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Management Report

Management reports, briefs issued by Samsung Economic Research Institute

Merger Is the Way

Merger Is the Way

KANG Won

Sept. 26, 2005

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In the grip of cutthroat competition and worsening balance sheet, survival is becoming an increasingly tougher proposition for many of Korea's small and medium-sized enterprises (SMEs). More and more, the question they face is either they seek merger or acquisition (M&A) as a way out of their difficulty, no matter how unpalatable that may be, or face the risk of losing their business altogether.

The Asian financial crisis of 1997 shaved the number of big corporations in Korea, but spared many of SMEs from decimation. Indeed, their numbers slowly grew through the birth of smaller companies from spin-offs and breakups of larger corporations. The number of SMEs that totaled 95,000 in 1996 shortly before the onslaught of financial crisis soared to over 110,000 in 2002 as the economy recovered.

But the growing competition amongst them, and worsening business conditions, have badly hit their profitability. All this is making SMEs tougher to survive as independent, thriving business entity.

A good measure of looking at this trend is through their balance sheets. Those with annual sales of over 10 billion Won show an average operating profit of as high as 5% and those below that level report an average operating loss of 10%. Their performance demonstrates big gaps, with smaller companies receiving proportionately thinner sales revenues and operating profits than their bigger cousins.

This trend is prompting many analysts to underscore the need for considering M&A as a way to give a new lease on life. This contrasts sharply with the past when mergers and acquisitions were mainly considered the way for corporate giants, rather than for small businesses. Now, even the government perceives that corporate consolidation may be the way to raise competitiveness of SMEs.

Mergers certainly appear a good way to enhance their managerial capacity. The absence of management competence remains a chronic problem crippling many small companies. Mergers and acquisitions can be used to pool resources and make up for the non-existing economies of scale. In a growth-stagnant market gripped by fierce competition, a small company overcomes difficulties by merging with another firm that can supplement its shortage. As SMEs have limited managerial resources, acquiring rival firms with requisite skills and resources can save them from crisis.

As a rule, technology start-ups in possession of state-of-the-art technology often lack other resources such as management know-how or marketing skills. In such cases, they can match up with companies that have complementary resources. One such example is the case of Intelix Inc., a global positioning system (GPS) maker. In 2004, it moved to acquire Axess Telecom Corp., a KOSDAQ-listed company with extensive global distribution channels in the CDMA (code division multiple access) wireless local loop (WLL) phone market. When this acquisition is finalized, Intelix hopes to combine the managerial skills of the two companies and more than triple its sales revenues.

On the other hand, companies facing over-competition in a mature market can expand market share by acquiring rival companies. The KOSDAQ-listed Sambo Corrugated-Board Co., Ltd. bought Hwaseung Paper Corp., a subsidiary of Hwaseung Group in June 2005. This deal enabled Sambo to claim the lion's share of the highly competitive paperboard market. As for Hwaseung, it can focus on its core competency. M&A deals can also be a good way for the selling party to exit from the market altogether. A company whose owner faces retirement without a clear succession plan in hand can choose this road to be acquired by others.

Compared with major economies of the world, Korea's M&A market remains tiny. The M&A market's share to GDP in the US is equivalent to 3.6 times that of Korea's. The absolute size of the M&A market in the US is 53.8 times bigger than that of Korea's.

In Korea, both the size of the M&A market and number of M&A cases had shrunken since 2000, but regained the momentum in 2004. It was different for mergers involving SMEs. After the bursting of information-technology bubble in 2000, M&A deals involving SMEs rose sharply, and then reversed course in 2004. However, SME mergers are expected to rise again from now on, as the government imposes more regulatory measures on KOSDAQ-listed firms, thereby forcing the financially weak companies to desert the market through sell-off.

Available data indicate that mergers and acquisitions definitely help struggling SMEs, especially those incurring losses. Of those taking M&A option, loss-making companies before the acquisition deals improved their profits by an average 19.5%. The profit-making companies before the takeover deals could not increase their profits further. A good 75% of loss-making companies improved their balance sheets after acquisition. Only 30% of those already profitable before the takeover managed to improve their profitability.


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