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IN THE MATTER OF AN ARBITRATION UNDER THE FREE TRADE
AGREEMENT BETWEEN THE REPUBLIC OF KOREA AND THE UNITED
STATES OF AMERICA AND THE UNCITRAL ARBITRATION RULES
PCA Case No. 2018-55
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In the Matter of Arbitration Between: :
MASON CAPITAL L.P. and MASON MANAGEMENT LLC, :
Claimants, :
and :
THE REPUBLIC OF KOREA, :
Respondent. :
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Friday, March 25, 2022
New York International Arbitration Center
620 8th Avenue
16th Floor Conference Room
New York, New York
The hearing in the above-entitled matter came on
at 8:42 a.m. (EDT) before:
PROFESSOR DR. KLAUS SACHS, President of the Tribunal
THE RT. HON. DAME ELIZABETH GLOSTER, Co-Arbitrator
PROFESSOR PIERRE MAYER, Co-Arbitrator
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ALSO PRESENT:
Registry and Administrative Secretary to the
Tribunal:
DR. LEVENT SABANOGULLARI
MS. JINYOUNG SEOK
Assistant to the Tribunal:
MR. MARCUS WEILER
Realtime Stenographer:
MR. DAVID A. KASDAN
Registered Diplomate Reporter (RDR)
Certified Realtime Reporter (CRR)
Worldwide Reporting, LLP
529 14th Street, S.E.
Washington, D.C. 20003
United States of America
Interpreter:
MS. MYUNG RAN HA
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APPEARANCES:
On behalf of the Claimants:
MS. SOPHIE J. LAMB, QC
MR. SAMUEL PAPE
MR. BRYCE WILLIAMS
Latham & Watkins, LLP
99 Bishopsgate
London EC2M 3XF
United Kingdom
MS. LILIA VAZOVA
MS. SARAH BURACK
MR. RODOLFO DONATELLI
MS. AMY CHAMBERS
Latham & Watkins, LLP
1271 Avenue of the Americas
New York, NY 10022
MR. BEOMSU KIM
MR. YOUNG SUK PARK
MS. WOO JI KIM
MS. SU AH NOH
MS. YU JIN HER
KL Partners
7th Floor, Tower 8,
7 Jongro 5 gil, Jongro-gu,
Seoul
Republic of Korea 03157
MR. ERIC DUNBAR
Evidence Presentation/Magna Legal Services
Party Representatives:
MR. KENNETH GARSCHINA
MR. RICK ENGMAN
MR. MICHAEL CUTINI
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APPEARANCES: (Continued)
On behalf of the Respondent:
MR. CHANGWAN HAN
MS. YOUNG SHIN UM
MS. HEEJO MOON
MR. DONGGEON LEE
Ministry of Justice
MR. JEONG MYUNG PARK
Ministry of Health and Welfare
Government of the Republic of Korea
MR. PAUL FRIEDLAND
MR. DAMIEN NYER
MR. SVEN VOLKMER
MR. SURYA GOPALAN
MS. JOY LEE
MR. ERIC LENIER IVES
White & Case, LLP
1221 Avenue of the Americas
New York, New York 10020-1095
United States of America
MR. MOON SUNG LEE
MR. SANGHOON HAN
MR. HANEARL WOO
MR. JUNWEON LEE
MR. MINJAE YOO
MS. SUEJIN AHN
MS. YOO LIM OH
Lee & Ko
Hanjin Building
63 Namdaemun-ro Jung-gu
Seoul 04532
Republic of Korea
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PRESIDENT SACHS: We will now open the session.
And as discussed, we will start today's program with the debate on the questions that Pierre Mayer asked you on the first day of the Hearing, and the first question is to the Claimants, so who will take the floor?
MS. VAZOVA: I will address that, Mr. Chairman.
PRESIDENT SACHS: So, please proceed.
MS. VAZOVA: So, Professor Mayer's first question, in relation to CLA-15, which is the Seoul High Court's conviction of President [Redacted] for bribery was as follows: Are there other places in the Judgment or another one by a Korean court to this effect that can be taken as evidence that Korea has, as its purpose, expropriating value from the Minority Shareholders for the benefit of the [Redacted] Family?
So, we have three references in response to this question. They come from CLA-13, CLA-14 and CLA-15.
Starting with CLA-13, which is the Seoul District Court conviction of Minister [Redacted] and CIO [Redacted], on Page 50 of the exhibit. The Court recognized that the structure of the Merger could lead to the benefits conferred only on [Redacted] and the Samsung Group Major Shareholders at the expense of the SC&T Shareholders.
Then on Page 52 of the exhibit, the Court went
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on to say that, unlike other SC&T Shareholders who could not affect the outcome of the Merger, there is a causal relationship between NPS's support for the Merger and benefits to [Redacted] and other Samsung Group Major Shareholders.
Now, that's a lower-court decision, but these particular facts were affirmed by the Seoul High Court on appeal, and where that is evident from the record is Exhibit CLA-14 which is the High Court's affirmance, on Page 48 of the exhibit.
Moving on to Exhibit CLA-14, which is the Seoul High Court decision, so--and the references in that document are Pages 45 and 48 of the exhibit.
Just to explain briefly, in the context of sentencing [Redacted] for breach of trust of the NPS, the Court finds that when CIO [Redacted] helped [Redacted] push through the Merger, he was at least aware that [Redacted] would gain a profit and the NPS would incur a corresponding loss. And then the Court also goes on to recognize, on Page 48, that the Merger would result in a loss to SC&T's Shareholders generally, not just specifically to the NPS.
And then finally CLA-15, which is the Seoul High Court conviction of President [Redacted]. There are a number of references in that exhibit on Pages 4, 12 to 13, and
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Page 15. Again I'll just very briefly describe what these are.
They're all descriptions of the purpose and effect of [Redacted]'s succession plan, which, as I noted in my Opening Remarks on Monday, the Court found to specifically include the SC&T-Cheil Merger. The Court explains in some detail that the purpose of the succession plan was to consolidate control over the Samsung Group for the [Redacted] Family at the lowest cost possible. And then the Court goes on to find that President [Redacted] solicited and received bribes in order to help Mr. [Redacted] implement that plan, including specifically the Merger.
So, we believe that between those different references, that addresses Professor Mayer's question, but, of course, happy to take any questions or any follow-up.
ARBITRATOR MAYER: Not from me. I don't know if someone else wants to say something about this. Yes?
MR. VOLKMER: Unless the Tribunal would like--
PRESIDENT SACHS: Yes, please.
MR. VOLKMER: Okay. So briefly, Professor Mayer and Mr. Chairman, we, of course, disagree with the premise advanced by Mason that the Merger itself was an extraction of value from SC&T's Shareholders. We say it was not, because it was conducted a market price, and it was in
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accordance with the ratio fixed at that market price, as you heard yesterday from Professor Dow. And it certainly wasn't value-extractive for a shareholder like Mason, who bought their Shares after the Merger was announced in full knowledge of the terms of the Merger.
Now, as for court references, the Korean courts in the Merger Annulment case and the Elliott Injunction case rejected the argument that the purpose of the Merger was to extract value, was to benefit Cheil at the expense of SC&T, and the references for that are R-177 at Page 14, and R-242 at Page 10.
ARBITRATOR MAYER: Thank you.
PRESIDENT SACHS: Thank you.
MR. VOLKMER: Excuse me, Mr. Chairman, to add one thing or two points.
Of course, if the purpose of the Merger itself was not to extract value, then the purpose of Korea's conduct cannot have been to extract value.
As for the High Court Decision that was mentioned in the case against President [Redacted], there is a reference that suggests that the Blue House's concern or purpose was to stabilize the Samsung Group's corporate governance, not to extract value. That's reflected in a report prepared by the Blue House in 2014, and that is quoted in the High Court Decision, where the High Court
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says that "the absence of the Samsung Group's Chairman, Mr. [Redacted], is being prolonged and the Samsung Group accounts for a significant portion of our economy. Samsung Group cannot falter in the midst of the succession process. The Government will figure out what the Samsung Group needs in the succession process and give help to the extent possible while inducing it to make more contribution to the national economy." That's R-258 at PDF Page 29.
And we would say that stabilizing Samsung's governance and supporting a succession plan is a purpose very different from expropriating value. So, even if it were possible to characterize the Merger as expropriating or extracting value, we would say that that is, at most, an incidental or indirect consequence of the purpose of stabilizing the corporate governance of the group.
ARBITRATOR MAYER: Thank you.
Mr. Chairman, you want to ask anything else--
PRESIDENT SACHS: I will ask you whether you are satisfied--
(Overlapping speakers.)
PRESIDENT SACHS: --with these statements. I am, but I note that in the second paragraph of the written version of your question number one, you refer to the Pages 86 and 103 of CLA-15, and you said that it was not
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entirely clear to you what the Court says here. And then later you say "my question is let's not discuss now at least but maybe later". Do you think this is a question we should discuss now, or did you mean that the Parties should address it in their Post-Hearing Briefs?
ARBITRATOR MAYER: Well, I meant at that time that we might be discussing during the Hearing, but given that we are on Friday and it's a long day, I think Post-Hearing Briefs may be the right place.
PRESIDENT SACHS: Okay. Then we turn to Question 2, which goes to both Parties.
Who wants to start? Claimant?
MS. LAMB: I can start.
PRESIDENT SACHS: Yes, please.
MS. LAMB: Professor Mayer, I believe you said your question was prompted by our discussion of the ILC Articles. You had in mind Article 31, and, in particular, Paragraph 10 of the Commentary, so just to sort of anchor us, as it were, back in that provision, CLA-166.
So, Article 31(1) of the ILC Articles, of course, is the statement that the responsible State is under an obligation to make full reparation for the injury caused by the Internationally Wrongful Act.
And in Paragraph 10 of the Commentary, which we find on Page 92 of the ILC Articles, there is then a
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discussion of the various terms that are used to describe the link which must exist between the wrongful act and the injury; for example, reference may be made to the formulation attributable to the wrongful act as the proximate cause, damage which is too indirect, remote, uncertain, and so on.
