[News analysis] How Samsung Electronics vice chairman consolidated power in the country’s largest chaebol

Posted on : 2018-11-30 15:51 KST Modified on : 2019-10-19 20:29 KST
Case of Samsung BioLogics accounting fraud an obstacle in Lee Jae-yong’s ascension to power
How Samsung Vice Chairman Lee Jae-yong inherited power
How Samsung Vice Chairman Lee Jae-yong inherited power

The finding by South Korea’s financial authorities that Samsung BioLogics engaged in deliberate accounting fraud throws a major roadblock in the way of a plan to help Samsung Electronics Vice Chairman Lee Jae-yong inherit control of the Samsung Group. The fire is spreading to the 2015 merger between Samsung C&T and Cheil Industries, which played a major role in this plan. The view at Samsung is that this incident is the biggest crisis since the influence-peddling scandal involving former president Park Geun-hye and her confidante Choi Soon-sil.

Lee’s inheritance plan largely consists of three stages: raising seed money, buying a stake in major affiliates at a cut-rate price, and expanding that stake through public listings and mergers. The first two stages of this plan were skillfully completed over the past two decades, but the third stage has been rushed along. The plan had to be accelerated when Lee’s father, Samsung Electronics Chairman Lee Kun-hee, was incapacitated by a heart attack in May 2014. If Lee Jae-yong directly inherits a controlling stake in the Samsung Group, the inheritance tax would run into the trillions of won (billion of US$).

Samsung SDS, in which Lee Jae-yong held a 9% stake, went public at the end of 2014. For a long time, Samsung had repeatedly and explicitly stated that it had no plans to list the company on the exchange. Samsung Everland – the company whose convertible bonds Lee had bought in 1996 on the cheap to multiply his seed money – was renamed Cheil Industries in June 2014. Cheil Industries, once a well-known fashion brand, had sold its fashion division to Samsung Everland at the end of 2013, and the rest of the company was acquired by Samsung SDS in July 2014.

Thanks to the public listing of Samsung SDS and the partial merger of Samsung Everland and Cheil Industries, Lee gained control of shares with a market value of over 6 trillion won (US$5.36 billion). The seed money he had used to acquire shares in the two companies in the late 1990s had been worth less than 10 billion won (US$8.9 million). At the end of 2014, Lee purchased about 20 billion won (US$17.87 million) worth of shares in Samsung Life Insurance and Samsung Fire and Marine Insurance, financial affiliates that play a key role in the Samsung Group’s control structure.

In May 2015, Cheil Industries (formerly Samsung Everland) laid the groundwork for combining with Samsung C&T. Considering that Lee held a 23.2% share in Cheil Industries and no share at all in Samsung C&T, it was in his interest to inflate the value of the former and deflate the value of the latter. Through a bizarre metamorphosis – in which Samsung Everland absorbed part of Cheil Industries and adopted its name before being merged with Samsung C&T – Lee ultimately acquired a stake in Samsung C&T, effectively strengthening his control of the group.

Samsung BioLogics was used to puff up Cheil Industries’ value. In 2010, the Samsung Group selected biotech and pharmaceuticals as one of five up-and-coming industries; in 2011, it established Samsung BioLogics to produce pharmaceuticals on a consignment basis; and the next year, it set up Samsung Bioepis to develop biosimilar drugs. Samsung Everland became the majority shareholder in Samsung BioLogics, while Samsung Electronics was its second largest shareholder. (As previously mentioned, Lee was the majority shareholder in Samsung Everland, which later changed its name to Cheil Industries before merging with Samsung C&T.) The stage was set for making Lee just as famous for biotech as his father was for semiconductors.

How Samsung inflated its numbers to convince shareholders to vote for merger

On July 1, just two months after announcing the merger plan in May 2015, Samsung unveiled a previously undisclosed Samsung BioLogics facility in Songdo, Incheon, to financial analysts, following a briefing about the company the day before, on June 30. These were part of a concentrated effort by the group to inflate Cheil Industries’ value. The reports written by financial analysts with a close relationship to Samsung were used as reference material by the accounting firm that assessed Samsung’s biotech business during the merger process.

The accounting firm’s assessment report then served as a major justification for the South Korean national pension fund, which was the single greatest shareholder (11.2%) in Samsung C&T, to vote in favor of the merger. That wasn’t the only problem. While Samsung BioLogics’ value was being exaggerated, no mention was made of the call option possessed by Biogen, an American pharmaceutical company in a joint venture with Samsung BioLogics. This call option gave Biogen the ability to acquire an additional 41% share in Samsung Bioepis by 2018. The rules of accounting require that call options be treated as debt, but Samsung BioLogics didn’t put this debt on the books until the merger went through. South Korea’s Financial Supervisory Service (FSS) believes that Samsung deliberately kept the call option off its books to exaggerate the value of stock at Cheil Industries, the majority shareholder in Samsung BioLogics.

