Saying farewell to privatization, where will South Korea's largest tobacco company go?

Saying farewell to privatization, where will South Korea's largest tobacco company go?

On January 9, 2024, Korea Tobacco and Ginseng Co., Ltd. (KT&G), the largest tobacco company in South Korea, announced that CEO Beak Bok-in expressed his intention to give up seeking re-election at the board meeting the day before. After the news was released, KT&G's stock price fell from a high of 90,900 won on the 10th to a closing price of 87,400 won on the 12th, and its market value dropped to 9.85T won (approximately US$749.6 billion).

Bai Furen joined KT&G in 1993 through open recruitment, took office as CEO in October 2015, and was re-elected twice in 2018 and 2021. During his tenure, he improved the global competitiveness of the new tobacco business by signing a 15-year long-term contract with Philip Morris International (PMI); and achieved record annual sales of approximately 6 trillion won (approximately 4,560 million won). One hundred million U.S. dollars).

But sales are reflected in profits and share prices, and the numbers are less pleasing to shareholders. During Baek's tenure, KT&G's operating profit dropped from 1.46 trillion won (approximately US$111 billion) in 2016 to 1.26 trillion won (approximately US$95.8 billion) in 2022; in the nine years since Baek was in office, the Korean Composite Stock Price Index KOSPI However, it rose by 26%, while KT&G's stock price bucked the trend and fell by 19% from its high in 2015.

According to previous forecasts by financial institutions, KT&G's revenue in 2024 may drop to 5.84 trillion won (approximately US$445.4 billion), while operating profit may also decrease by 10.5% to 1.13 trillion won (approximately US$). If the forecast is accurate, this will be the first time KT&G has faced a revenue decline since 2018.

South Korea's largest tobacco company is about to bid farewell to the Baek Bok-in era, which lasted about nine years. What happened to KT&G, which made a bold statement in 2020 to "become the world's fourth largest tobacco company by 2025"? Who will be the next to take the palm print? Where will the Korean tobacco market go in the foreseeable future?

South Korea’s HNB market under siege

In 2023, the profit of the Korean tobacco market will reach US$9.198 billion, and according to statistics agency forecasts, it will achieve an annual growth of 0.78% in the next five years. The latest buzzing news in the Korean regulatory market is the rumor that synthetic nicotine will be included in the new tax policy.

According to South Korean customs data, the total amount of e-cigarette oil imported in 2021 is 378 tons, of which 98 tons contain synthetic nicotine, accounting for 26% of the total.

Currently, South Korea levies five taxes and fees on natural nicotine: consumption tax, new value tax, national health promotion fee, local tobacco consumption tax and local education tax; in contrast, synthetic nicotine is not subject to any taxes and fees. South Korean Congressman Choi Hye-young recently proposed imposing the same taxes and health promotion fees on synthetic nicotine as natural nicotine starting next year. According to analysis by the National Assembly Budget Policy Office of South Korea, if the new tax policy is implemented, it is expected to increase tax revenue by 101.2 billion won (approximately US$7.707 billion) in the next five years.

This could be good news for KT&G. Because KT&G’s new tobacco business is mainly focused on the heat-not-burn (HNB) business, there are no atomized e-cigarette brands on sale. Once this new tax law is implemented, atomized e-cigarettes, which are the main competing products, will be heavily taxed.

KT&G, which has been established for more than 100 years, was privatized in 2002. It has five major subsidiaries, involved in ginseng, medicine and other fields, but it is best known for its tobacco business and is the only reconstituted tobacco leaf manufacturer in South Korea. According to Euromonitor International, KT&G ranked fifth in the world in terms of sales volume and market share in 2019. It was also in 2020 that the company announced its intention to join the "Big Four".

There are policy reasons behind not getting involved in vaping. As early as 2019, South Korea's Ministry of Health and Welfare recommended that people stop using atomized e-cigarettes and promised to determine as soon as possible whether the sale of e-cigarettes should be banned; in October 2022, South Korea's Ministry of Health and Welfare issued a document strongly recommending that people stop using atomized e-cigarettes before issuing relevant hazard tests. Stop using vaping e-cigarettes before results. At the same time, the Korean government has proposed a series of improvement measures to eliminate the "dead zone" in e-cigarette supervision.

For similar reasons in the Japanese market, HNB has the upper hand in South Korea. KT&G then focused on HNB as a new type of tobacco. At present, the company's HNB brands include Lil series, Fiit series and MIX series of adapted cigarette cartridges. Among them, the Lil series of smoking equipment performed well. In May 2023, Lil accounted for 48% of the market share in South Korea's HNB market, defeating Philip Morris' ace IQOS with a market share of 42%.

