Lone Star chalks up painful success in Korea

November 29, 2010

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

HONG KONG — It is seven years since Lone Star bought into Korea Exchange Bank, and four years since the U.S. distressed-asset fund started trying to get out. Lone Star has finally agreed to sell its majority stake in the lender to domestic rival Hana Bank. The sizeable returns it has made explain why buyout groups like Blackstone and KKR are interested in South Korea, although Lone Star itself may not be rushing back.

The firm bought its 51 percent stake in 2003 to help KEB plug a capital hole. Lone Star focused the bank on growing profits rather than the loan book, ushered in restructurings, and took out chunky dividends. KEB’s shares have outperformed the FTSE Korea Financials index by close to 50 percent.

Yet Lone Star also tested Korea’s low tolerance for foreigners who make a profit turning around troubled companies. State prosecutors declared the deal “illegal” in 2006. Later, Lone Star’s Korean boss was sentenced to prison, though subsequently exonerated, for manipulating the share price of a subsidiary. Tax probes and legal wrangles derailed two attempts to sell out — first to Kookmin Bank, and then HSBC.

Despite the sour grapes, KEB has paid out well. Lone Star put up 1.4 trillion won or $1.2 billion for its stake in KEB in October 2003, and three years later invested a further $800 million. On the way, it recouped some $670 million of dividends, according to KEB filings, and $1.3 billion from selling down 14 percent of its stake. With a $4.1 billion exit secured, the group has tripled its money.

Overall, the investment has generated a 25 percent annual internal rate of return according to a Breakingviews calculation assuming an unlevered deal. Assuming Lone Star borrowed part of its investment outlay, the real returns could be even juicier.

KEB may be a mere success rather than a triumph. Had the fund sold to HSBC at the initially posited price of $6.3 billion, the returns would have been closer to 40 percent,  in half the time. Still, with memories of Lone Star’s earlier treatment still raw, the new generation of buyout giants targeting South Korea may be glad their predecessor didn’t make provocatively excessive returns.

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