[Controversy Over Re-listing After Demerger] ① OCI and Dongkuk Steel Announce Holding Company Transition... Tension Builds Ahead of General Meeting

Most Majority Shareholders Benefit from Re-listing after Demerger
Deferred Corporate Tax Benefits for Holding Company Conversion Process Until This Year
Board Approval Must Be Completed by First Half of the Year

Since the beginning of this year, companies and individual investors have been in a tense standoff over re-listing through a spin-off. Spin-offs are usually pursued to improve corporate governance, but conflicts often arise between major shareholders seeking to expand their control and minority shareholders trying to defend against dilution. In particular, concerns about dividend reductions during spin-offs have led to strong resistance from minority shareholders. In February, a spin-off plan was rejected at Hyundai Department Store's extraordinary general meeting due to opposition from minority shareholders and the National Pension Service, causing companies like OCI and Dongkuk Steel, which have announced spin-off plans, to appear tense ahead of their upcoming shareholder meetings.

Hyundai Department Store Headquarters, Daechi-dong, Gangnam-gu, Seoul (Photo by Yonhap News)

OCI, Daehan Steel, Dongkuk Steel, Chosun Refractories, etc. Pursue Spin-offs

OCI will put the spin-off agenda to a vote at the general meeting on the 22nd. For the spin-off agenda to pass at the meeting, one-third of the total issued shares and two-thirds of the attending shareholders must agree. If the agenda passes, the surviving company OCI Holdings will become a holding company, and the newly established OCI will be the operating company. OCI Holdings will handle subsidiary management and new business investments, while OCI will be responsible for chemical and electronic materials businesses. The split ratio is 69% (OCI Holdings) to 31% (OCI). OCI disclosed that the spun-off company plans to acquire 300,000 treasury shares (about 1.26%) as of the 24th.

Dongkuk Steel, which decided on the spin-off at a board meeting last December, will hold an extraordinary general meeting on May 17 to proceed with the spin-off. Under the holding company Dongkuk Holdings (surviving company), Dongkuk Steel (hot-rolled business) and Dongkuk CM (cold-rolled business) will be subsidiaries. Dongkuk Steel stated that under the holding company structure, it aims to enhance the expertise of each business and strengthen competitiveness. The split ratio is 16.7% for Dongkuk Holdings (holding company), 52.0% for Dongkuk Steel (hot-rolled business), and 31.3% for Dongkuk CM (cold-rolled business). As of the end of Q3 last year, Dongkuk Steel holds 4.12% treasury shares.

Daehan Steel will also hold a shareholder meeting on the 15th to proceed with a spin-off dividing into DHO (holding company) and Daehan Steel (operating company). The newly established Daehan Steel will handle the rebar business. Chosun Refractories will hold a shareholder meeting on May 17 to put a spin-off agenda to separate into Chosun Refractories Holdings (holding company) and Chosun Refractories (operating company) to a vote.

The stated reasons companies pursue spin-off re-listings are to strengthen business competitiveness and improve corporate governance. However, the market views spin-offs critically because while major shareholders’ control expands after the spin-off, minority shareholders’ equity value is inevitably diluted.

Treasury Share Magic Effect, Paid-in Capital Increase by Contribution in Kind Favors Major Shareholders

A spin-off is a corporate division method where shareholders hold equal shares in both the existing and newly established companies. The problem is that during the spin-off process, major shareholders can expand their stakes through the 'treasury share magic' and paid-in capital increase by contribution in kind.

The treasury share magic refers to the restoration of voting rights for treasury shares held by a company undergoing a spin-off. Unlike a physical division, shareholders hold equal shares in both the existing and new companies in a spin-off. For example, suppose major shareholder Hong Gil-dong holds 10% of 'Daehanminguk' and the company is spun off into the surviving company 'Daehanminguk Holdings' and the new company 'Seoul Corporation.' Hong Gil-dong would then hold 10% in both 'Daehanminguk Holdings' and 'Seoul Corporation.' If Daehanminguk held 5% treasury shares, after the spin-off, 'Daehanminguk Holdings' would also receive a 5% stake in the new company 'Seoul Corporation.' Treasury shares, which previously had no voting rights, become voting shares through the spin-off. Major shareholder Hong Gil-dong can increase control over the new company without additional cost by combining his 10% stake and the 5% stake held by the holding company 'Daehanminguk Holdings.'

