Hyundai Motor Company-Beijing Automotive Joint Venture Case Study Topics in Emerging Markets Prof. Mei April 9, 2003 Michael Cheng

Before the economic crisis of 1997, South Korea's postwar economy had been the envy of most developing countries. By using the Japanese model of high savings, close cooperation between government and business, and export-oriented growth, the country quickly transformed itself from a poor war-torn nation into an industrial and technical powerhouse. GNP per capita in South Korea had risen from a mere US$200 in 1960 to more than US$11,500 by 1996.

But rapid growth hid a much darker side of development. Close cooperation between government and business also fostered a system of corruption and speculation. The Korean economic crisis escalated through a series of marked events in 1997: business bankruptcies and employment insecurity; a sharp rise in interest rates, dramatic fluctuations of the exchange rate, and a collapse in stock prices; exodus of foreign currency, a contraction of foreign bank loans and growing difficulty in foreign debt settlements. Each step in the escalation of the crisis brought the Korean economy closer to an overall meltdown. To stem the crisis, Korea began negotiating with the IMF for a huge bailout. In December 1997, Seoul agreed to a US$57 billion rescue package, but the IMF insisted the aid be equated with reforms in South Korea's financial system. The changes endorsed by the IMF are expected to cause mass unemployment. According to the National Statistical Office, the nation's jobless rate reached 3.1% last December, the highest figure in 54 months.

The government announced that the economic growth rate for 1998 is expected to be around 3% and unemployment at 3.9%. However, various other private economic research institutions have presented a much more pessimistic outlook. Daewoo Economic Research Institute forecasts 1998 economic growth rate of 2.2% and unemployment rate at 5.0%. From these figures, it is possible to estimate that unemployment will reach about 1.2 million people, a sharp increase from the current level of 470,000.

In the wake of the Asian financial crisis, South Korea began an economic reform program designed to address some of the conditions that made its economy vulnerable. Most importantly, the South Korean government has begun to break the hold of the chaebols (large, multi-industry conglomerates) over the financial sector. The lack of an "arms length" business relationship between borrowers and lenders had led to many South Korean financial institutions having a very large ratio of non-performing loans. While there is no intention of forcing the chaebols to divest their financial subsidiaries, the government has increased regulation to prevent chaebols from arbitrarily channeling money into other subsidiaries. Chaebols also have been pressed to spin off their non-core businesses and to rationalize their corporate structures. To stimulate domestic demand, the South Korean government under President Kim Dae-jung enacted a package of tax cuts directed at lower and middle-income workers. 

Under its newest president, the South has embarked on a thoroughgoing program of economic reform. The economy has opened up to short- and long-term capital from abroad. Jobs are less jealously protected than they were. Minority shareholders now have powers to question managers. Starting this year, companies will have to comply with international accounting standards. The supervision of the financial system has been overhauled to meet international norms.

To judge by the economic indicators, these measures have been unexpectedly successful. In the first quarter of this year GDP was 4.6% up on a year earlier. The won is back to 1,170 against the dollar, and the stock market is back to pre-crisis levels. Exports have begun to rise again. Stocks have been run down and industrial production has perked up.

Financially, South Korea is more integrated into the world economy now than it was in 1994. Foreigners are major players in the capital markets, accounting for nearly 40 percent of stock market transactions, and South Korean residents have greater opportunities to move their funds abroad. The use by South Korean financial firms of off-balance sheet transactions and financial derivatives, which did not exist in 1994, is expanding rapidly. While it is true that the South Korean stock market actually rose during the last crisis, the expanded role of foreign participants and the increased complexity of the financial transactions mean that the market today is far less susceptible to political intervention than it was a decade ago.