Merger put Samsung in state of capital impairment

This choice ended up backfiring in a devastating fashion. After the merger went through in September, Samsung C&T assessed the value of its biotech business (including Samsung BioLogics and Samsung Bioepis) as being worth 6.9 trillion won (US$6.17 billion) while it was combining the pre-merger books in order to prop up its stock value. This had the effect of also raising the value of Biogen’s call options (that is, debt) to 1.8 trillion won (US$1.61 billion), which put Samsung Biologics in a state of complete capital impairment. Since capital impairment would prevent the company from not only going public but also taking out bank loans, Samsung had to prevent this at any cost.

Documents that Samsung Biologics submitted to the Samsung Group’s Future Strategy Office (FSO) at the time show that the group considered three options for preventing capital impairment—revising the call option contract, converting Samsung Bioepis to an affiliate, and reducing the value of the call option—and ultimately opted for the second of these. Converting Samsung Bioepis to an affiliate created a huge amount of profit for Samsung Biologics, at least in the books. Resorting to this kind of change in bookkeeping requires unusual circumstances, such as the loss of control over the company, but Samsung Biologics justified this by noting that “the corporate value increased when sales permits began coming in for products developed by Samsung Bioepis.” The financial authorities concluded that this was “4.56 trillion won [US$4.07 billion] worth of deliberate accounting fraud.”

During the same period, Samsung C&T’s value was being suppressed. Despite owning the popular Raemian brand of apartments, Samsung C&T slashed its supply of apartments in 2015, when the merger was being pursued, and it concealed the fact that it had won an order for a large power plant overseas shortly before the merger, only revealing this afterward. It also handed over some of its overseas construction business to Samsung Engineering. There were even rumors going around that the company was going to sell off Raemian, which was the number-one brand in the apartment industry.

These actions were all aimed at reducing Samsung C&T’s corporate value, which could be regarded as breach of trust. Samsung C&T’s value ended up falling around 10% in the first half of 2015, even as stock prices at other large construction firms were rising by 20% or 30%. When the merger went through, Cheil Industries was valued as being worth three times more than Samsung C&T, even though Samsung C&T had three times more assets than Cheil Industries. Lee became the majority shareholder in post-merger Samsung C&T, which serves as a holding company for the Samsung Group, with a share of 17.23%.

Lee increased grip on Samsung Electronics while gaining control of Samsung C&T

Lee started working for Samsung Electronics in 1991 and became the company’s vice chairman in 2012. Back then, he had only a 0.6% share in Samsung Electronics. That remained the case until Chairman Lee Kun-hee’s hospitalization in 2014, at which point the campaign to give Lee Jae-yong stable control of Samsung Electronics went into overdrive. By maximizing the value of Cheil Industries, in which Lee held a 23.2% share, and then merging that company with Samsung C&T, in which he had no shares at all, Lee could gain control of Samsung C&T while simultaneously strengthening his grip on Samsung Electronics.

Prior to the merger, Samsung C&T held a 4.1% share in Samsung Electronics. By convincing then president Park Geun-hye to help with the national pension fund and on other matters, Lee managed to use the Samsung C&T holding company to gain control of the Samsung Group’s dual dynamos of Samsung Electronics and Samsung Life Insurance.

But not everything that Lee has gained through this process has been positive: namely, the stigma of having secured his inheritance through illicit means. With the 6.1 billion won (US$5.45 million) in seed money that he received from his father in 1996, Lee bought 4.8 billion won (US$4.29 million) worth of convertible bonds in Everland in 1996 and 4.7 billion won (US$4.2 million) in bonds with warrant at Samsung SDS in 1999.

Those convertible bonds he bought in Everland way back then, after passing through Cheil Industries, have become stock in Samsung C&T that is presently worth more than 3.2 trillion won (US$2.86 billion). The value of his stock in Samsung SDS is also currently worth 1.3 trillion won (US$1.16 billion). Lee gained shares in key affiliates in the group through convertible bonds and other questionable means. Lee’s current stake in the Samsung Group amounts to 6.3 trillion won (US$5.67 billion). A simple calculation shows that, over the course of some twenty years, his seed money multiplied a thousand fold.

By Choi Hyun-june, staff reporter

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