Adding the paid-in capital increase by contribution in kind (public tender stock exchange) procedure further increases major shareholder Hong Gil-dong’s control. This procedure usually involves receiving shares in the new company at a certain ratio in exchange for shares in the holding company (surviving company). For example, Hong Gil-dong transfers 10% of 'Seoul Corporation' shares to 'Daehanminguk Holdings' and receives 10% of 'Daehanminguk Holdings' shares in return. Through the spin-off and paid-in capital increase by contribution in kind, major shareholders can significantly increase their stake in the holding company. Professor Kim Woo-chan of Korea University’s Business School pointed out, “If the holding company’s control over subsidiaries is strengthened using treasury shares during the spin-off process, the control rights of ordinary shareholders may weaken.”

Currently, all four listed companies?OCI, Daehan Steel, Dongkuk Steel, and Chosun Refractories?have announced restructuring plans involving paid-in capital increases by contribution in kind and have notified that new shares may be allocated for treasury shares. Accordingly, minority shareholders are protesting that the expansion of major shareholders’ control could dilute the equity value of existing shareholders. In Korea, holding company stocks often trade at relatively low prices. Since investors prefer to hold stocks of operating companies with real business substance, the participation rate in paid-in capital increases by contribution in kind tends to be low.

The Economic Reform Solidarity criticized Dongkuk Steel’s spin-off, stating, “If Chairman Jang Se-ju and related parties participate in Dongkuk Holdings’ paid-in capital increase by contribution in kind during the holding company transition, their stake in the holding company will increase significantly from 26.28% to about 83% after the split,” and added, “The company’s public asset, treasury shares, is being used to expand the controlling shareholder’s power.” This criticism stems from such context.

In response to such criticism, an industry insider said, “If the owner family’s stake is initially low, the effect of control enhancement through spin-off is not significant,” and added, “It is unfortunate that the intention to strengthen business competitiveness through holding company transition is misunderstood due to the formula ‘spin-off re-listing = major shareholder control expansion.’”

Treasury shares do not have dividend rights, but dividend rights are restored after a spin-off. Previously, only shareholders received dividends, but after the spin-off, the holding company (surviving company) also receives dividends. The failure of the spin-off at Hyundai Department Store’s shareholder meeting is believed to be influenced by this factor. An accounting expert pointed out, “There were two main reasons minority shareholders opposed the spin-off agenda at Hyundai Department Store’s shareholder meeting, which was expected to pass smoothly: the plan to place the profitable subsidiary Hanmu Shopping under the holding company with a higher major shareholder stake after the spin-off, and the lack of a concrete response to the request for treasury share cancellation before the spin-off.”

Unlike Hyundai Department Store, OCI and Dongkuk Steel show little conflict with minority shareholders regarding subsidiary governance. Therefore, the spin-off agenda is expected to pass smoothly at their shareholder meetings. However, with recent shareholder proposals from private equity funds raising voices for shareholder rights, the market is paying attention to minority shareholders’ voting intentions. Some suggest that if the effects of holding company transition and shareholder return policies are not clearly presented, variables may arise in the spin-off vote.

Corporate Tax Deferral Until This Year... A Golden Opportunity for Holding Company Transition

Another background for companies pursuing spin-offs is the 'corporate tax deferral.' In 2019, the National Assembly proposed an amendment to Article 38-2 of the Restriction of Special Taxation Act, deciding to end the tax deferral benefit for holding company transitions in 2021. Corporate tax deferral means postponing capital gains tax or corporate tax on contribution in kind until the disposal of shares when establishing a new holding company or converting an existing domestic corporation into a holding company.

Contrary to the original plan, due to the worsening business environment caused by COVID-19, the tax deferral period was extended from the end of 2021 to the end of 2023. This year is the last chance to enjoy the corporate tax deferral benefit during holding company transitions.

Moreover, the amendment to the Fair Trade Act is also considered a factor increasing the incentive for tax deferral benefits. Previously, holding company transitions required holding at least 20% of listed subsidiaries’ shares (40% for unlisted companies), but now the threshold has been raised to 30% (50% for unlisted companies). This means the burden for holding company transitions has increased accordingly.

The spin-off re-listing process, including preliminary review, re-listing, and contribution in kind, is known to take about 6 to 10 months. Therefore, to benefit from the corporate tax deferral by the end of the year, board approval must be completed by the first half of the year. This is why companies are rushing to pursue spin-off re-listings recently.

Professor Kim Gap-soon of Dongguk University’s Business School said, “Tax deferral is merely postponing taxes to be paid, so it is hard to see it as a cost-saving for companies,” and added, “Moreover, decisions are not made solely based on tax deferral effects during governance restructuring such as holding company transitions, so from a shareholder perspective, how to view spin-off re-listings is a more important point.”