Two weeks ago (published last week) I interviewed Ori Eyal, Founder and Managing Partner of Emerging Value Capital Management for ValueWalk as part of the ValueWalk Value Fund Interview Series. One of the emerging markets that has caught Ori Eyal’s attention is South Korea (along with Israel), specifically, South Korean preference shares.
Rupert Hargreaves: Emerging Value Capital Management ’s largest position is a basket of South Korean preferred stocks. Around a fifth of your portfolio is allocated to this asset class, what do you like about South Korean preferred stocks in particular?
Ori Eyal: This is actually my favorite topic. There’s an anomaly in South Korea that I don’t believe exists anywhere else. These shares, we call them preferred, but their correct name is preference shares. These preference shares are almost the same as common shares, but the main difference is that the preference shares don’t have voting rights — somewhat similar to Class A and Class B shares in the US. Now, when you have a company, let’s say Samsung Electronics with these two share classes, you would expect the shares to trade at roughly the same valuation, or maybe a 10% discount due to the different voting rights attached to the stock but what we actually see is a huge a price discount, a discount of maybe 50% to 60% price different. It makes no sense. I’ve looked at all 140 of these preference shares trading in South Korea and carefully selected a basket of 20 shares. I’ve already said that I believe South Korea is one of the best-emerging markets in the world to invest, so having a great market, plus these super cheap securities make it highly compelling. I see a potential upside of 100% on this basket. These aren’t junk stocks either. All the companies are profitable and pay dividends. The only difference between the common and preference shares is that the preference shares don’t have any voting rights, but even if they did, it wouldn’t be much use to you because these companies are all controlled by the owners. It would be irrational to pay a premium to acquire the common shares when you can acquire the preference shares for much less.
RH: I remember this idea was pitched several years ago by Andrew Weiss at the Sohn London Conference. The Weiss Korea Opportunity Fund, which also tracks a basket of South Korean preference shares, is up by 36.1% since inception, 14 May 2013. The discount on the preference shares has narrowed since 2013, but not by much, do you see a catalyst that’ll drive a higher valuation going forward?
OE: Since I first put it together, my basket is up by around 100%, the discount is narrowing in some securities. When I first put the basket together, around three years ago, the discount was around 70% – 80%, now it’s narrowed to around 50%, which is still high, but if you started at 80%, that’s a big difference. There’s a second element that’s going on and that these preference shares, all 140 of them, don’t move together. Some of them, their discounts have narrowed a lot. For example, with Samsung Electronics there’s no longer a big discount. Others, the discount, is still quite wide, you need to do your research and pick and choose the ones that still have a good discount.
I have tremendous respect for Andrew Weiss, we both started investing in South Korean Preference Shares around the same time in 2013 but the Weiss Korea Opportunity Fund started out with too much capital, they got stuck with the relatively less attractive preference shares, while I’ve been able to pick and choose among the smaller but more attractive preference shares.
RH: Are there any restrictions on trading these shares?
OE: No, there are no restrictions but if you want to trade in Korea you have to get something called a Korea Investor ID, it’s just some paperwork. When the Emerging Value Fund first entered the Korean market and applied for the investor ID, the Korean regulators asked me to promise that I was not going to short any individual names, I guess they were worried that if I shorted the market it might cause some problems, but there are no serious restrictions on the long side that I know of.
RH: Do you have any examples of the South Korean shares you currently own?
OE: Of course, one of the names in the basket is Lotte Chilsung Beverage Co Ltd
(KRX:005305). This is a subsidiary of the Lotte Group, and it has a 40% share of the South Korean beverage market, including soft drinks, coffee, tea, energy drinks, beer, whiskey, etc…They also own some other assets, including approximately 30% of Pepsi Cola Philippines and some real estate. They have a real competitive advantage over peers. If this were a US company, you would pay more than 20 times earnings for shares of this kind of company but because it’s South Korea, the company’s shares are quite cheap. The preference shares are trading for under six times EBITDA [Coca-Cola is trading at 20 times EBITDA], the preference shares are trading at a huge 57.5% price discount compared to the respective common shares.
Another example from Korea is Amorepacific Corp (KRX:090430); this is South Korea’s leading cosmetics group. They have a 34% market share in multiple leading brands in all cosmetic distribution channels, online, door-to-door and duty-free. They also produce some other household products. The Chinese also love these South Korean cosmetics; this company is on the way to becoming one of the world’s leading cosmetics brands. The preference shares of Amorepacific trade at a 42% price discount to the common shares, so you’re paying around ten times free cash flow — that’s a bargain basement valuation for such a fast growing, wide moat, free cash generating business. I think it’s very attractive.
RH: Are you hedging the FX risk here?
OE: Good question. There are two things you can hedge. You can hedge the Korean market by going short a Korean index ETF, or you can hedge the FX risk. In the global value fund, I chose not to hedge because I believe that both the market and Korean currency are undervalued. I do offer the Korean Preference share strategy for managed account clients, and if they want me to hedge, I will.
Regarding the question on hedging in general: I hedge on a case by case basis. I’ll only hedge if I feel the wider market and currency is expensive. I’ll consider factors such as purchasing power parity, the market’s valuation, price to book, price to earnings, etc…Is the economy growing? It’s on a case by case basis but right now, the majority of our investments are in the US, Canada, Israel and South Korea, and I feel that all of these markets (except possibly the US) are cheap, so I’ve not hedged them.
You can find the rest of the interview at the links below.