But competition in this field has already heated up. According to data from Euromonitor International, South Korea's HNB market size will reach 2.2 trillion won (approximately US$167.5 billion) in 2023, and is expected to reach 2.4 trillion won (approximately US$182.8 billion) by 2025. As the Korean HNB market continues to heat up, many multinational tobacco companies are competing fiercely in the Korean market.

In February 2022, British American Tobacco (BAT) launched a new product Glo Hyper , sources said that Philip Morris Products SA, the Swiss headquarters of Philip Morris, has applied for trademark registration of its heated tobacco product SENTIA in South Korea. SENTIA is a cigarette cartridge specially designed for the IQOS ILUMA series. It has not yet been launched in South Korea. At the beginning of 2024, there is news that there is currently no HNB share in South Korea. Japan Tobacco International (JTI launched liquid cigarettes in South Korea in 2019 The electronic cigarette product Ploom Tech, which the company stopped selling in 2021, is ready to return to the Korean market again.

South Korea's domestic new tobacco market, which has been divided by PMI, KT&G and BAT, may usher in a state of melee in the future after JTI returns to the fray. Among the many international big tobacco companies, KT&G is the only competitor that has completely given up on atomized e-cigarettes and focused on HNB. It can be said that it is not going into the battle with an "all or nothing" determination.

However, as KT&G's only bet, the growth of the company's HNB division has stagnated in 2023. From 2020 to 2022, KT&G's tobacco business (including cigarettes and HNB) nearly tripled from 279.3 billion won (approximately US$212.6 billion) to 876.3 billion won (approximately US$666.5 billion); but in the first half of 2023, the company's HNB sales increased from The 436.3 billion won (approximately US$331.6 billion) in the same period last year fell 10.7% to 389.6 billion won (approximately US$296.1 billion).

Without an absolute product advantage compared to the giants, it is still unknown whether KT&G is really ready.

“Going overseas by agreement” and “Profit offsetting”

KT&G's overseas expansion is largely driven by the strategic cooperation agreement signed between KT&G and Philip Morris International in 2020. This agreement is a major achievement during Bai Furen's term and plays an important role in KT&G's entry into the Russian and Ukrainian markets. In these two markets, KT&G is able to share resources and infrastructure with PMI; in Ukraine, the latter is even fully responsible for the sales of KT&G's products. On January 30, 2023, the two parties extended the three-year cooperation agreement signed in 2020 to 15 years.

Also in 2020, KT&G also signed a 2.2 trillion won (approximately US$1.8 billion) contract with Dubai-based fast-moving consumer goods giant Alokozay Group for a period of 7 years and 4 months. The agreement will help KT&G avoid the huge cost of establishing an independent sales network in the UAE and also safeguard a portion of KT&G's overseas business, as it requires Alokozay to purchase a certain amount of KT&G products during the agreement period.

However, this "agreement-based overseas expansion" has its drawbacks: once the situation of the other party to the agreement changes, KT&G will most likely have to make passive adjustments. For example, due to the outbreak of the Russia-Ukraine war, Philip Morris International, an American company, has significantly adjusted its layout in Russia: Philip Morris International's fourth quarter financial report for 2022 specifically pointed out that after the Russia-Ukraine market is included, the company's global total shipment growth has been reduced from 2.6% dragged down to 1.2%; and KT&G, which originally had no clear political leanings, had to take action: KT&G also specifically mentioned in the financial report that the sanctions against Russia by the United States and even the entire West, such as restrictions on SWIFT settlement methods, have affected The company's new market in Russia.

In addition, although the agreement requires Alokozay to purchase a certain amount of KT&G products, the unit price for such bulk agreement purchases is generally low. Such use of "profits" to compete for "sales" has also led to KT&G being questioned as a "vain pursuit of sales" at the expense of profits.

But going to sea continues. In October 2023, KT&G held a high-profile groundbreaking ceremony for its new factory in the Almaty region of Kazakhstan. KT&G President Bai Furen, the governor of the Almaty region and other local dignitaries were all present. KT&G said that this new factory will become a "hybrid production base" in the Eurasian region, which can reflect that KT&G regards Kazakhstan as a key strategic base for its Eurasian business growth, and will establish a complete value chain locally and strengthen Overseas direct business ambitions.

With the group's sales growing in Latin America, South America and Africa, KT&G had been confident that growth would continue. However, according to the latest 2023 Q3 annual report, in the first nine months of 2023, KT&G's export value was 1.293 billion won (approximately US$98.382 billion), a shrinkage of approximately 7% from 1.393 billion won (approximately US$1,059.09) in the same period in 2022.

