Double Star to take over Kumho Tire by June

Following an intense weekend, It appears that China’s Qingdao Double Star will become the de facto controller of Kumho Tire by the end of June this year.

We informed our readers of this over the weekend, together with an in-depth analysis. To learn more, subscribe to the April issue of our global tire industry newsletter.

Last Friday (30 March), the deal looked far away, but by Monday (2 April), Korean unions, Creditors and management of Kumho Tire had agreed a memorandum of Understanding (MoU)

Details of MoU

  • No forced job losses for three years (5000 Korean workers)
  • Double Star to retain all shares for at least three years
  • Workers to accept a pay freeze from 2017-2019
  • Gwangju and Goksung Plants to improve productivity by 4.5%
  • Above plants to close for 40 days/year with workers paid for 10 of those
  • Workers to return 25% of bonuses given over two years.

Ahead of the agreement, Kumho management had said it had gained a no-strike commitment from the Unions, that meant no strikes of more than a week. It is not clear if this is in the final MoU between the various parties.

Although Double Star has not officially signed the arrangements, that is expected later this week, along with an injection of cash following a restricted rights issue. Double Star chairman chairman Chai Yongsen previously said his company is patient, but that patience will not last for ever. He continued, “There’s an old Chinese saying, ‘If you love someone, at the end you’ll be together,’”

Financial arrangements

  • New shares to be issued and bought by Double Star
  • Double Star to pay KRW646,300mn (USD608mn) for new shares
  • Double Star will own 45% of the total equity (including new shares)
  • KDB and other creditors shareholding drops to 23.1% from 41.01%
  • KDB and other creditors to ease re-payment terms on existing debts
  • KDB and other creditors to provide cash to service interest payments.
  • KDB, Unions and Management to form a ‘future committee’ to advise DStar

A year ago, Double Star was prepared to buy the creditors’ 41-percent shareholding for KRW955bn (USD850mn), valuing the company at KRW 2328bn. That fell through after KDB and the creditors turned down a demand from Double Star to cut the price by 16%. The current deal values the company at just KRW1435bn.

The existing shareholders have accepted a drop in value of almost 40% in a year. This reflects their desperation to sell as the only possible means of recovering the outstanding debts owed by Kumho Tire.

Events over Easter

Ahead of the Easter weekend, Kumho Tire management and creditors, as well as government, all said that – without the Double Star deal – Kumho Tire would default on its debt repayments due today (Monday), and this would lead the creditors to declare the company bankrupt, leading to huge job losses and a fire sale of assets, reported to be worth just KRW460,000mn (USD440mn), according to an accounting firm’s due diligence on Kumho Tire.

Korean Unions, who had be refusing to sign any agreement over fears that Double Star would steal intellectual property and then close factories in a so-called ‘Dine and Dash‘ stripping of assets, agreed early on Saturday to hold a vote among their members over the deal. The Unions agreed to recommend the deal to members, based on the fact that there was no realistic alternative.

The vote was held on Sunday morning (April 1), Korean time and approved the Double Star deal. The vote in favour was 60.6%, with a turnout of 91.8% of 2741 eligible members. Local newspapers said few of the workers were happy with the deal, but felt they had no choice but to accept.

What happens now? Our view

Up to now, Double Star has given few indications of its plans for Kumho. The company said earlier this month that if its bid is successful, management expects to remain hands-off for a period of a year or two.

We think it unlikely that Double Star management will adhere to this commitment.

We do not believe the Chinese owners will be prepared to watch the company losing money at the rate it is doing at present, and remain hands-off.

We have also heard that management, unions and creditors are to form an advisory panel,called a ‘future committee’ to advise Double Star management on running the company.

Double Star (DS) is best known in China for its sports shoes, and has a smaller business making truck tires.

Kumho Tire (KT) makes almost exclusively passenger car and light truck tires, albeit with some military contracts for aircraft tires and heavy vehicles.

The management in Double Star’s Qingdao headquarters remains very traditionally Chinese.