And then over the page, we're told that other factors may also be relevant whether the State organs deliberately caused the relevant harm; and then, Professor Mayer, to your point, or whether the harm caused was within the ambit of the rule which was breached having regard to the purpose of the rule, and I believe that it was that concept, if you will, that prompted your question. So just before I get into the hypothesis that you put forward.
So, just taking that formulation whether the harm caused was within the ambit of the rule that was breached having regard to the purpose of the rule, well, the first step, of course, is to ask ourselves what is the relevant rule that the commentaries are referring to here. It is, of course, the international obligation of Korea, itself under Article 11.5 of the Treaty, to accord to investments of foreign investors the minimum standard of treatment, including, of course, the fair-and-equitable-treatment standard.
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So, the question for us is whether Mason's harm was within the ambit of Korea's own minimum-standard-of-treatment obligation, having regard to the scope and purpose of that international obligation. Of course, we went through the content of that in Opening.
The question is not as Mr. Friedland sought to suggest in Opening: Did NPS have a duty of care to Mason under its Rules. That, with respect, is a strawman argument, which is why I didn't address it in Opening. For the avoidance of doubt, we did, contrary to what was suggested, address it in our papers. I invite you to look again, at your leisure, at Paragraph 319 of our Reply.
Very briefly, what we said there was that this argument too is without merit, not least because it is based on Korea's continued mischaracterization of the facts. Mason is not seeking to hold the NPS responsible for losses arising from any legitimate exercise of the NPS's Voting Rights. Rather, Mason seeks to recover losses suffered as a result of the Blue House, the Ministry of Health and Welfare, and the NPS's criminal scheme to transfer billions of dollars of value from SC&T to Cheil at the expense of other Shareholders including Mason. Because the losses claimed are the actual, foreseeable and intended consequences of Korea's actions, the proximity requirement is satisfied.
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So, the scope and purpose of the relevant rule, Professor Mayer, in our respectful submission, is the international rule. That's confirmed, we say not least by the ILC Commentary itself. Picking up from where we just left off, the Commentary continues: "The requirement of a causal link is not necessarily the same in relation to every breach of an international obligation." We drop to a footnote. We see that the case cited there is one from the Iran-U.S. Claims Tribunal and, indeed, the relevant rule to which this is citing was the breach of the treaty itself, the Algiers Accord, and further confirmation if it is needed can be found in the S.D. Myers Case, which we have in Authority RLA-93. That's the Second Partial Award on remedies, on damages.
There is a discussion from Para 94 onwards which confirms that the key to these cases is the but-for test, and that all of the natural consequences of the breach of the minimum standard of treatment are recoverable as long as they are not too remote.
Specifically, Paragraphs 159 to 60: "Damages are recoverable if they were caused by the event, whatever that was if the acts engaged the minimum standard of treatment"--here they do--"and the losses are not too remote."
Professor Mayer, your hypothesis was, in
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essence, that the wrongful acts remain the same, but we are to assume that the Government did all of the things that we say it did, not because the President was in a corrupt scheme but instead because the President considered that what was good for Samsung was good for Korea. Well, the conduct in that hypothesis would still be within the scope and ambit of the rule under the facts of our case because the methods used in the hypothesis still undermine the rule of law, and that decision and rationale on our facts were still arbitrary--or is still arbitrary and it is still idiosyncratic.
The factual predicate to your question, sir, does not change the fact that the President's Order followed and well-understood by those in her chain of command, regardless of its motivation would not have been a good-faith exercise of decision-making powers consistent with the rule of law. She did not have the right to intervene in the Merger Vote. She was still subverting the machinery of State to impose her will, to the detriment of the rule of law and those making investment decisions. So this would not be a case in which it would be appropriate to accord any deference at all because there was somehow good-faith regulation of matters within a State's border.
Her decision to intervene on an individual
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business transaction outside the structures, Rules, and policies safeguarding the independence of the NPS is, in our submission, precisely the type of arbitrary conduct that undermines the Investment landscape. Had the President wanted to change those structures so that she could lawfully impose her whim, she would have needed to go through a legislative process so that the merits and demerits of having such a right of intervention and the risk of abuse of it could be debated democratically and openly, including as to the risk that that will create for market confidence and the impact on investor confidence. And had she done that, rather than acted in the shadows, market participants would have known of the risk of idiosyncratic political interference when choosing whether or not to invest in a Korean company, including one in which the NPS has a very substantial influence.
As to the specific motivations for her decision in your hypothesis, well, of course, there are myriad cases in which an organ of the State has resolved to take a certain action such as nationalizing a protected investment because it considers it to be in the sovereign interest, and that can violate any number of standards under a treaty, whether it amounts to an improper taking, unfair unequitable treatment, denial of justice. It all just depends on the modus through which the objective is
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realized.
So, in sum, we don't actually even need to show that she intended to benefit [Redacted], though, of course, we say she did. In the hypothesis, we would simply be examining whether her determination that the Merger was, with respect, as she euphemistically says in the Blue House memo "[Redacted]." We will be examining whether that was, indeed, still arbitrary idiosyncratically, whether it was made rationally, and whether it was made in good faith.
To conclude, sir, given everything we know about the utter lack of economic and business rationale for this Merger, we would still say that, indeed, that was a decision taken in flagrant violation of Korea's commitments under the Treaty.
ARBITRATOR MAYER: Thank you for this very detailed answer. Thank you.
I guess Mr. Volkmer would like to say something.
MR. VOLKMER: Excuse me. So, we just heard that the NPS's Shareholder vote and the NPS's duties under its guidelines are a strawman, and we would say that, of course, Claimants wish that it were a strawman, but it is at the very core of their case. It is NPS's vote, and the NPS's compliance or non-compliance with its guidelines that are at the core of Mason's case. So, we say that we
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cannot divorce the act that caused--allegedly caused--the harm, namely the NPS's Shareholder vote, from the Government's conduct.
So, our answer, then, to Professor Mayer's question remains that there is no proximate effect between the Government's conduct in the scenario described in the question and the harm caused, and that is for the reasons discussed on Monday. Under the guidelines, the NPS owed no duty to Mason. It owed a duty only to Korean pensioners. And if the NPS exercised its shareholder voting rights in breach of the guidelines due to government interference, then Korean pensioners, but not Mason, may have a basis to complain. Any harm to Mason would be too remote because that harm would not be within the ambit of the rule breached as described in Article 31, or the commentary to Article 31.
That's all I propose to say.
ARBITRATOR MAYER: Thank you, thank you.
Now, I guess we come to the--unless there is a reply. No.
We come to the third question. I don't know who starts.
MS. VAZOVA: I'm happy to start.
ARBITRATOR MAYER: Good.
MS. VAZOVA: So, Professor Mayer's third
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question was as follows: Assuming there was some illegal pressure from, let's say, Korea on the NPS, then the question is--and it is debated: Would NPS have voted Yes in the absence of such pressure or not? And my question is, who has the burden of proof?
So, we would respectfully submit that the debate perhaps arises from the fact that there are effectively two questions nested into Professor Mayer's question.
The, shall we call it, threshold question of whether the NPS actually approved the Merger because of illegal pressure. We bear the burden of that. We would submit that we have readily discharged that burden two and three times over.
The second question, and that's the direct question asked by the Professor, is: Would the NPS have voted Yes anyways in the absence of such pressure? In other words, did the illegal pressure make a difference to the outcome of the vote?
Now, Korea says no, it doesn't because look at all these reasons why the NPS could have voted Yes anyways. The burden of proving that, in our respectful submission, lies squarely with Korea. It is their defense. We have already made out our affirmative case. In the actual world, there was corruption. Korea approved the Merger because of the pressure that was exerted on the
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NPS as a result of that corruption. So now, it is Korea that needs to show if it wants to defend against our affirmative case, that in the hypothetical and counterfactual world, in which there was no corruption, Korea--the NPS would have approved the Merger anyways.
But even if the burden is placed at our feet, which we very firmly reject that in principle, we think we have readily discharged that burden as well. Before we started this Hearing--I'm just looking at CLA-14, at Page 43--the Seoul High Court had already found that, but for the manufactured synergy, the Investment Committee at a minimum would not have approved the Merger. The outcome of that, and I think Respondent admitted as much in their Opening remarks, then the Merger would have gone to the Expert Committee for resolution. And we would respectfully submit that after the evidence we have heard over the past couple of days, including in particular from Mr. [Redacted] and Professor Dow yesterday, the Tribunal can comfortably conclude that absent illegal pressure and had the Merger vote been referred to the Expert Committee, the NPS would not have approved the Merger regardless of who bears the burden of proof on that issue.
ARBITRATOR MAYER: Thank you. Is it again Mr. Volkmer? Yes.
MR. VOLKMER: Yes.
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So, we're not sure that we can make out a meaningful distinction between the two questions that were just formulated. And let's go just back to what Mason asserts in its submissions.
Mason asserts that the Korean Government caused the Investment Committee to vote in favor of the Merger and that the Investment Committee would not have voted for the Merger in the absence of pressure by the Government-- and I'm quoting from Mason's Reply at Paragraph 304. So, that is Mason's assertion, so Mason must prove it. Mason must show that the Investment Committee wouldn't have voted Yes, but for the alleged pressure. This is consistent with the usual requirement under international law that Claimants bear the burden of proving the facts on which their case relies, including facts relating to causation. There is no reason to depart from that principle here.
Even if Mason could show that the Investment Committee would have voted for the Merger because of pressure from the Government, this would not show that, absent pressure, the Committee necessarily would have voted against the Merger, and that's because there are other outcomes that would have been possible. For example, there could have been no majority for any of the voting options, and in that that case, as we've just
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heard, there would have been a referral to the Special Committee because the decision would have been difficult to make for the Investment Committee.
Now, Mason doesn't even try to prove that the Investment Committee, at least seven members, would have voted against the Merger, and Mason instead argues that the Merger should not have been referred to the Investment Committee in the first place. According to Mason, the Merger should have been referred to the Special Committee; and, if it had been referred, the Special Committee would have voted against it. And that's in Paragraph 305 of the Reply.
So, on its own case, Mason has the burden of showing that if the Merger had been referred to the Special Committee, it is more likely than not that the Special Committee would have voted against it.
