1. Lost 15 Years

It’s a term used in Korea (“주인 없는 회사”) to describe companies with fragmented shareholder base and no one monitoring the management team. Might be quite common in other countries, but they are very rare in Korea; almost all companies in Korea have “owner family” who controls the business, with as little as 5% stake.

KT&G was privatized 20 years ago, in 2002, and since then it had no shareholder that actively oversaw the business. Naturally, people in Korea call KT&G an ownerless company, and assume the company is inevitably loosely managed.

All numbers are from KT&G’s annual report Mar 2022.

(A) current market cap (based on average August 2022 stock price) is KRW9.8 trillion, excluding treasury shares.

(B) Cash and cash-like assets are KRW6.4 trillion.

(C) Value of ginseng company is KRW3.7 trillion.

A (9.8 trillion) is less than B + C (KRW 10.1 trillion), and we haven’t even counted in the value of tobacco business yet.

This “negative EV” is not only unfortunate, but also very rare for a blue-chip company like KT&G, which is also KOSPI’s 33rd largest market cap company (as of August 31, 2022).

Note:

• Please see Episode 3 (Ginseng) for more on the valuation of ginseng business. Watch here
• Please see Episode 4 (Focus) for the value of subsidiaries and Real Estate business. Watch here
• Please see Episode 5 (Cash) for more on cash. Watch here

The same numbers we just used:

(1) Cash and cash-like assets are KRW6.5 trillion.

(2) Value of ginseng company is KRW3.8 trillion.

Now on top of these, let’s think about “the value of tobacco business”.

KT&G’s global peers are trading at the median of 12.2x EBITDA (2021). When we multiply 12.2 times tobacco business EBITDA 2021, we get KRW11.5 trillion.

So, if we add 6.4 + 3.7 + 11.5, we get KRW21.6 trillion, which is roughly 2x of the current market cap (average August 2022 stock price).

But this is just the immediate potential right now, if KT&G focuses on its core business and grow them on a global scale, in the next 5 years the stock price can more than quadruple.

You can find more details on our 5-yr projection here.

Most critically, management team has no incentive to care about stock price. Their companesation is disconnected from stock price movement, and in this circumstances, they will be inclined to opt for zero-risk, maintaining staus quo, even if they know how to triple the stock price.

We believe aligned incentive, the core principle of Governance, is the key to maximizing sharhoelder interest.

Flashlight has an in-depth expertise in designing and implementing stock-base compensation to management team in Korea. We have witnessed countless cases where stock option leads to immediate, real change in management team’s behavior.

YTD Sep 2022 KOSPI is down by more than 20%, whereas KT&G is up almost 10%. Why?

In our view, KT&G’ has little room to decline because it has a negative EV, hugely discounted from its inherent value. KT&G is different than other stocks that reflect the present value of their future prospects.

Not exactly something to write home about.

Below is the list of the top 5 shareholders we see from Blomberg (Sep 30, 2022). This may not be accurate, but nevertheless we are sharing this as a quick reference.

• NPS (National Pension Service of Korea): 7.5%
• First Eagle Investment Management: 7.1%
• Industrial Bank of Korea: 6.9%
• BlackRock: 4.7%
• ESOP (Employee Stock Option Plan): 2.8%