In the land of giants, a true colossus is set to rise. In South Korea, home to the world’s largest shipbuilders, two of the top three companies – Hyundai Heavy Industries and Daewoo Shipbuilding & Marine Engineering – are set to merge, forming a combined entity which would hold more than 20% of the global market for ships and offshore platforms.

Or perhaps not.

The merger plan faces major barriers, from union fury at both HHI and DSME to the need for approval from antitrust regulators’ around the world. And one expert with decades of experience in the Korean shipbuilding industry has come out against the merger.

Farewell, 1997

Last Friday, HHI signed an agreement to take over a controlling stake in DSME from the largest-stakeholder, state-run Korea Development Bank, or KDB.

If the deal goes ahead, it would mark – at long last – the Korean state’s exit from the most traumatic economic experience the country has suffered since it was founded in 1948: The 1997-8 Asian financial crisis.

That crisis sparked a huge number of state bailouts, but most of the acquired assets have since been disposed of and reprivatized. DSME is the last major company still owned by the Korean taxpayer. In addition to KDB, another major stakeholder is the Korean National Pension Fund.

South Korea’s – and Asia’s – biggest corporate victim of that crisis was Daewoo Group. In 1999, the sprawling “chips-to-ships” conglomerate imploded under US$50 billion in debt that had been camouflaged by fraudulent accounting. At the time, it was the world’s largest bankruptcy.

The group was broken up and disposed of, but while some parts were sold to foreign investors – notably Daewoo Motors, acquired by and still operated by GM – DMSE held strategic value. As it was one of only two Korean yards which built warships, including submarines, it was not offered to overseas players.

DMSE was also one of the most profitable parts of the group, but ironically, that heritage as the cash cow of the Daewoo empire was at the root of its debt problems. “They were always profitable, so [Daewoo Group founder] Kim Woo-choong used them to lend to Daewoo Auto and Daewoo Electronics, and made them loan to unprofitable arms,” said Peter Bartholomew, COO of Seoul-based Industrial Research and Consulting, which has been engaged in the Korean shipbuilding sector since its early days in the 1970s.

Enter leviathan?

According to local press reports, HHI’s deal with KDB, which has been in the works since early this year, is worth $1.8 billion and will result in the creation of a new entity, controlled by HHI but with KDB as a secondary shareholder. The new entity will subsequently be listed.

However, that is not the full cost. HHI is also expected to cough up an additional $2 billion to cover DSME’s debts.

South Korea vies with China as the world’s largest builder of ships, but leads the field in value-added terms. While Chinese yards are volume players in low-end vessels like bulk carriers, Korea is the sectoral leader in higher-tech products such as LNG carriers and off-shore drilling rigs.

South Korean firms, notably its “Big Three” – HHI, DMSE and Samsung Heavy Industries, or SHI – are noted for their high technologies, speed of delivery and quality execution.

Fearing job losses, workers – DMSE employs nearly 10,000, a number which does not include thousands of subcontractors – have responded predictably. Along with auto and bank workers, shipbuilding unions are among Korea’s most powerful and hundreds of DMSE workers clashed with riot police outside KDB’s headquarters in Seoul on the day the proposed merger was announced.

HHI’s powerful union has also come out against.

Last week’s street battles followed industrial unrest in February, when HHI emerged as the sole bidder for DMSE, after SHI declined to bid.

There are also white-collar concerns about the merger. According to Japanese data, the two firms hold 23% of the global market, and the two yards also held 72 orders for LNG carriers – among the most high-tech, lucrative products built by shipyards – in early 2019, making up approximately 60% of the global market.

According to Korean data, last year HHI had an order backlog totaling 11.14 million compensated gross tons, the largest in the sector, while DMSE’s number was 5.84 million. Those account for 21.2% of the global total.

These numbers will raise both eyebrows and hackles. Given that WTO member South Korea is a top 10 trading nation, tied into a web of international regulations, the decision on the merger is not simply Seoul’s to make – a problem South Korea’s anti-trust chief admitted during a visit to Brussels on Wednesday.

Kim Sang-jo, head of Seoul’s Fair Trade Commission, said he would make a fast decision, but “a key issue is to make antitrust regulators of other countries accept our judgment.” He added that any South Korean decision is meaningless if other countries do not approve the acquisition.