Now, on Monday, we referred you to Bilcon v. Canada, that was RLA-174, which considered a causation scenario analogous to the one described in Professor Mayer's question. So, briefly on Bilcon: The Tribunal was presided by Judge Bruno Simma. The Tribunal found that Canada had breached its NAFTA obligations by conducting an arbitrary environmental assessment for a quarry project, which arbitrary assessment resulted in the project being denied environmental approvals. The
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Claimants claimed lost profits on the basis that, if the environmental assessment had been conducted properly, then the Project would have received approvals, would have proceeded, and would have generated profits.
Canada argued lack of causation because the necessary approvals may never have been granted anyway, even if the environmental assessment had been conducted properly.
The Bilcon Tribunal observed that it was "confronted with a situation of factual uncertainty where, in the view of one of the Parties, the same injury would have occurred even in the absence of unlawful conduct," and the Tribunal held that in such a situation, it remains the Claimants' burden to prove causation in "all probability" or "with a sufficient degree of certainty." And that's in Paragraph 1110 of that Decision.
Now, on the facts, the Tribunal found that there was a realistic possibility that the Project would have been approved as a result of a hypothetical NAFTA-compliant environmental assessment. But it cannot be said that this outcome would have occurred "in all probability" or "with a sufficient degree of certainty." And that's because there were several potential grounds on which the necessary environmental approvals could have been denied even if there had been a properly conducted
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environmental assessment. And you can find that discussion in Paragraphs 168 to 174 of the Award.
The only injury established with sufficient certainty was that the Claimants had been deprived of an opportunity to have a fair and non-arbitrary environmental assessment. But any injury resulting from the outcome of that assessment was too uncertain.
We say that the same applies to our case. In the Bilcon Tribunal's words, you are confronted with a situation of factual uncertainty, because it is uncertain how the NPS would have decided on the Merger but for the alleged pressure from the Korean Government. In that situation, Mason has the burden of showing that, but for the alleged interference, the NPS, in all probability, or with a sufficient degree of certainty, would have voted against the Merger. And we say that, based on the record of this arbitration, Mason cannot discharge that burden.
ARBITRATOR MAYER: Thank you very much.
Anything else from anybody? Not from me anyway. No.
Well, I was very interested in your answers, both--the three of you, so thank you.
PRESIDENT SACHS: Yes. I think that was helpful. It was a, sort of, mini oral argument--Closing Argument and certainly helpful. Thank you very much.
So, we will proceed with the program of today,
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which means that we will hear Professor Wolfenzon first.
MS. LAMB: Sir, just very briefly before we hear from the Professor. I still owe Dame Elizabeth one reference, so can I just read that in now before we start on the much more interesting material?
PRESIDENT SACHS: Please.
MS. LAMB: It's the reference to the Interest Rate that raised your question, Dame Elizabeth. Mr. Pape erroneously said in his Opening that the statutory source that he cited was the post-judgment rate. It was not. It was the pre-judgment rate in Korea and the reference in our materials is CLA-53, and it's Article 379 of that statute.
ARBITRATOR GLOSTER: Thank you very much, indeed. That clears that point up. Thank you.
PRESIDENT SACHS: Okay. May we then ask Professor Wolfenzon to join us?
PROFESSOR DANIEL WOLFENZON, CLAIMANTS' WITNESS, CALLED
PRESIDENT SACHS: So, are we all set?
Good morning, Professor Wolfenzon. Before we give you the floor for your presentation, in front of you is a declaration for expert witnesses. Could you please read that Declaration for the record.
REALTIME STENOGRAPHER: There is no microphone on.
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PRESIDENT SACHS: You have to switch the microphone on.
THE WITNESS: This--yes. Yes, okay.
PRESIDENT SACHS: Yes.
THE WITNESS: Should I read it again?
PRESIDENT SACHS: Could you repeat, please.
THE WITNESS: Of course. I solemnly declare upon my honor and conscience that my statement will be in accordance with my sincere belief.
PRESIDENT SACHS: Thank you very much.
Now, you will give us your presentation. You'd submitted two Expert Reports to these proceedings dealing with the valuation of conglomerates. And so, we invite you to make your presentation.
DIRECT PRESENTATION
THE WITNESS: Yes. So, good morning, Members of the Tribunal, good morning, everyone. My name is Daniel Wolfenzon, and I'm here to present my opinions on the case.
So, let me start with my qualifications. I am a Professor of Finance and Economics at Columbia Business School, currently Chair of the Finance Division and Faculty Director of the Global Family Enterprise Program. I have a Ph.D. in Economics from Harvard University.
And since my days in the Ph.D. program, I have
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been interested in studying business groups and family firms, and I've published the papers that I list here.
These papers studied the complex ownership structure of groups, the reason why these structures form in the first place, the valuation impact of these complex ownership structures, and in other papers, I've also developed formulas and algorithms to summarize these complex ownership structure.
Let me give you a brief overview of what I'm planning to talk about today. So, I will start describing the mechanics of stock-for-stock Mergers, and I will explain why the Exchange Ratio was unfavorable to SC&T Shareholders. I will explain that, for this reason, the Stock Price did not reflect the Intrinsic Value of SC&T. That's going to be Part 1.
Given this fact, I am going to explain that the alternative method is to use the SOTP, the Sum Of The Parts. I will be very brief here because you heard about this method yesterday.
The method consists simply in adding the parts of a holding company, and there is this view that a holding-company discount should be applied to the Sum Of The Parts. So, in the third part of my presentation today, I am going to explain why no holding company needs to be applied to the Dr. Duarte-Silva valuation.
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There is more agreement here than is apparent.
I agree that some of the factors that have been mentioned impact the value of holding companies. Undoubtedly, the Korean discount is a well-established fact. It's also well-established that Korean companies have severe governance issues.
What I believe is the main disagreement, is that I think that these effects should be included at the moment when the parts are valued as opposed to at the very end of the process with a subjective discount.
So, as I said, let me start with talking about stock-for-stock Mergers. So--and this is--I'm going to go quickly over this. So, in a stock-for-stock Merger, an acquirer issues new Shares that it then exchanges for Shares of the target at some specified Exchange Ratio.
So, what I have here is a stock-for-stock Merger in figures. So here, the red firm is merging with the blue firm. These rectangles here represent the value of these firms as a stand-alone. And when they merge, there are no synergies, the total value of the combined entity is just the sum of these two pieces. Now, what I have on the left is, you know, if you want, what happens prior to the Merger. On the right, you have what happens after.
Once the two firms are combined, what fraction of the total value is receiv--what faction of the total value is
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received by the target Shareholders. All the acquired Shareholders depend critically on this Exchange Ratio.
Now, I have here a red line, which is what the Exchange Ratio determines. So, below the red line, that is the part of the value that goes to the target Shareholders; above the line goes to the acquired Shareholders.
Now, based on the Exchange Ratio, that makes these transactions fair for both groups of Shareholders. So, you can see it here in the--in the--in the illustration. The reason why I say this is fair is that, as you see from this illustration, the Shareholders of the grain--of the green firm, to call it one way, they contribute the same amount to the combined entity as they get out, and the same is true for the Shareholders of the blue entity.
Now, I have to say that when prices reflect the Intrinsic Value of the firm, this Exchange Ratio is simply share--the ratio of the prices. Now, if for whatever reason--and we're going to go through those reasons in a second--the Exchange Ratio is lower, then have you a situation like the one I'm presenting here. In this situation, the target Shareholders lose some value, and the reason is, as you can see, the contribution to value, the green rectangle, is much higher--or higher, than what
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they get out of this combination, and so this loss is represented there in the dark gray square.
The other side of the same coin is that the Shareholders of the blue firm obtain more than what they put in. You can see that they--they are receiving everything above the red line, so they get, in addition to their contribution, again, this dark gray area.
All right. So this is, in general, what happens at the combination, you know--and what I'm showing you here is simply just this graph but scaled by numbers for SC&T and Cheil. I have to say, I took these numbers from Dr. Duarte-Silva's calculation out of the last day of trading for SC&T and Cheil. What can you see--and then--and the red line, which is the--what determines the distribution of value between acquirers and target Shareholders post-merger. I just computed with the Exchange Ratio and the number of Shares. And so, as you can see, SC&T Shareholders contributed 57 percent of the total Equity Value but obtain only 29 percent.
Now, as I was telling you, this is post-merger, and you probably remember from yesterday, this graph--sorry, this figure that Dr. Duarte-Silva presented. This--mechanically, this is what happens at Merger on the left. And as you can see on the right, if you go back weeks and months, what you see is that that value transfer
[Page 834]
is embedded in the prices of SC&T and Cheil. And you see that, you know, kind of, confirming this idea, you know, the magnitude of the discount is very similar to the magnitude of the premium.
Now, I left an important element in all of this story which is, I didn't tell you how the Exchange Rate is computed. Now, in many countries, like the U.S., for example, the acquirer is free to offer any Exchange Ratio. And, of course, they will offer an Exchange Ratio that is attractive to the target.
In contrast, in Korea, this Exchange Ratio is set by a formula and the formula is an average of Stock Prices of the target and the acquirer over the last month, week, and day. Now, if these Stock Prices reflected Intrinsic Values, then the Exchange Ratio would be fair, as I mentioned in my Slide 5. However, if Stock Prices do not reflect Intrinsic Value, the Exchange Ratio of this formula could still lead to unfavorable Exchange Ratio for target or acquirer Shareholders.
So, what I want to talk about now is, what are the reasons why the Stock Price deviated from Intrinsic Values in this case. I'm going to, you know, mention two: One is the threat of a value transfer; the other one is the timing of the Merger Announcement.
So, the threat of value transfer, I show you in
[Page 835]
this Figure 4 before, the one that Dr. Duarte-Silva showed you yesterday, that there was a value transfer embedded in the Shares. The--if you remember, the green area was very similar to the blue area, so th--this--this was a symmetric figure. And so, that is a good indication that there is a value transfer going on. It would be very difficult to think that this is just a coincidence.