Hyundai Financial Analysis
Introduction:
The collapse of the Asian market bubble in 1997 was more than just a devaluation of Asian companies and markets. The effects of this crisis forced these companies to reevaluate their financial and investment position in their own countries. Previous to the market crash, Korean, and other Asian markets where relatively successful. However, underlying all the success of those companies in Asian markets was basically an inefficient economic trend of reckless borrowing and overvaluation. At this point, the ripple effect took into action and Korean companies, including its biggest automaker, Hyundai Motor Corp, suffered from overcapacity and smaller companies like Kia Motor had no choice but to join their rival, Hyundai. To offset the negative effects that this crisis caused, Hyundai Motor Corp. was forced to invest in other countries to maintain a positive profit margin. This not only helped their financial outlook, but it also made it clear to other manufacturers that Hyundai was a legitimate global player.

Since the Asian market crisis, Hyundai has experienced an increase in revenues for the past five years. Evidence points to Hyundai’s commitment to global expansion as a main factor for this success. With new manufacturing plants in India, China, Europe, and the United States, and joint ventures with other automakers in different countries, Hyundai has been able to stay afloat in the volatile foreign car market. Hyundai also has its new product development strategy to thank for its financial success. This became evident in 2002 when Hyundai announced joint ventures with DaimlerChrysler and Mitsubishi to produce new technology and automobiles. Since the crisis, Hyundai has invested a total of $6.25 billion and plans to invest even more in the future to continue its global success.

The year ending in 2002, Hyundai’s sales topped 24 trillion won which translates into approximately $20 billion. Since the Asian crisis, Hyundai has been able to more than double its sales in the past five years, a feat that is almost unheard in any industry, especially in an industry where volatility and trends are unpredictable and the competition is fierce. A primary factor in this substantial growth is the exporting Hyundai has done with other emerging market countries and in developed countries. Exporting accounts for almost half of all automotive units sold in 2002. Interestingly, Hyundai has been able to achieve financial ratios like this across the board. Hyundai’s assets, revenue, number of units, return on sales, and net income have all almost doubled since 1997.

As mentioned before, the Asian financial crisis’ origin came from reckless borrowing by companies that did not look much to the future effects of this. Unfortunately, Hyundai was one of those debt hungry corporations. However, like any resilient corporation, Hyundai was able to learn from their mistakes and corrected the problem almost immediately. Rather than borrow from unstable treasuries, Hyundai turned to partnerships and equity to finance their global strategy. At their debt-ridden peak, Hyundai’s debt-to-equity ratio was close to 300%, currently, however, they have a ratio in the lower bound of 50%. A lot of the success that contributed to this tremendous growth is their affiliate companies in which their ownership varies. Hyundai has interest in over a dozen affiliates including internet companies, Hyundai Motor in countries such as China and Germany, and chemical companies.

Trading on Korea’s KSE composite index, Hyundai Motor Corp trades at 24,000 won with an average volume of 1.5 million shares. Hyundai does pay a dividend of 850 won, which is a common practice in the automotive industry both in domestic and foreign markets. With a price-to-earnings ratio of 5.03, Hyundai does lag compared to the competition. The industry’s average P/E is approximately 21.65, a relatively low P/E when you look at conglomerates such as Ford, General Motors, or DaimlerChrysler. The vast differences between the P/E ratios could be explained by a couple of factors. Being a cyclical industry, the P/E ratio would not be a good benchmark to compare these companies. A more accurate ratio that one could use would be the Price-Earnings-Growth ratio. Since Hyundai is in an emerging market and has experienced unprecedented growth in the past five years or so, a PEG ratio would incorporate the growth aspect to the valuation regression.

Discount rate:

Our valuation of equity started with the estimation of growth. Looking at analysts’ estimations ranging from 2.5% to 9%, and doing our own estimation, we estimated an appropriate growth rate of 7%. Originally, we thought it would be best to have a lower growth rate; however, it is our assumption that Hyundai is a stable company that has enough earnings and expansion potential to increase their growth for at least the next 10 years. Looking at the balance sheets of Hyundai, we found that the free cash flow to equity is approximately 420 billion won. Using the Gordian Growth stable growth DCF model for equity valuation, we found the value of the company as 6.7 trillion won. Hyundai, having 219 million shares outstanding, translates into a target price of 30,605.44 won. Currently, Hyundai Motor Corp (Ticker: 05380.KS), last traded at 25,000 won on March 28, 2003.