Monopoly watchdogs in China, the European Union and Japan are sure to scrutinize the proposed mega-deal with eyes wide open. Decisions are not expected any time soon. According to Yonhap news, a South Korean decision is likely to take up to 120 days, while according to Nikkei Asian Review, decisions from other nations’ regulators are not expected until the end of the year.

Yet another barrier could be a tug of war between local governments. While both companies are based in Korea’s heavily industrialized southeast, HHI is in the city of Ulsan, which has special administrative status, while the DMSE yards are on the island of Geoje-do, which is overseen by the provincial government.

Then there are corporate culture and managerial practices. “Hyundai come from a construction background, and they have a rough-and-tumble, military-style managerial culture, while Daewoo are more technocratic, more genteel,” said Bartholomew. “Their managerial procedures, interpersonal relations and roles – everything is very different.

“I don’t want to say I like one better than the other – they both work – but Daewoo is more flexible and if I were in Daewoo, I would be very concerned about Hyundai imposing their way of doing things.”

There is one encouraging precedent for the merger. Hyundai Motor acquired Korea’s second-largest carmaker Kia Motors, another 1997 victim, in 1998. While the two companies remain separate, the umbrella under which they merged, Hyundai Motor Group, has been widely seen as a success.

Hyundai Motor Group and HHI are entirely separate companies, led by different branches of the Hyundai Chung family, following the break-up of the Hyundai Group after the death of founder Chung Ju-yung in 2001.

In February, KDB head Lee Dong-gull said now is the time to sell its stake in DMSE, given that the shipbuilding sector appears to be in recovery mode. “I see an over 50% chance for the deal,” he said.

Crown jewel to black hole

For years, KDB, which holds 55.7% of DSME, has been determined to recover as much taxpayer money as possible. As a result, it has failed to dispose of its stake in DSME, despite multiple tenders from bidders that include conglomerate Hanwha Group and steelmaker POSCO.

Since the collapse of Daewoo Group, the company has received multiple state bailouts totaling a whopping 12 trillion won, or $10.6 billion. Moreover, old habits may die hard. In 2016, Seoul’s Board of Audit and Inspection found a $1.27 million hole in DSME accounts.

The company was also at the center of a lobbying scandal in which company executives offered reporters incentives to governmental money, and in 2017, the company CEO was jailed on accounting fraud charges.

Neither KDB nor DSME has been helped by the perfect storm that has battered the industry. In the long aftermath of the 2008 global financial crisis, low oil prices and the increasing uptake of shale gas in North America have cut demand for offshore drilling platforms and pricey LNG carriers.

At the same time, Chinese yards weighed down the sector with massive overcapacity.

In this environment, there is one possible synergy for HHI. While DMSE and SHI have maintained their offshore engineering arms, despite the problems facing that sub-sector, HHI has put its into hibernation and shed staff.

“They are struggling with offshore plant,” Bartholomew said. “They are hanging on by a thread.” That makes DMSE’s offshore production assets a prime purchase.

And overall – despite its bedraggled reputation – DMSE is a quality company, Bartholomew insists. “In my opinion, they have got the best designed, laid-out and productive shipbuilding facility in Korea,” he said. “And their operations are very good – it is a total misconception that Daewoo is a mismanaged company.”

However, in a country where industrial development was largely led by conglomerates headed by powerful controlling families, there may be pressure to ease HHI’s takeover. DMSE has had no chairman figure since Daewoo Group went belly up. “[DMSE] has no owner, so they need a godfather, a big ‘Poppa,’” said Bartholomew, with reference to local sentiment.

But if it goes ahead, a very big player in the local shipbuilding space evaporates. “I am worried. There are only three major yards, and we need the competition of all three,” he said, noting that Hyundai already owns six yards nationwide, and of those, it has already mothballed one, in Gunsan.

Since the merger deal was announced last week, both companies’ stocks have slid, though not precipitously. HHI’s stock was 125,500 won on March 8, the day the merger agreement was signed with KDB, and has slid marginally to 124,000 won. DSME’s has fallen from 30,200 won on March 8 to 29,150 won.