Now, Professor Dow, you know, claims that, you know, this theory is circular. To some extent, you know, there is an element of circularity, but I want to argue that this is not a logical flaw. Let me just walk you through what, you know, economists called a self-fulfilling prophecy. Which is essentially that, once expectations actually caused the ex--you know, the--the expectations itself. So, the idea here is, imagine that investors expect a Merger at a low Exchange Ratio for whatever reason I'm going to, you know, perhaps tell you--I have time--I'll tell you why I think this is a reasonable expectation.
So, if they expect a lower--a Merger at a lower Exchange Ratio, they will then--would be expecting a value transfer, as I explained before. This, in turn, will depress Stock Prices today, and the [Redacted] Family, seeing these prices, would find it attractive to go ahead with the Merger, confirming the initial expectations; right?
[Page 836]
I hope this doesn't sound too academic. We see examples of this in the real world every day. For example, current debate about inflation expectations actually causing inflations.
Now, why would anybody believe that there's going to be a Merger and an exchange at an unfair Exchange Ratio? Well, you know, it's been known for a long time that there was going to be a succession in the Samsung Group. There was no need for a heart attack to happen; right? People get old and die, and there is a need to transfer the control to--to--to the family members.
Actually, I have a quote here from a very interesting paper that Professor Bae wrote in 2002. Oh, well, he actually--even in 2002, he was aware that, you know, there was a gradual, you know, movement towards a transfer of group chairmanship in the--in the Samsung Group.
Now, SC&T was, you know, very likely to be involved, it was a key to succession. And then, the other fact that might have, kind of, made people believe that this was a likely scenario is that stock-for-stock mergers are at a--a common mechanism to transfer control to the next generation in Korea. I think I have to speed up.
The other potential mechanism is simply the timing of the Merger. So, it is--it is in--it would
[Page 837]
benefit the [Redacted] Family to announce the Merger when the price of SC&T is particularly low and the price of Cheil is particularly high.
Now, it is true that prices are unpredictable, but they are unpredictable to investors in the market. There is a lot of information, there is a lot of lit--there is big literature in finance showing that insiders, corporate insider, are actually able to time the market, for example, when they repurchase Shares. So, the fact that the [Redacted] Family is more knowledgeable about the path of prices than the market, I don't think is a stretch.
All right. So, this takes me to my second point, which is the Sum Of The Parts. Let me just tell you that everybody here agrees that this is a standard method of valuation. It consists of three pieces. You value the parts in the conglomerate, is the core and the subsidiaries. You add these parts together, and then you subtract debt. There is, of course, the issue of whether you apply the discount or not, and this is where I'm going to go now, so I will explain in my third part--this is my second part, only I'm going to explain in my third part why I believe the discount is not necessary.
All right.
So, there has been many arguments, I kind of
[Page 838]
started today talking about them. The Korea discount affects value of firms in Korea and the conglomerate, there are governance problems at the holding company level perhaps. There could be a realized capital gains, there might be illiquidity of some of the holdings. I will talk about these issues in a second. So, we all, I think--well, I don't agree with all of them, I'll tell you which ones I agree but at least the Korea discount that the governance problems are aspects that I truly believe affect Korean conglomerates.
As I was telling you before, while I will agree that some, again but not all of these affect--impact the value of the holding company, the best way to include these effects is in the valuation of each of the individual parts. And again, not as a subjective and imprecise discount to SOTP. So, we should do our best to value the parts correctly in order to avoid trying to use an SOTP discount at the end.
Now, how do we avoid using a discount and try to precisely incorporate these effects? Well, we try to use Market Values. We use comparable, and we select the comparables in a way that addresses these valuation issues.
So, this is a table, and I'm going to spend some time here. So this is a table and I hope most of the
[Page 839]
reasons that might affect the value of the holding company, I have a column saying whether it's applicable to SC&T or no, and then finally how--if it's applicable, how it is included in the final valuation of Professor--Dr. Duarte-Silva.
So, let's start with the Korean discount. You know, I think that we all agree that this is already embedded in the valuation, so I guess there is no discussion here but just as an illustration. How do we--how do we include the Korean discount when we value the parts? We do two things: One, we use Market Values which are already depressed by the Korean discount. Market Values are already depressed. And second, we use, to value the core, we use multiples of firms that are in Korea, so they already embed these Korean discount, so there is no need again to apply another discount.
Now, a similar explanation hold for the next factor, severe governance problems at the holding company level. Now, the idea here is that there might be governance problems at the holding company level. I have here "unclear" because the academic literature on this point is not definitive. And let me tell you why. The evidence is mixed. On the one hand there is a large literature showing that firms that are at the top of the group, likely the holding companies, have higher
[Page 840]
multiples. That is, they value more. At the same time, there are other studies that claim the opposite, that the holding companies actually have, for whatever reason, more severe agency costs.
The point here is, no matter whether we believe that there is a benefit or a cost--sorry, or whether there are severe holding agency problems at the holding company or not, what Dr. Duarte-Silva does is he uses as comparables firms that are themselves holding companies. Again, so no need really to decide on the direction of this factor.
I will talk about unrealized capital gains and the Illiquidity Discount on traded holdings. I think, for example, that unrealized capital gains would generate a discount. This is, I agree that it might not be--this might not be--it might not be in the Market Price, but it might trigger a tax liability. However, I don't think that this is applicable to SC&T. I have a slide for that.
There is another theory that is in the Report that, having been presented here later, Professor Bae might talk about it, which is about the liquidity discount of the traded holdings. I don't think this is a valid theory. I will explain why.
There are two more here. In the interest of time I will just talk about the last one, you know,
[Page 841]
Professor Bae in his Report also mentions that there is a low profitability of SC&T Core. Again, I'm not sure about that. However, I have to say that the multiples used to value the core are Enterprise Value over EBITDA multiples, so using profits or earnings, if you want, in the denominator helps mitigate that potential problem.
All right. So, I agree with Professor Dow that, you know, if one were to sell stock--the stock that SC&T holds in other firms, that will trigger a capital gains tax. The question is how likely this is. And I don't think that it's likely. The reason why these--why SC&T holds Shares in SEC and SDS is precisely because it wants to keep control of these firms, and Professor Bae, in his Report makes the same point, so I think that we are in agreement on this.
But there is a more important point here, or perhaps equally important, which is even in the unlikely event of liquidation, the price at which these Shares are going to sell is not going to be the Market Price but rather higher. They're going to be--there is something that is called the Control Premium, which means that when blocks of Shares are sold in the market, the price per share is higher than the Market Price applied for Shares that are not sold in block, and the reason why--the reason for this increased value is because the Market Value
[Page 842]
control, buying 20 percent, for example, 10 percent, of a firm conferred some amount of control which is valued in the market. I cite in my Second Report one academic study that Reports an average block premium in Korea of at least 16 percent.
All right. I'm sorry you haven't heard this one, although it's in the Report, the next comment that I want to make is about, you know, this idea that there should be an illiquidity discount applied to the holdings because the SC&T is not planning to sell these Shares. I have to say that, first, even though they're not planning to sell their Shares, they could. I mean, this is not the situation we typically think when we are dealing with illiquid assets. An illiquid asset is an asset that is difficult to sell, not that the owner of the asset is unwilling to sell.
But even then, investors in the holding company, SC&T, can actually effectively sell Shares in the subsidiaries by simply selling the Shares of the holding company. There is no need for the holding company to sell the Share. And actually, this view is supported by finance professionals who actually do not apply a discount even to illiquid holdings owned by firms that trade in liquid markets. I have a quote here from Professor Damodaran. So, even if you believe that these holdings
[Page 843]
are illiquid, there are reasons to believe that a Illiquidity Discount doesn't apply.
All right. In the last part of today, I want to talk a little bit about what the academic literature says about the holding-company discount. So, as I told you when I was introducing myself, I have been working on business groups since my graduate degree, that's 20-something years ago. And in early 2000s, there was a lot of interest in the study of business groups, and Professor Bae published a paper in 2002, which is very well cited. And I have been going to conference and, you know, been engaged with this topic. The reality is that I have not heard about a holding-company discount--let me rephrase that. I've heard about the holding-company discount anecdotally, but I have never seen a systematic academic study that documents this fact.
When I read the reports, you know, I went back to the journals to find evidence for this, so what I did is a search on the top three finance journals for the last 20 years, for all papers that mentioned the word "business groups" and other related terms. I came up with 51 papers, and no paper actually talked about the holding-company discount. The papers do talk about valuation of business groups. They talk about whether the market:book ratio is high or low, depending on the
[Page 844]
situation in the group but that is very different from saying that they are worth less than the Sum Of The Parts. It's just very valuable, not very valuable. It doesn't mean that the parts are not adding to the total. Actually, no paper goes far to make that claim.
All right. Actually, Professor Bae in his Report, admits that there is no academic literature on this topic. Just to, you know, provide context that, you know, I'm not the only one claiming this. His view is that holding companies--this holding-company discount applies only in Korea, and for that reason is not of the interest of the major finance journal, and I think that--I think this is incorrect. Business groups are prevalent in many countries. Professor Bae, himself, explains that business groups are prevalent not just in Korea, but in Brazil, Chile, China, India, Indonesia and so forth, and even in developed countries such like Italy and Sweden, and this is a short list, I would say.
So I would not see why business groups that are kind of quite similar would not have also a holding-company discount. I have to say that there is a lot of interest also in the academic literature about Korea. Korea is an interesting country to study Corporate Finance.
Actually, out of the 51 papers on business
[Page 845]
groups on all the world, 12 of them, 20 percent of them are about Korea, so there is an interest in research in this area.
I went to a leading textbook, one that I use in my class, and this textbook in the chapter of the Sum Of The Parts actually does not recommend either the application of the discount. They simply say just add the value of the core assets, the subsidiaries, the cash, and subtract debt, and also the recommendation of this book in terms of what to do with the value of the subsidiaries is just to add--just to use the Market Price.
I wanted to see at least how a leading researcher in conglomerates and family firms teaches this topic in her class, so Professor Villalonga is a well-known researcher in these topics, and she wrote a note on Sum Of The Parts that she used to teach--well, used to because she moved from Harvard, but she used to teach this at Harvard Business School, in a class on family firms there, and she concludes there in one of the paragraph with this sentence: "The research findings imply that the practice of applying a discount to SOTP values is not only arbitrary but, in fact, wrong."