It is worth mentioning that according to financial disclosures, no external customer of KT&G accounts for more than 10% of profits. Such a retail customer structure not only helps KT&G resist instability, but also proves that the company does not have a stable and deep market "one meter wide and ten meters deep", allowing KT&G to serve as an anchor to consolidate its advantages and have no worries. The earth circle new ground.

In the global market, heavy reliance on Philip Morris and the "Grand Agreement", the impact of geopolitics, and the absence of a stable anchor have made KT&G's overseas expansion full of uncertainty.

“Closed-door meetings” and evaporating pensions

On January 11, KT&G's Supervisory Structure Committee announced 24 candidates for the next president on the 11th, and Bai Furen, who expressed his intention to resign on the 9th, was not among them. 2FIRSTS asked KT&G about the next CEO candidate and the selection process. No reply as of press time.

The current 24 candidates will be reviewed by the recommendation committee and a second round shortlist will be produced and made public in mid-February. It is expected that the final candidate will be determined by the end of February. Finally, the next CEO will be determined at the regular shareholders' meeting at the end of March, reflecting the collective wishes of all shareholders.

To understand the motivation behind the entire personnel change, we must start with the CEO selection system of large companies like South Korea. Take Posco, South Korea's largest steel company, as an example. To select a new CEO, it is usually based on the "President Re-election Priority Review System" and a "president" of about 7 people is composed of some board members. Candidate Recommendation Committee" will then determine the CEO candidates, and then announce the final candidates through voting. It is neither transparent nor has the process been clearly recorded in documents. The whole process can be described as a "closed-door meeting."

KT&G's approach is similar. Normally, the entire process needs to go through three stages: "Regulatory Structure Committee - President Candidate Recommendation Committee - Approval of the Shareholders Meeting" and takes about three months. However, in early December, the board of directors completed the entire process and informed public. What was criticized about the whole process was that the only candidate given by the "President Candidate Recommendation Committee" was Bai Furen, who was about to complete his third term; and the entire decision-making process only took 11 days.

On December 13, Singapore-based Flashlight Capital Partners, one of the shareholders of KT&G, published a cartoon on the entrance of the Korean Corporate Governance Forum website, trying to use the most popular form to call on young South Korean investors to oppose KT&G’s management. Flashlight will describe the entire process as a "word game" and a "closed vote", call for changes to the CEO selection process, and ask the board to appoint two independent directors.

KT&G is not the only CEO of a dispersed holding company who failed to achieve re-election in the past year. In 2023, Korea Telecom (KT) and Posco (POSCO) both continued to fail due to obstruction from their largest shareholder, Korea National Pension Service (NPS).

The reason is obvious: Korean people’s “pension money” has been bet on these large companies by the Korean National Pension Fund.

The National Pension Company of Korea is currently the third largest shareholder of KT&G, and the largest shareholder holding 6.3% of KT&G's shares today is the Korean policy bank Corporate Bank (IBK). The bank is state-owned by the government of the Republic of Korea. In 2018, it opposed Baek Bok-in's third term of office. He believed that there were problems with the president selection process and questioned the entry of activist investment funds into the company.

When the stock price trend is not optimistic, the dissatisfaction caused is indeed justified. When a large part of the evaporated market value came from national pensions, dissatisfaction spread throughout society: through the attitude of corporate banks, the Korean government showed a negative attitude towards the re-election of KT&G CEO; shareholders also questioned the management's ability to “The futile pursuit of sales” at the expense of profits.

Whether it is the market or personnel changes in large companies, they are always a reflection of society. Bai Furen's voluntary abdication this time was largely driven by public opinion. During the COVID-19 epidemic, South Korea set off a wave of retail investment, attracting many young people to enter the market, and retail investors' influence on the market is increasing day by day. Meme stocks such as game retailer GameStop also became popular overnight during the epidemic, which reflects how online communities can shake up the capital market.

This is also the reason why Singapore’s Flashlight Capital Partnership, one of the shareholders of KT&G, chose to use the Internet to “defend rights” this time. Two weeks after the comics went online, KT&G, unable to resist the pressure, ceremonially released the CEO's "recruitment notice" on December 28, 2023, and promised that the entire selection process would be "transparent" and "open".

After giving up his intention to seek re-election, Bai Furen expressed in an interview that he hopes to appoint the next CEO of a global leader who has the ability to lead the realization of future visions and promote higher growth of the company; but such a giant ship will not be able to turn around in the new era. What other obstacles will we encounter?
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