This monolithic Chinese culture will be a significant handicap as DS tries to stem the losses at KT and then integrate the businesses and management cultures in KT’s Korean and overseas operations. KT operates in Korea and other international environments and almost exclusively in the passenger car tire business.

Kumho Tire losses

KT reported an operating loss of KRW117,089mn in the 12 months to December 2017 (a little over USD100mn). That might be acceptable for a short transition period, but it is not sustainable over any length of time. Double Star is paying six times that for a near-controlling stake in the company, and much of that money will be available to it during the turn-around process. Nevertheless, KT’s annual operting loss amounts to around 10% of Double Star’s annual turnover. The company recorded sales of CNY7,257mn –just over USD1000mn –in 2016.

If KT’s losses were reducing, then DS management could maybe afford to leave day-to-day management at KT to the Koreans. But KT’s losses are accelerating fast. The operating loss in 2017 was three times the loss in 2016.

We accept that there were other factors diverting the attention of KT’s management in 2017, but it seems to us that one of the first moves from the new owners must be to act aggressively to stem these losses. The measures announced in the MoU (See box, above) go some way toward this, but will not be enough on their own.

We have heard of many customers stopping or reducing the orders placed with Kumho due to the uncertainty around the company’s future.

We hope the clarity provided by this deal will remove that uncertainty, but there has to be a concern that any robust decisions by Double Star management to stabilise the business will push the combative unions to test the strength of the new owners.

We have no idea how Double Star management, which has no experience of handling a union-led strike, could handle that situation.

Integration needs strong, experienced management

In our experience, this kind of cross-cultural situation desperately needs a senior Chinese national who is in the inner circle of Double Star management, speaks fluent Korean, and is sympathetic to the concerns of the Korean management and workers.

We have seen no evidence that such individuals exist, either within Double Star, or Kumho Tire. It has to be the top priority of Double Star to appoint that kind of person, who will be in charge of the turn-around project and the subsequent integration activities.

The ‘Future Committee’ of Korean management, workers and creditors goes some way toward this objective, but the need to create this panel underlines the need for Double Star to have access to trusted advisors. Furthermore, the panel does not necessarily have the interests of Double Star at heart.

The fact remains, however, that Double Star’s management has never successfully operated any business outside China, and certainly has no clue about operating as an OE and replacement supplier in the international passenger car tire business, with its requirements for technical development as well as distribution, dealer incentives and other aspects of the international tire industry.

This means the DS management will be forced either to trust the existing KT executives, or to step in and make decisions on the basis of no experience in this industry.

Implications for overseas operations

Up to now, this whole affair has been handled as a financial story internal to Korea. Neither the Koreans, nor the Chinese appear to have given any thought to the impact of their discussions in Korea are having on the overseas operations of Kumho Tire, or their customers, or, indeed the wider tire industry.

This is another major mistake.

I have lost count of the people – many of them very senior – who have asked me about the future of Kumho Tire. Outside Korea, no-one – including senior management at Kumho Tire’s subsidiaries – has any clue about what will happen in the coming months. This uncertainty has hit morale and led to the loss of orders mentioned above.

As soon as Double Star signs the deal and releases the funds, they need to recruit a global communications agency to reassure stakeholders around the world that this deal will result in benefits for Kumho Tire and its stakeholders. A large part of that communication will necessarily be with international trade press and at trade events.

Our best view, in the absence of any guidance from Kumho, is that all international operations will be starved of funds; capital expenditure will be slashed and workers will be asked for pay freezes and improved productivity, as has been demanded from Korean workers. Kumho is already under-invested after a decade or more of austerity. Another decade of under-investment will do the company no favours.

It is our experience that some Chinese managers have become over-confident in their own abilities, based on success in the Chinese market. This success leads them to believe they have the skills and experience necessary to succeed in the international business environment.

The best possible outcome would be for us to be proved wrong.

We hope that is the case, but, unfortunately, the evidence does not appear to support that outcome. Only time will tell.

David Shaw

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