And then Professor Bae also makes a comment that this Professor Villalonga was referring only to the U.S., but reading the note I don't think this is the case, and I
[Page 846]
have many quotes here that provide background.
All right. Another very straightforward reason why this is not--and Professor Dow mentioned this yesterday--another reason why this cannot be a generalized fact is because there are some, even in Korea, some conglomerates or some holding companies that trade at a premium. Cheil trades at a premium. Traded at a premium before the Merger. SC&T even in some periods have traded at a discount.
All right. In the last minute, I want to--I'm going to very briefly--I already mentioned this before when I was telling you that the literature, the academic literature has looked at Tobin's Q, which is essentially a market:book ratio to understand the valuations of holding companies and not at the holding-company discount, and the interpretation that a low Tobin's Q is equivalent to a holding-company discount, I think, is wrong. And this is kind of present in many of the comments and the analyses of Professor Bae, but I don't have time to go there.
Let me end with my conclusion in the last 30 seconds that I have.
So, a discount to SOTP prior to the Merger is due to the expected value transfer. I mean, it would be a coincidence that the premium and the discount are almost exactly the same magnitude. Since the market was
[Page 847]
embedding this expected value transfer into the Stock Price, the Stock Price is not an accurate measure of Intrinsic Value, so the best alternative is the SOTP method.
And finally, as I explained to you, I believe that Dr. Duarte-Silva's methodology to compute the SOTP adjusts for factors that affect the value of SC&T, obviating the need to apply a second discount. There is no evidence that the holding-company discount in the academic literature, textbooks--perhaps in the academic literature that I reviewed in the textbooks that I show you, or taught by at least myself and one other finance professor, and I don't think that I have seen, like, convincing evidence at least as a general point that the holding-company discount exists.
And that is the end of my presentation.
Sorry, I forgot to mention I included an errata here. I made a mistake in one of my Reports. My Second Report. Where I claimed that one firm was trading at a premium to SOTP when in reality it was trading at a discount. I have to say that I don't think that affects my conclusion because I was trying to illustrate that some firms trade at a premium and others at a discount.
PRESIDENT SACHS: Thank you very much.
We still have time before the coffee break to
[Page 848]
start cross-examination. Mr. Gopalan?
MR. GOPALAN: Thanks, Mr. President.
BY MR. GOPALAN:
Q. Good morning, Professor Wolfenzon.
A. Good morning.
Q. You used the term "Fair Market Value" at several points in both of your Reports; correct?
A. Yes.
Q. You don't define that term in either report?
A. I do not.
Q. Could we go to CRA-177, please.
A. Am I supposed to be--sorry. No? Okay.
Q. That's a cue to FTI to bring up the document.
A. Yes, I know that. It's just not in my screen. Sorry, this is the first time I'm doing this so.
Q. No worries at all.
So, this is a frequently cited World Bank document called the "Legal Framework for the Treatment of Foreign Investment." If we could go to Page 26, please.
And in that first paragraph, it provides a definition of "Fair Market Value," which I will read for the record. It says: "The price that a willing buyer would normally pay to a willing seller of the investment after taking into account all relevant circumstances such
[Page 849]
as the nature and duration of the investments. Throughout, reasonable criteria would be applied with a view to ascertaining the market value of that investment."
Do you see that?
A. Can you highlight it for me, please?
Yes, I see that.
Q. Do you agree with that definition?
A. Actually, I believe that this is--I don't have a view on this definition. This is--you know, I'm finance professor. I'm not familiar with legal definitions.
Q. So, when you used this term "Fair Market Value" in your Report, what do you mean?
A. I'm referring to an Intrinsic Value.
Q. So, to you, Intrinsic Value and Fair Market Value are equivalent?
A. They're not.
I understand that, according to this definition, for example, the Investors would be buying and selling Shares of SC&T at the price that includes the value transfer; right? However, I would not consider that the Intrinsic Value or, if you want, a stand-alone value, absent the threat of the Merger.
Q. The question is: "Fair Market Value" and "Intrinsic Value," are they the same thing to you?
A. I'm not familiar with this definition. I am--in
[Page 850]
my explanation that I just gave you, they are not, so--but... Yeah.
Q. In your Report, you used them for the same purpose, they're equivalent terms in your Report?
A. I might not have--I might have been not very careful with that definition, yes.
Q. But, in truth, they're different things?
A. Okay, so let me--so, I think what I would say is that, in my Report, I have been thinking about--
PRESIDENT SACHS: Could I ask you to speak up a little.
THE WITNESS: Sure, sure.
In my Report, I was referring to Intrinsic Value as the value of SC&T specifically without--in the but-for world without the expected value transfer. That's the way I was thinking about it in my Report. I'm sorry that these legal definitions escape me a bit.
BY MR. GOPALAN:
Q. That's totally understandable, but just to be very clear, Fair Market Value is the price, and for you that's something different to Intrinsic Value?
A. Yes, yes.
Q. And the Fair Market Value of an asset changes over time; right?
A. Absolutely.
[Page 851]
Q. And that's the same for any asset? It could be a house, it could be a share in a public company?
A. Yes.
Q. So, a buyer today may pay something else for the same asset tomorrow?
A. Yes.
Q. And that's for any number of reasons?
A. Absolutely.
VOICE: Sorry, Witness, keep your voice up.
THE WITNESS: I'm sorry, yes, yes.
BY MR. GOPALAN:
Q. I have the same issue, actually.
So, when one offers an opinion on the Fair Market Value of an asset, you're offering that at a very specific moment in time?
A. Yes.
Q. The Valuation Date matters?
A. The Valuation Date matters, yes.
Q. You addressed Sum Of The Parts in your Reports in your presentation this morning.
A. Um-hmm.
Q. That's a standard widely used valuation technique?
A. Yes.
Q. It's used frequently by many stock analysts?
[Page 852]
A. Yes.
Q. And different analysts reach different Sum Of The Parts conclusions?
A. Yes.
Q. And they could reach different conclusions or different valuations, despite doing the analysis on the same day?
A. Yes.
Q. And that difference could be attributable to various factors?
A. Yes.
Q. It could be the companies they chose to-- the comparables they chose to value the Company's core business?
A. Um-hmm.
PRESIDENT SACHS: Mr. Wolfenzon, once again, otherwise it's very difficult for David our court reporter to follow you.
THE WITNESS: Yes.
BY MR. GOPALAN:
Q. It could also be due to the method that they adopted to value unlisted holdings?
A. Yes.
So, let me elaborate on this a bit.
So, having said that, no analyst, two people
[Page 853]
doing the same valuation of a company can reach different conclusions. There are valid and invalid reasons to arrive to that two different conclusions, so we can disagree about the growth of the Company but there are standard methods in finance that are--I mean, robust of course, they rely on assumptions, but, you know, I cannot, for example, apply a discount when it's not warranted.
Q. You wouldn't apply a discount if it's not warranted. You wouldn't apply a discount to a Sum Of The Parts valuation?
A. If it's not warranted.
Q. Others might disagree?
A. People can be wrong, if you're asking that question, yes.
Q. Let's turn to--
A. The truth, in my opinion, there is, you know, there are situations where no discount is warranted. I understand that other people might believe it is. My interpretation of the academic literature and applicable evidence is that, you know, we should not. I think I'm here to express that opinion.
Q. That's your good-faith academic opinion?
A. Yes.
Q. Let's go to one Analyst's Report on SC&T. If we could pull up CRA-70, please.
[Page 854]
This is a Deutsche Bank Analyst Report from 23 April 2015.
Do you see that? It's in the top right-hand corner.
A. Yes.
Q. And the Merger at issue in this case was announced on the 26th of May 2015, so this was published before that?
A. Um-hmm, yes.
Q. We look at the data in the top right-hand corner, we see that SC&T's Share Price on this day is KRW 61,400.
Do you see that?
A. Yes.
Q. And the price target is KRW 78,400.
A. Yes. I see that.
Q. So, the price target is where the analyst expects the price will go; correct?
A. Agree.
Q. It's speculative?
A. Well, it's his view.
Q. It's subjective?
A. It's his best effort to come up with a price, a future price.
Q. It could be wrong?
[Page 855]
A. This analyst could be wrong.
Q. Let's go, please, to Page 5. Figure 12, if we could zoom in on that, please.
This is a Sum Of The Parts analysis, isn't it?
A. Um-hmm.
REALTIME STENOGRAPHER: Can the Witness say "yes" instead of "um-hmm"?
THE WITNESS: Yes. Absolutely.
My apologies.
BY MR. GOPALAN:
Q. So, this analyst uses a Sum Of The Parts analysis to derive the target price.
Do you see that?
A. Yes.
Q. And if we look at the line "all listed equity"--and if we could highlight that the full way along--we will see that this analyst applies a 30 percent discount to SC&T's listed holdings.
Do you see that?
A. Yes.
Q. And he uses that to derive his target price?
A. Yes.
Q. Now, if I wanted to buy a share of SC&T on the date of this Report, 23rd of April 2015, I would pay the Market Price, wouldn't I?
[Page 856]
A. You would.
Q. And nobody would pay this target price of KRW 78,400?
A. If you buy the share--I don't understand the question. If you buy the share in the market, you pay the price.
Q. Is that the Market Value?
A. That is a current value, yes, um-hmm.
Q. Okay. You reviewed Dr. Duarte-Silva's Sum Of The Parts valuation carefully in the process of preparing both of your Reports?
A. Yes.
Q. And is your opinion that no discount should be applied to that valuation?
A. Yes.
Q. Did you validate the rest of Dr. Duarte-Silva's Sum Of The Parts analysis?
A. Which parts?
Q. Did you agree with his estimation of SC&T's core business?
A. What I review of Dr. Duarte-Silva's valuation is the methodology that he followed. You're asking me if I look at every single detail of the analysis. I did not.
