Home / Insights / In pursuit of Korean intangibles

This major market composition change does not seem to have been fully recognised by investors, and this change is significant. Since the Global Financial Crisis, for example, Korea’s technology stock market capitalisation has risen from 30.9% to 46.4%. The health care sector surged from 0.7% to 6.2%. Financial services remained stable at 13%1.

Fig 1: Growth of GFCF Intangibles as measured by the OECD (current price)2

Fig1-In-pursuit-of-Korean-intangibles 

A major disparity remains, for example, between South Korea’s equity performance and that of other equity markets, especially the US in the past 10 years. This disparity is arguably due to investors undervaluing Korea’ hitherto intangibles. Over the past 10 years, South Korean equities – as a ratio of the country’s growth in intangible assets2 – have been trending down (see fig.2). This is a concrete though limited example that investors are overlooking the intangible value in South Korea.

Fig 2: Ratios of Market Index/Intangibles2

Fig 2: Ratios of Market Index/Intangibles2 

A KNOWLEDGE-BASED, HIGH-INCOME ECONOMY

South Korea is considered the world’s most innovative country today3. The country has been putting more resources into R&D and tertiary education. Over the past 20 years, its gross domestic product (GDP) spending on R&D has surged from 1.74% in 1991, to 4.23% in 2016, overtaking both the USA (2.74%) and China (2.12%)4. The country has also been proactively investing in human capital, with tertiary education expanding significantly.

In 2016, for example, nearly 70% of South Korea’s 25-34-year olds attained tertiary education, the OECD’s highest percentage5. This, coupled with their educational prowess in mathematics, reading and science6, presents a strong foundation for the country’s talent development.

This empirical evidence shows that South Korea has a strong commitment to a knowledge-based economy.

This commitment comes in tandem with economic prosperity. When the Korean War ended in 1953, South Korea was one of the world’s poorest countries. In 1960, the country’s GDP per capita was only USD158 – just a small fraction of the US’s USD3,007. Since then, South Korea has emerged into a high-income country, earning a GDP per capita of USD27,539 in 2016 – nearly half of the US7.

INTANGIBLE INVESTMENT ACCOUNTS FOR HIGHER VALUE IN THE MOBILE PHONE INDUSTRY

Now, let’s move on to discuss some typical examples of companies making successful intangible investments. Mobile communication has evolved from basic phones used for voice communication, to smartphones that are capable of providing data-intensive content, such as video calls, gaming apps and online web streaming.

While growth in the mobile phone industry has been strong and steady, market leaders have changed. Since 2011, previous leaders Nokia (Finland) and Blackberry (Canada) have been dethroned by Apple (USA) and Samsung (South Korea) – currently the two biggest smartphone brands in the world by market share8.

In the production of smartphones, Apple sources most of its components and technology from third parties, whereas Samsung makes most of them internally, including the processors and displays that Apple also needs for its iPhones. One thing they have in common though, both operate under a strong brand and are responsible for considerable R&D and product design – the intangible assets that underscore the value capture (34%-42%) from their smart phones (see fig.3).

Fig 3: Success in the smartphone industry is based on intangibles9

Fig3-In-pursuit-of-Korean-intangibles 

Developing new technology is important, but brand-building is equally important. Samsung is a success case in pursuing a process of investing in new technologies for dynamic random-access memory (DRAM). In 2004, the South Korean tech giant developed the world’s first 8 GB NAND flash memory chip10.

In addition, Samsung also sponsored major sporting events to build brand awareness. Such events include the Seoul 1988 Olympic Games, and the later Nagano 1998 Olympic Winter Games in Japan. Samsung has emerged as a top global brand. In 2017, US-based brand consultancy Interbrand Group estimated that Samsung has a brand value of USD56,249 million, ranking number six in the world, just behind Apple, Google, Microsoft, Coca Cola and Amazon11.

Such intangible investments, together with the company’s technological advancement, began bearing fruit in the late-2000s. Since then, Samsung Electronics’ shares skyrocketed 857%, outperforming the KOSPI, which only climbed 140%12.

BIOTECHNOLOGY AND HEALTH CARE SECTORS

Investors can also find tremendous potential for intangible value in Korea’s biotechnology and healthcare sectors, where significant investment has been made in R&D and human capital.

Research personnel in the South Korean pharmaceuticals industry have reportedly increased by 30% from 2011 to 2016. Furthermore, the South Korean Government has promised to invest USD9 billion to develop 20 new drugs, one of the very incentives aiming to take the country into the top seven pharmaceutical-producing countries by 202013.

