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Effectiveness of Due Diligence Inspection of GM Korea Called into Question
Plan B Needed
Effectiveness of Due Diligence Inspection of GM Korea Called into Question
  • By Michael Herh
  • February 15, 2018, 11:15
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The Korean government shall consider putting a halt to the due diligence inspection into GM Korea and rejecting a request for financial support from GM if GM does not come up with a detailed and specific long-term investment plan.
The Korean government shall consider putting a halt to the due diligence inspection into GM Korea and rejecting a request for financial support from GM if GM does not come up with a detailed and specific long-term investment plan.

 

As the headquarters of GM will shut down GM Korea's Gunsan Plant in Korea, the Korean government has decided to conduct a due diligence inspection of GM Korea. But some experts are skeptical about whether or not the due diligence inspection will produce appropriate and credible results. The due diligence inspection requires cooperation about internal management information and data from GM Korea. But taking into consideration the fact that GM Korea has kept mum about internal management information and data even to the Korea Development Bank (KDB), the second largest shareholder of GM Korea, the due diligence inspection itself may wind up being a formal act.

On February 14, it was said that the KDB clarified its position that three prerequisites should be fulfilled including the disclosure of the cost of sales and transfer prices, the elucidation of allegations about unfair high-interest-rate transactions with the head office and the exercise of shareholders’ rights for audits prior to the due diligence inspection of GM Korea. The KDB says that the bank will embark on a due diligence inspection only if GM Korea accepts it. In the near future, staff members of the KDB and GM Korea will meet to discuss the scope of the inspection.

However, until now, GM Korea has blocked even the second largest shareholder KDB from getting its hands on GM Korea’s accounting books among others up to the hilt so it is unclear whether GM will accept the KDB’s demand with a positive mind. The KDB is the second largest shareholder with a 17% stake in GM Korea and tried to exercise rights such as inspecting GM Korea’s accounting books and financial conditions guaranteed by the commercial law. But GM Korea did not cooperate, making the KDB fail to do that.

In addition, the KDB inserted shareholders’ rights for audits in an agreement between shareholders when cutting a deal to sell Daewoo Motors, the predecessor of GM Korea to GM in 2002. However, in March of last year, the KDB asked GM Korea for 116 pieces of information including the cost of sales and administration expenses. However, only six pieces of information were submitted and the rest was not disclosed. GM Korea called the rest “secrets.” It is said that GM Korea refused to provide even information on board meeting processes or minutes of board meetings.

In March 2016, the KDB drew up an intensive management plan to conduct management consulting, strengthening preemptive monitoring, and strengthening minority shareholders’ rights after designating GM Korea as a company subject to intensive management. But the KDB could not implement the plan due to GM Korea’s opposition. This means that the KDB is the second largest shareholder of GM Korea in the Commercial Law, but virtually has neither intervened nor played any roles in management.

In particular, in connection with an allegation that GM Headquarters took excessive unfair profits by inflating transfer prices while providing parts or technology to GM Korea, KDB requested GM Korea for information and data germane to transfer prices several times, but GM Korea rebuffed it.

GM Korea has not cleared up an allegation that GM Korea plied high-interest-rate unfair trade with GM Headquarters. GM Korea borrowed 2.4 trillion won from GM Headquarters at an annual interest rate of 5%, saying that the company needed more funds. The interest which had paid to GM Headquarters until 2016 ran to 462 billion won. "Several years ago, there was controversy over transfer prices with GM Headquarters so we attempted to confirm it at the government level but we had no choice but to stop as we could not confirm data on how much value is added to numerous processes,” a KDB representative said. “Although transfer price controversy is resurfacing, there is virtually no way to confirm that transfer prices are excessive and exorbitant."

While the Financial Supervisory Service (FSS) is looking into the facts about R&D cost items as GM Korea’s accounting practices become an issue of concern, it is highly likely that the FSS will encounter its limitations. Some insist that a reinvestigation such as a parliamentary inspection should be launched into whether or not GM Korea borrowed funds from GM Headquarters at a high interest rate, exorbitant expenses for business support from the headquarters and controversy over transfer prices which are issues raised by political circles.

The KDB believes that as GM Korea suffered a net loss of about 2 trillion won over the past three years, and its financial health deteriorated to such an extent that the company fell into the impairment of capital in the first quarter of last year for the first time since its establishment, it is urgent to grasp GM Korea’s exact financial situation by carrying out an in-depth due diligence inspection based on information such as cost of goods sold or transfer prices. The KDB will reportedly determine whether or not to give GM Korea supports such as capital increase with consideration demanded by GM Korea based on the results of the due diligence inspection. GM is planning to go ahead with a capital increase of about three trillion won with consideration and asked the KDB to take part in the capital increase. Taking its stake into account, the KDB will have to invest about 500 billion won (US$450 million).

It is also noteworthy whether or not the KDB and GM Korea will see eye to eye on the three prerequisites, the scope of the due diligence inspection and the selection of a third and external specialized organization even though GM Korea accepts the due diligence inspection. It usually takes two to four months to complete a due diligence inspection of a company. Therefore there is a physical limitation as it is difficult for the KDB to meet the due diligence deadline of the end of February which GM Korea proposed in deciding whether or not to support GM Korea. This sets off reproaching voices against GM Korea that GM is only pressing the Korean government after setting the deadline that cannot be met by the Korean government.

Korean Gov’t Mapping Out Plan B in Preparation for GM’s Withdrawal

It is said that the Korean government is formulating Plan B for GM’s withdrawal from Korea while the Korean government is preparing countermeasures for each scenario after the due diligence inspection of GM Korea. Regardless of the results of the GM Korea inspection, the government is planning to provide conditional support for GM Korea such as a put option on KDB's stake of 17.02%.

In preparation for GM's rejection of conditional supports from the Korean government, the Korean government will prepare measures for GM Korea’s partners and employees such as the suspension of the repayment of loans and the stabilization of the local economy at the same time. The Korean government judges that preemptive responses are needed to deal with sudden moves such as the closure of Gunsan Plant by GM Korea.

On February 14, the Korean government began to devise countermeasures for each scenario in consideration of the results of the KDB’s due diligence inspection in a working level discussion. It is analyzed that at present the liquidation value of GM Korea eclipses its continuance value due to the plan on the closure of Gunsan Plant.

"Regardless of the outcomes of the inspection, we will have to set conditions for funding and propose conditions by taking into account put options and a capital decrease among others,” a government official said. “We are discussing a plan to cope with GM’s withdrawal."

The Korean government’s basic and key policy is to focus more on industrial outlooks and growth potential than the financial part. Accordingly, GM Korea's future growth potential may overwhelm its liquidation value, depending on how much GM Headquarters will invest in GM Korea prospectively. In the due diligence inspection, the KDB will thoroughly grasp GM Korea’s plan for long-term investment in Korea.

The Korean government will also consider putting a halt to the due diligence inspection and rejecting a request for financial support from GM if GM does not come up with a detailed and specific long-term investment plan.

In the event that GM’s maximum cooperation enhances GM Korea’s continuance value and future growth potential, the Korean government will propose a conditional support plan for financial support requested by GM. That is to say, if GM asks for a capital increase with consideration, the KDB will propose the reduction of capital stock without any refund and a put option as large as the amount of new input by the KDB among others. 

Financial authorities will provide the suspension of the repayment of policy funds’ principals and the extension of their maturity to GM Korea's partners. They will also make measures for the payment of interest only after the end of the extension of their maturity. It is expected that they will expand special guarantees and provide special guarantees for small business owners.