Q. So, did you, for example, review his methodology for valuing Samsung Biologics?
[Page 857]
A. I have--I remember what he did, yes.
Q. And you agree with that?
A. Yes.
Q. Now, Dr. Duarte-Silva's Valuation Date was the 17th of July 2015; correct?
A. Yes.
Q. Sorry, just into the microphone.
A. Yes.
Q. So, that's the date of the Merger Vote?
A. Yes.
Q. If we have time, if we could go to RDE-12, please. If you could bring that up. Thank you.
Dr. Duarte-Silva's Sum Of The Parts produces a per-share price estimate of SC&T that's just under KRW 120,000 on the date of the Merger.
Do you see that?
A. Yes.
Q. For a share of SC&T actually traded at just over KRW 60,000 at the same time?
A. Um-hmm, yes.
Q. So, the Market Price is about half of what the per-share price implied by Dr. Duarte-Silva's valuation; right?
A. Yes.
Q. And if I wanted to buy a share in SC&T on the
[Page 858]
17th of July, I would pay the Market Price?
A. You would pay the Market Price.
Q. And it's the same if I wanted to buy a share in February 2015, for example? I would pay the Market Price?
A. You would pay the Market Price.
Q. It wouldn't matter to me what Dr. Duarte-Silva's valuation is, his Intrinsic Value--
(Overlapping speakers.)
A. Well, I believe--and the reason what Dr. Duarte-Silva is doing this valuation is not to estimate the price in the actual world but to estimate the price in the but-for world, yes.
So, what I would say is that, in the but-for world, you will have not seen these prices going forward. You would have seen something different--sorry, you would have seen his but-for value.
Again, I admit that, you know, it would be, you know, too presumptuous of me to say that this would be exactly the price, but I would say that this is the--given, you know, my knowledge of, you know, a solid methodology.
Q. Understood.
So, in February 2015, months before the Merger Vote, if I wanted to buy--
A. Sorry?
[Page 859]
Q. This is marked on the graph. On the top panel just next to December 14, you can see February 15 at the bottom on the horizontal axis.
A. February 15, yes, sorry, yes, you mean 2015.
Q. Yes.
A. Perfect, yes.
Q. That's a few months in advance of the Merger Vote?
A. Yes.
Q. If I wanted to buy a share of SC&T in that month, I would pay the Market Price?
A. I mean, yes.
I have to say--yes.
Q. I'm about to move on to a whole new different module, Mr. President, so it might be a good time to take the break.
PRESIDENT SACHS: We will resume at 10:15, David.
(Brief recess.)
PRESIDENT SACHS: Mr. Gopalan, may we ask you to proceed.
MR. GOPALAN: Thanks, Mr. President.
BY MR. GOPALAN:
Q. Professor Wolfenzon, for a large highly traded public company, the presumption is that the Stock Price
[Page 860]
tells us the Fair Market Value; right?
A. For a large traded public company, you can buy and sell Shares at the current Market Price.
Q. And having regard to what we've looked at before, the definition of "Fair Market Value"--
A. Um-hmm.
Q. --the Market Price for a share in such a public large company would be the Fair Market Value; correct?
A. Again, I prefer not to use the term because I'm not familiar with the nuances of the definition, but I can definitely tell you that you can buy and sell Shares at the current Market Price.
Q. My difficulty with that, Professor Wolfenzon, is that you used the term "Fair Market Value" at several points in your Report.
A. Yes. I've realized that you have very specific meaning to that. I can clarify what I meant if you show me the Report.
Q. Okay. Let me ask you. When you reviewed Dr. Duarte-Silva's Sum Of The Parts analysis, you saw that he valued SC&T's holdings in many other Samsung Group companies.
A. Yes.
Q. And he did so at their Market Prices.
A. Yes.
[Page 861]
Q. And you were okay with that? You thought that was a reflection of Fair Market Value.
A. Yes.
Q. But, for you, SC&T--the Share Price of SC&T did not reflect the Fair Market Value.
A. Yes.
Q. And you offer reasons in your Reports why the Stock Market price of SC&T did not capture the Fair Market Value of Shares in SC&T on the date of--
(Overlapping speakers.)
A. Sorry, let me--I explain why the current Market Price of SC&T does not reflect the value at which this firm would trade in the but-for world.
Q. You explain why SC&T's Market Price does not reflect an estimate of the Intrinsic Value of SC&T; correct?
A. Today? Yeah, in their--are you asking me or you are asserting that?
Q. It's a bit of both, actually.
A. Okay. So--
Q. I'm asking you: Is it your opinion that SC&T's Share Price on the 17th of July 2015, the date of the Merger Vote--
A. Um-hmm.
Q. --didn't reflect its Intrinsic Value?
[Page 862]
A. So, what I can tell you, what I have under--what I've been thinking about in my Report is that the price of SC&T reflected the value of its components but at the same time reflected value transfer to Cheil. So the price embedded a transfer to Cheil.
So, I can give you an example, if you want me to clarify.
Q. Not just yet, if that's okay.
In Dr. Duarte-Silva's Sum Of The Parts, the listed holdings included several other Samsung Group companies; correct?
A. Yes.
Q. It included Samsung Electronics, Samsung SDS--
A. Um-hmm.
Q. --Samsung Engineering. You had no issue with those components being valued at their Market Prices?
A. No.
Q. So, for you the only issue was SC&T.
A. Yes.
Q. Is it fair to say that the presumption is that we can trust the Market Price?
(Voice sounding.)
Q. I'll repeat the question.
Is it fair to say that the presumption is that we can trust the Market Price unless there's reason to
[Page 863]
doubt it?
A. Unless there is reason--I think that you don't need me for that question. That's almost a tautology.
Yes, it--
(Overlapping speakers.)
Q. That's a "yes"?
A. Yes.
Q. Okay. Let's go to your Second Report, to Paragraph 57, please.
We'll go to the last sentence of Paragraph 57, and I'll read it for the record: "For the reasons set out in this report, Prof. Dow has not presented convincing evidence that these reasons did not each play a role in the determination of the exchange ratio and, taken together, caused SC&T's shares to trade at the discounted fair market value shown through Dr. Duarte-Silva's SOTP valuation of SC&T's shares."
Did I read that correctly?
A. Yes.
Q. But the Share Price of a big company like SC&T is presumptively its value; correct?
A. I think that we are--if you allow me to explain again, I think we are mixing terms. So, clearly--and I'm not going to dispute this--leading up to the Merger Announcement, the Merger Vote, the--you could buy and sell
[Page 864]
Shares at what is the Market Price. What I'm saying is that the Market Price, this Market Price that you are paying, reflects many things. It has--parts of it are the components of the holdings. At the same time, it reflects value transfer. Now, I don't know how -- My view is that the value transfer disappears in the event of a failed merger.
So, we--the problem--I think that the reason why we are going around and around this question is because we have two scenarios in mind. So, there is the scenario which I believe that you are calling "the real world/what actually happened," and the scenario of what could have happened. And so, I am telling you that, of course, in the real world, we are exchanging the Shares at the price, at the Market Price. What I'm telling you is the best estimate of the Market Price in the but-for world would have been a different price.
Q. Okay. You said that a reason--and you said it this morning and you said it again in your testimony--
A. Um-hmm.
Q. --the reason SC&T's Share Price was undervalued compared to its intrinsic value--
A. Um-hmm.
Q. --was the threat of value extraction--
A. Um-hmm.
[Page 865]
Q. --and that's.
A. Yes.
Q. And you say that a reason that that--that there is a threat to value extraction is the risk of a transaction that favors the [Redacted] Family at the expense of SC&T's Shareholders.
A. Yes.
Q. Right?
So you said, I think just a minute ago, you don't know--pull up the quote so I'm not misquoting you. I will quote you: "I don't know how my view is that the value transfer disappears in the event of a failed merger." Right?
A. Can I see that? Is it possible for me to see my own--or that is not possible? No?
PRESIDENT SACHS: It was in the Transcript. You just said this.
Could you--oh, I'm sorry, I realize you don't see the Transcript, so but please quote it again.
MR. GOPALAN: Sure. Maybe FTI could pull that up, if it's possible, but if not, I can just read it out again.
FTI TECHNICIAN: What was the time stamp?
MR. GOPALAN: 10:24:47.
THE WITNESS: Thank you.
[Page 866]
BY MR. GOPALAN:
Q. So, my question to you, Professor Wolfenzon, is: In the event of a failed merger, the succession issue is unresolved, isn't it?
A. Yes.
Q. The [Redacted] Family still has control of the Samsung Group; correct?
A. Yes.
Q. So, SC&T's Shares would probably still be trading at an undervalue; right?
A. It depends on what you think about what will happen. Yeah, my understanding is that there were other avenues to a--to effect the transfer, and the--should the Shareholders vote no for one transaction, I don't see why they would vote Yes for another, seeing that perception.
Q. That's not an opinion you express in any of your Reports.
A. No. No, no, because I was not confronted with this question.
Q. But this morning in your presentation, you said succession has been a long-standing issue that's weighing on SC&T's Share Price.
A. Yes. Yes, exactly, yeah. The acquisition--so the acquisition of--and by the way, you are asking me questions that I understand that I have not expressed an
[Page 867]
opinion in my Reports.
But I--there were, as I understand it--and I cannot remember now--other potential avenues for transfer that might not have been involved SC&T, but again this is a speculation.
Q. It's speculation.
And so, at the same time, undervalue in SC&T's Share Price could have been unrelated to the Merger specifically; right?
A. I don't think so.
Q. Well, you said that there were other transactions possible to the Samsung Group to consolidate succession; right?
A. Yes, but I haven't studied them, so I don't know whether they were undervalued, overvalued; I have no idea about that.
Q. It's also fair, then, to say, that your conclusion that SC&T's undervalue is due entirely to the Merger is also speculative.
A. My conclusion? Can you repeat the question?
Q. Sure. SC&T, the reason it was trading at an undervalue historically is due to a threat of a merger or a threat of succession problems.
A. A threat of a--yes, a threat of a merger.
Q. That's speculative, isn't it?
[Page 868]
A. You know, there is evidence on that; right? So, I mean, this is not purely speculative. If you look at the premium on Cheil and a discount on SC&T, they are very similar.
