares in other Samsung companies directly to C&T shareholders. Indeed, C&T has as a concession to Elliott agreed to include a resolution at the EGM to amend C&T’s constitutional documents to permit such distributions to be made (though there has been no commitment to actually declare such distributions if the resolution is passed). Cheil has also said that if the merger is successful, it will increase dividend levels and also create a corporate governance committee to oversee future acquisitions.
However, even if no such settlement is achieved and the merger goes ahead, we can still expect Elliott to continue to vigorously put pressure on the board to act independently from the Lee family and preserve shareholder value.