The “approval of the acquisition of a defense company” has emerged as a new variable in the sale of Kumho Tire, for which Chinese tire maker Doublestar was selected as the preferred bidder. Since Kumho Tire supplies tires for Korean military fighters and trainers, a Chinese corporation must pass a rigorous verification and approval process set by the South Korean government.
The South Korean government is said to have emphasized this point to three Chinese-based companies -- Doublestar, Shanghai Aerospace Industries (SAI) and Jipro which participated in the main bid to take over Kumho Tire in January. It was reported that this point was also notified to the tire company’s creditors that are the sellers. Some analysts say that the South Korean government was concerned over the possibility that Kumho’s defense business will be transferred to the Chinese company as well if the cash-strapped tire maker is sold off to a Chinese company.
According to the investment banking industry and the Ministry of Commerce, Industry and Energy on March 14, if Kumho Asiana Group chairman Park Sam-koo fails to exercise a preferential right to take over Kumho Tire, Doublestar should apply for the acquisition of a defense company to the South Korean government next month. Then, the South Korean government must notify Doublestar of whether or not they approve the deal within 30 days at the longest.
In order to acquire a defense company, regardless if the acquirer is a domestic corporation or a foreign corporation, both the industry ministry and the defense ministry should determine whether the corporation has the ability and willingness to maintain production facilities and technology, based on the Defense Business Act. In addition, foreign corporations should be subject to regular inspections and background checks regularly in compliance with security regulations. The representative of a foreign corporation is also prohibited from obtaining information related to defense products. If the sale is made without approval even though there is a defense division in the deal, it could be sentenced to less than one year in jail or a fine of up to 5 million won. In the worst case, the sale could be nullified.
The South Korean government has strictly dealt with foreign corporations’ acquisition of Korean companies that produce defense materials and hardware. There has been no precedent for the South Korean government to okay a Chinese company’s acquisition of a South Korean defense company. At the time of the foreign exchange crisis in 1998, the South Korean government allowed a foreign company's acquisition of a South Korean defense company for the first time for foreign investment attraction. The most recent approval was Morgan Stanley's acquisition of a stake in Hyundai Rotem in 2006. Hyundai Rotem was engaging mainly in train cars at the time, but also produced and delivered defense products such as combat vehicles. For this reason, most companies which produce defense materials spin off their defense material sector and sell the rest only. However, Kumho Tire's defense products account for only 1% of total sales, making it difficult to spin off the production unit as a separate company.
Some industry experts believe that it will be possible for Doublestar to operate the defense business after a verification process since Kumho Tire's defense business accounts for a small portion. However, there is also a prediction that the South Korean government may put a brake to the sale of the tire company in order to avoid disputes over technology leakage to China in the midst of a Terminal High Altitude Area Defense (THAAD) system controversy. "The sale of Kumho Tire is not general sale, and financial institutions like the Korea Development Bank (KDB), a state-run bank, are its creditors, so it cannot be ruled out the South Korean government may interfere with national interests as a just cause. Until recently, there have been cases where the US and Japan unofficially interfere with similar deals for fear of technology leaks," an IB industry official said. In fact, when a Japanese company was pursued by a Korean company, the Japanese government used Japanese competitors to stop it. However, it is highly probable that the South Korean government’s intervention may collide with the preferred bidder Doublestar and further with the Chinese government amid the situation that the THAAD controversy is generating a huge fire storm.
Under the circumstances, Kumho Tire's main creditor bank KDB and chairman Park are fighting each other over whether a consortium should be permitted or not for Park’s acquisition of the tire maker. On the same day, the KDB officially informed chairman Park of conditions in the contract with Doublestar. Accordingly, Chairman Park should inform the creditors about whether or not he will exercise his preferential right to take over Kumho Tire and how he will raise funds to buy the company by April 13. "I asked the creditors to say yes or no for the approval on a plan to take over the company after my forming a consortium. Why does the KDB only still say no even though the bank is not the shareholder with a 100% stake?” chairman Park said. He added that he will take a legal action against the KDB for not discussing forming the consortium. Park also made it clear that he will not submit a plan to raise funds requested by the KDB in the course of the exercise of his preferential right to take over Kumho Tire.
"If Park asks the creditors to allow the consortium including a fund-raising plan during the exercise of his preferential right to acquire the tire company, the creditors will discuss the matter legally," an official at the KDB responded to Park’s claim, adding, "It defies common sense to allow a consortium without procedures and specific details."