Q. Okay. We're going to come to that evidence shortly.
A. Um-hmm, um-hmm.
Q. In your First Report, you analyzed SC&T's Share Price between the Merger Announcement and the Merger Vote.
A. Yes.
Q. Right? So, that's between 26 May 2015 and 17 July 2015.
A. Yes.
Q. And you concluded that SC&T's Share Price was affected by the terms of the Merger Announcement.
A. Yes.
Q. It was affected by the Merger Ratio, specifically.
A. Yes.
Q. Let's go to your First Report's Paragraph 48. Let me read this for you: "As I explained in this section, the Korean system for the determination of merger ratios is open to exploitation and, in the case of SC&T-Cheil, an unfavorable exchange ratio for SC&T's shareholders was achieved through two particular
[Page 869]
mechanisms: selection of the timing of the merger by the boards of SC&T and Cheil, and the potential manipulation of the stock price of SC&T."
A. Yes.
Q. I read that correctly?
A. Yes.
Q. Now let's look at your Second Report.
A. Yes.
Q. We'll go to Paragraph 50. Again, I'd like to read this for the record: "In our First Reports, Dr. Duarte-Silva and I explained that there are three principal reasons why the stock market prices of SC&T did not capture the intrinsic or Fair Market Value of SC&T and Cheil on the date of the merger vote. We noted that, most importantly, on the day of the vote, the stock market prices already incorporated the threatened value transfer from SC&T to Cheil."
I read that correctly?
A. Yes.
Q. Threatened value transfer was not one of the two reasons you set out in your First Report.
A. No.
Q. The words "value transfer" don't actually appear anywhere in your First Reports.
A. No.
[Page 870]
Q. But you say now that it's the most important reason why SC&T was not priced fairly as of 17 July 2015.
A. Yes.
Q. It didn't just become the most important reason between your First Report and your Second Report?
A. I've been--you know, I've been reading them and studying them and analyzing this case, yes.
Q. You just overlooked it in the First Report.
A. That's a very strong word. I think that I--you know, I might have thought about it, but I didn't include it, yes, but that's it.
Q. But it's the most important reason. You just missed it.
A. If you ask me today, I think so.
Q. Let's take a look--
A. You asked me--sorry, let me just--
Q. Sorry.
A. --say it correctly, yes.
Q. Let's take a look at what you say about that reason in your Second Report. It's Paragraph 52 of your Second Report.
Now let me read this again: "In his Second Report, Dr. Duarte-Silva addresses Professor Dow's disagreement with the proposition that the stock market prices already incorporated the threatened value transfer
[Page 871]
from SC&T to Cheil prior to the merger vote, and concludes they are without merit. In my view, the fact that the market prices already incorporated the threatened value transfer from SC&T to Cheil is not surprising."
And then you list a series of subparagraphs.
A. Yes.
Q. So you're summarizing here what Dr. Duarte-Silva's--Yes.
Q. --opinion is?
A. Yeah.
Q. And his opinion was that SC&T's Share Price incorporated threatened value transfer.
A. Yes. It was a very--yes, I thought the evidence was convincing.
Q. You say you're not surprised by his conclusion; right?
A. Yes.
Q. Are you actually offering your independent opinion that SC&T's Share Price was incorporated--incorporated threatened value transfer--
A. I haven't done, so if you are--
(Overlapping speakers.)
Q. Let me repeat that question.
Are you actually offering your independent opinion that SC&T's Share Price incorporated threatened
[Page 872]
value transfer on the Merger Vote Date?
A. So, I--the analysis is not mine. I haven't run the numbers. I've seen the analysis, and I've read it, and I found it convincing.
Q. Have you reviewed all the evidence that Dr. Duarte-Silva looked at?
A. Absolutely all the evidence?
Q. Yes.
A. No.
Q. So, you're just endorsing Dr. Duarte-Silva's analysis; right?
A. I'm not sure what you mean by "endorsing." My apologies for not--I just don't want to make a statement that is--when I don't understand exactly the nuances of the word.
I read the analysis--sorry, I read the analysis. I look at the graphs, and I--you know, and that convinced me the same way that when I form an opinion about an academic decision and I read a paper, I do not necessarily-- run the analysis myself. I read the report, I read the paper, I read the analysis, and I trust, you know, the result.
Q. That was enough for you, Dr. Duarte-Silva's analysis, to reach the conclusion?
A. Yes.
[Page 873]
Q. There are many reasons why a stock might trade at an undervalue to its intrinsic value at a given point in time; right?
A. Yes.
Q. And you didn't perform any event study before the Merger Announcement linking news of the SC&T-Cheil merger to decline in the SC&T Share Price.
A. I didn't.
Q. And neither did Dr. Duarte-Silva.
A. No.
Q. You didn't consider, in fact, any other potential impacts on SC&T's Share Price in the lead-up to the Merger Announcement; right?
A. What do you mean "consider"? In what report?
Q. In either report. We--you just testified that there are many reasons why--
A. Yes.
Q. --a Share Price might have been undervalued?
A. Yes.
Q. --and you didn't consider anything other than the potential merger.
A. Well, the evidence on the value transfer is very convincing.
Q. You didn't consider any developments, for example, in the Korean Stock Market more generally in that
[Page 874]
period.
A. No.
Q. You didn't consider how SC&T's peers in the construction industry were doing at the time either, did you?
A. Yeah. I read reports of the--you know, that the construction industry was not doing well.
Q. Okay. I suggest to you that it's very unreasonable to narrowly identify one reason for a stock price's undervalue over a period of several months. What's your response to that?
A. You think that--so you are telling me that the evidence that I presented is--or that Dr. Duarte-Silva presented is not convincing? Is that the question?
Q. Not quite. We'll come to that evidence in a--shortly. My point is that you've accepted that there are various reasons why a stock might trade at an undervalue.
A. Yes.
Q. And my suggestion to you is that, with that understanding, it's unreasonable not to look at any other factors as explaining why a Stock Price might be down; right?
A. You know, one should look at so--I don't know what the standards are here, so let me tell you what we do
[Page 875]
in academic research. We do not consider all possible--you know--try to consider possible theories that explain the same aim--and then we provide also evidence in favor of the, you know, theory we are trying to prove.
Q. Okay. Let's look at some of that evidence.
In your Report, you described the evidence that Dr. Duarte-Silva relies on as strong. Sound right?
A. Yes.
Q. Okay. Let's look at CRA-48, please.
And before we get into the text of the document, let me ask you: You also say that market commentary from the time supports the theory of value extraction that Dr. Duarte-Silva has articulated.
A. Yes.
Q. And so, when you--sorry, go ahead.
A. Yes. So--and I'm sure that you are going to show me evidence that, you know, not everybody was thinking the same way, yes. But, you know, the, you know, several reports that I read indicated that, yes.
Q. So, you reviewed several reports on this issue; right?
A. Um-hmm.
Q. And some of them said that--some of them didn't mention value extraction at all; correct?
A. That is true.
[Page 876]
Q. Now, this is one that Dr. Duarte-Silva relied on, presumably you also reviewed; is that right?
A. I don't remember.
Q. So, Dr. Duarte-Silva cited three reports. He relied on three reports for this--for his idea that SC&T's Share Price traded at undervalue due to value extraction. Do you un--
A. So--
Q. I'll just finish that question.
So, is that consistent with your understanding?
A. So, I don't remember how many. I just want to say that the argument does not rely solely on this report; right? So there is this evidence of the value transfer, as well.
Q. Right. But Dr. Duarte-Silva relies on three reports.
A. Um-hmm.
Q. And you described his evidence as strong, didn't you?
A. Yes.
Q. Okay. So, let's look at one of those reports now.
A. I have to say that, you know, there is--there are different pieces of evidence; right? There is the evidence on the value transfer, and then there is the
[Page 877]
evidence on the, you know, market commentary. The fact that one piece of evidence is not as strong, as I'm sure you're going to show me now, doesn't necessarily mean that the entire--taken together, the entire evidence is weak, but I'll stop there and wait for your question.
Q. When you write a paper in your field, you cite to evidence to support the assertions you make; correct?
A. Yes.
Q. So, it's a reasonable assumption that the evidence that Dr. Duarte-Silva relies on and which you validate should substantiate what he's saying; correct?
A. It should. You know, I don't like--you know, in my--in my field of study, we don't--you know, we try to review all the evidence for and against, yes.
Q. Okay. So, let's go to the first paragraph, the third sentence, please, and if we could highlight that. It starts with "we attribute the recent pullback."
So--sorry, just for context, this is a--an Analyst Report by Samsung Securities from January 2015.
A. Yes.
Q. And as I mentioned, it's one of the Reports that Dr. Duar--one of the three Reports Dr. Duarte-Silva relies on in his First Report as evidence about SC&T's Share Price reflecting the possibility of value extraction?
A. Yes.
[Page 878]
Q. Now, this Report says: "We attribute the recent pullback in the price to fresh concerns about--over the Roy Hill Project, the possibility of provisioning for the Saudi Qurayyah IPP Project, and third, rumors of a Merger with Cheil Industries, which listed on December 18, 2014."
The fact is this one and two here have nothing to do with the Merger; right?
A. Yes. But--yes, this is talking about the decline in price.
Q. Yes.
A. Yes. So, this analyst, I do not think is--and maybe we can go to the evidence, but I don't think this analyst is saying that the decline in the--in the deviation from SOTP but...
I mean--go ahead.
Q. My point is just that these--these two factors may have led to a decline in SC&T's Share Price in advance of the Merger; right?
A. From--I don't know from when to when.
Q. Well, the Report was published in January 2015; right?
A. Okay. They could have--yes, they could have led to a decline.
Q. And neither you nor Dr. Duarte-Silva bothered to try to investigate the price impact of these factors?
[Page 879]
A. No.
I mean, people--you know--you know, analysts will come up with a million reasons why prices can go up and down. The--as I--as I--as I keep saying, there is very striking evidence of a value transfer by computing the--I mean, I apologize for repeating this again, but if you ask me: Yes, I did not consider the other two for a decline in price. I did find, however, very strong evidence for a value transfer, and I think it's unreasonable to collect all possible speculations and analyze them all. I think that we've analyzed or I've analyzed--reviewed evidence of a value transfer in--that was presented by Dr. Duarte-Silva.
Q. Dr. Duarte-Silva explained that the entire--the single reason SC&T traded at an undervalue before the Merger Vote was fear of the Merger.