Many investors are unaware that South Korea is not only a world leader in patent applications per resident, (see fig.4), but also has one of the world’s highest numbers of researchers in employment (see fig.5). This is something that investors cannot afford to miss.

Fig 4: Resident applications per million population (by origin)14

Fig4-In-pursuit-of-Korean-intangibles 

Fig 5: Researchers per 1,000 employed, 201615

Fig5-In-pursuit-of-Korean-intangibles 

M&A IS A CATALYST TO UNLOCK THE “UNDISCOVERED” INTANGIBLE VALUE

From 2010 to 2017, the price-to-book (P/B) ratio for Korean equities (KOSPI) has remained stable at around 1x while that for US equities (S&P 500) has soared from about 2x to 3x16. The disparity could be the result of less prominent mergers and acquisitions (M&A) activity in Asia, including South Korea (see fig.6 & 7), leaving most of the intangible value “undiscovered”.

Fig 6: M&A transactions forecast, USD billion17

Fig6-In-pursuit-of-Korean-intangibles 

Fig 7: M&A forecast (number of deals)17

Fig7-In-pursuit-of-Korean-intangibles 

Heading into 2018 and 2019, it is not surprising to see South Korean M&A become more active as the country’s family-run conglomerates, known as “chaebols”, embark on a restructuring push to add transparency. This could be a catalyst to unlock the “undiscovered” intangible value of many Korean companies.

This is because as a global accounting practice, if a company acquires an intangible asset – such as a brand or patent – it is capitalised as an asset on the balance-sheet. However, if the intangible assets are developed internally, they will be expensed immediately, thus shaving earnings. In this way, “a company pursuing an innovation strategy based on acquisitions will appear more profitable and asset rich than a similar enterprise developing its innovations internally,” write Feng Gu and Baruch Lev in a recent issue of the Financial Analyst Journal18. In Korea, we are seeing cases of M&A that unleash the “undiscovered” intangible value.

For example in February 2018, Kolmar Korea – a key original equipment manufacturer of Korean cosmetics – announced its plan to acquire a 100% stake in CJ HealthCare (the health care operation of CJ Cheiljedang), for about KRW1.3 trillion (USD1.1 billion).

CJ Healthcare has long been undervalued. Some analysts have estimated its value of only KRW692.4 billion19. This acquisition is an example of unlocking the hidden intangible value of CJ Cheiljedang’s healthcare business. The offer price implies a long-undiscovered intangible value of KRW607 billion, or an 88% premium over its estimated value. This reflects the R&D in CJ Healthcare, as well as the brand building efforts in its products such as ‘Condition’ - South Korea’s most popular anti-hangover drink.

ACTIVE INVESTING KEY TO LOCATING THE INTANGIBLE VALUE IN SOUTH KOREA

Therefore, in South Korea where M&A activity is relatively low, active investing is pivotal in discovering the expensed intangibles. This is particularly important as Korean companies operate in a close-knit society, valuing seniority and communicating mainly in their mother tongue.

Having said that, it is an uphill task for analysts and investors to determine the intrinsic value of a Korean company by just crunching numbers in reported earnings, assets, and price-to-earnings, book-to-market ratios.

Analysts and investors should be more proactive in analysing information and materials that accompany earnings calls, investor days, letters to shareholders, not to mention investigating the company’s business operations physically and interviewing their clients for feedback. Although most of the figures and information are unaudited, they could be used to derive strategic implications of the company’s intangible investments and thus the intrinsic value.

This also helps investors to avoid companies that misallocate resources in R&D. Perhaps it takes time for major players in South Korea to adjust their valuation standards. Those with a head start in building their proprietary valuation model, coupled with local expertise, should be more likely to generate excess returns.

 

Paul-Kim_125x137px 
Paul Kim

Chief Investment Officer, Equities

Eastspring Investments Korea


Darren-Choi_125x137px 
Darren Choi

Equity Portfolio Manager

Eastspring Investments Korea



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  • ARTICLE
  • ASIA
  • BIOTECHNOLOGY
  • DARREN CHOI
  • EASTSPRING
  • EDUCATION
  • EMERGING MARKETS
  • EQUITY
  • INNOVATION
  • INSIGHTS
  • INTANGIBLES
  • KOREA
  • M&A
  • PAUL KIM
  • PHARMACEUTICAL
  • R&D
  • SOUTH KOREA
  • TECHNOLOGY
  • THOUGHT LEADERS
  • THOUGHT LEADERSHIP
  • UNDER-VALUE

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