A. Um-hmm.
Q. You can't agree with that, can you?
A. The entire reason?
Q. Correct.
A. You could have--I mean, I propose other rationales, right, in my Report.
Q. What you don't propose is other--other impacts on the Share Price that could have driven it down unconnected to the Merger; right?
[Page 880]
A. No, the reason why I don't--the reason why I'm not finding this conversation that illuminating on the "value transfer" theory is that it's one-sided; right? So, what is very striking about the data, again, is that whenever the discount increases, there is a commensurate increase in the premium, which I don't think theory one or two witnesses heavily explain.
But again, I haven't--you know, you put me on the spot with this, and that would be--that would be my reaction to this evidence.
Q. Let's--let's look at some of the evidence that you--I think you've been alluding to now. In Paragraph 53 of your Second Report, you say: "First, the Sum Of The Parts of SC&T is well below its Market Value of Equity leading up to the vote. Second, and conversely, the Stock Market Value of Equity of Cheil was above its Sum Of The Parts."
A. Um-hmm.
Q. Right? This the evidence you were talking about is strong?
A. Yes.
Q. And if you look to what you cite to in Paragraphs--well, in Footnotes 52 and 53, you direct us to see Dr. Duarte-Silva's Report.
A. Um-hmm.
[Page 881]
Q. Right?
A. Yes.
Q. So, why don't--why don't we do that. We'll go to Figure--Dr. Duarte-Silva's Second Report, Paragraphs 68 and 69.
And actually, I think we can just go to Figure 4, which is beneath that.
So, the green part of this table is supposed to illustrate the discount for SC&T to the sum of its parts; is that right?
A. Yes.
Q. And the blue part is supposed to show the premium for Cheil to the sum of its parts?
A. Yes.
Q. But the Sum Of The Parts analysis that forms the basis for this graph, that's Dr. Duarte-Silva's own analysis; right?
A. That is true.
Q. He doesn't cite any third-party Analyst Reports to substantiate the data on the table?
A. So, the way the--this--well, of course he's--I mean, he's not taking this analysis from somebody else. He's doing this analysis himself and I--he, you know, he collects--you know, that he collects data from Analyst Reports to determine what are the right comparables, he
[Page 882]
uses Market Prices. So, he, you know, he clearly explains all the sources of information, so I don't understand what do you mean when he doesn't cite sources.
I mean, he is citing his--and the reason why he doesn't cite sources is because he cites where he gets the data from what the Reports he uses to find the comparables, but, of course, this is his own analysis.
Q. You're aware that methodology underlying this analysis is disputed in this Arbitration?
A. The--
Q. The methodology that he adopted to come up with these figures is disputed.
A. Some of it--I believe that, you know, people have different opinions about--about the methodology, but if you tell me exactly what is the--in dispute, I can--but I--yes, I know.
Q. Okay. In light of the fact that it is disputed--
A. Um-hmm.
Q. --you didn't think it was necessary to test or compare any part of Dr. Duarte-Silva's analysis against third-party analysts, your own research, anything else?
A. I didn't--I didn't do it, no.
Q. As an independent expert, you were happy just accepting what Dr. Duarte-Silva did?
[Page 883]
A. I mean, "accepting" is--is a loaded word. What I did is I reviewed the methodology, as I explained, which is consistent with my view of how the SOTP should be computed. I thought that, really, this was a very careful methodology. I--I--I reviewed the sources of the data--I mean, everything seemed to be done properly.
I don't think that--so, I didn't think that it needed, kind of, my independent analysis. I--again, this--I take this evidence as valued because I think that it's been done correctly. The same way that I read the academic paper and not always go and replicate the study to believe its conclusions.
Q. Okay. Just staying on Figure 4 for a second, do you see that between April and May 2015, Figure 4 shows that Cheil was trading at a premium?
A. Between May and--
Q. Between April and May 2015.
A. Yes.
Q. So, you can see that by the blue--
A. Um-hmm.
Q. The blue being above the line, really.
A. Yes, I can see it.
Q. We could pull up CRA-104, please.
This was an exhibit to Dr. Duarte-Silva's Report, and it's an Analyst Report prepared by Macquarie
[Page 884]
Research, an Australian bank. If you see the date, it's
at the bottom, it's--of the Page--29th of April 2015.
A. Um-hmm.
Q. And if we go back to the top of the document on
the left, we see that the Share Price for Cheil is
KRW 166,500. And the Sum Of The Parts analysis, which is
just beneath that, the 12-month target, is KRW 190,000.
Do you see that?
A. Yes.
Q. So, at least some analysts in this same period
didn't think Cheil was trading at a premium?
A. I--can you--can we go and look at the analysis
that this analyst is doing? I mean, I--I mean, if the
question is: Is there a person who did not agree or did
not come up with the same number as Dr. Duarte-Silva?
Yes. But I haven't reviewed the methodology of this
specific analyst.
Q. The point really is just that others disagreed
to the point where they saw that Cheil was also trading at
a discount.
A. Dr. Duarte-Silva has computed the--you know, you
are showing me one--you are showing me one Analyst Report.
My reading of the evidence--not the evidence. My reading
of the Analyst Reports around this period was that Cheil
was trading at a premium. If you selective--if you select
[Page 885]
one out of many--and I don't have the data with me showing
a discount--I have nothing to say. I have to agree that
this is a discount. Although, again, I have to say that I
have--this is the opinion of an analyst. I haven't
reviewed the methodology of this analyst. I don't know
what comparables this analyst is using. I don't know
whether this analyst is correcting the way that
Dr. Duarte-Silva corrected his Sum Of The--these
multiples.
So--yes. If you--if you give me a number, and
you want me to compare this number with 166 versus--what
is the comparison here?
Q. 190,000.
A. Yes.
So, the other thing that I would have--that I
have to say about Analyst Reports is that this is a price
target; right? So, this is an expectation of what the
price would be in 12 months; right? So, if I show you--I
mean, having said what I said. So, if I show you, for
example, that--that, you know, the price target for
Wal-Mart, right, is above its Market Price, you would not
conclude that there is a holding-company discount; right?
So, I mean, this is an aspirational price, but--and again,
I haven't reviewed the methodology here.
Q. Right. And they use the Sum Of The Parts
[Page 886]
analysis to derive that aspirational price; right?
A. They--they are try--by aspirational, and let me
be clear here, I mean the--what the price as the name
suggests should be in 12 months from now.
Q. Professor Wolfenzon, there is a very fundamental
interdependence between your evidence and
Dr. Duarte-Silva's, isn't there?
A. Interdependence. So, I--you know, if you're
asking me whether I read his Report, yes.
Q. I mean, you relied heavily on his evidence
regarding so-called "threatened value transfer" as a means
to disregard SC&T's Share Price and validate the use of
the Sum Of The Parts analysis; right?
A. I use a lot of his--I use his evidence, yes.
Q. And then he relies on your evidence to not apply
a holding-company discount to the Sum Of The Parts
analysis that he does; right?
A. I think he does rely on my evidence for the
absence of a holding-company discount. My evidence--I
wouldn't say that I have evidence--well, I have some
evidence plus some theoretical--well, what I would call
theoretical results.
Q. Your good-faith academic opinion about the
holding-company discount?
A. Exactly.
[Page 887]
Q. Right. And the end result of this
interdependence is--
A. So, again, I'm not--I'm not sure what--what--you
know, the loaded word here "interdependence." I--I wrote
an analysis saying that there is a holding company--that
there's no holding-company discount, and Dr. Duarte-Silva
seems to agree with that. He presented some evidence that
I find persuasive, if that's what you're asking--you know,
that's in the Reports, yes.
Q. Well, the end result of this interdependence is
that you--Dr. Duarte-Silva estimates a Share Price of
SC&T, it's double the Market Price on the same day; right?
A. Again, you keep insisting on that. These
are--you're comparing apples and oranges.
Q. It's a value that's so much higher than SC&T's
Share Price has ever been in its history; do you agree
with that?
A. It is--well, I have to review the--the--I have
to review the evidence, but saying that--you know, saying
that a stock is valued above its historical value doesn't,
you know--doesn't tell me anything. It is a value that is
above the current Market Price because it is a value that
is computed under different assumptions.
Q. It's an estimate of Intrinsic Value that's
100 percent higher than the Market Price on the same day;
[Page 888]
correct?
A. It is--it is--and I won't dispute that is
100 percent higher than--than the current market. I--I
would say that is these are apples and oranges because the
evidence suggests that the current price is affected by
this value transfer, and that is not reflected in the
but-for world.
So, I mean--if you--I mean, want me to
accept--I--I can--happy to accept facts, is the--if the
number that he gets two times the current Market Price,
yes, but again, my explanation for that is that these are
apples and oranges.
Q. You've also testified today that you're unsure
whether succession issues would weigh on SC&T's Share
Price in the but-for world; right?
A. Did I?
Q. This is the same testimony that we highlighted
on the screen earlier.
A. Well, if--yes, okay.
Q. You don't think it's unreasonable--you don't
think it's unreasonable to assume that the Intrinsic Value
would be realized in a Share Price in that event?
A. Can you--can you explain what event you have in
mind?
Q. The event being that, upon a rejected merger,
[Page 889]
there would still be succession issues that the [Redacted] Family
would need to resolve and that SC&T's price would,
therefore, still be depressed.
A. I find it very--I don't find it very convincing
that after the rejection of a Merger the family would come
and try again. As I--as I told you, there is evidence
that they mentioned that they were not going to try again,
and there were alternative plans for the group
restructuring.
Q. So, your evidence depends on the factual
assumption that the [Redacted] Family wouldn't reattempt this
Merger?
A. The--the--yes.
Q. Okay. Let's move on to a different topic. One
of the two reasons, that you identified in your First
Report, was the timing of the Merger.
A. Yes.
Q. Under Korean Law, the Exchange Ratio for Mergers
involving affiliates of the same chaebol is a function of
Market Prices of the target and acquiring company over the
preceding months; right?
A. Um-hmm.
Q. And the objective behind that rule is to protect
Minority Shareholders from unfair Merger Ratios that may
not be negotiated at arm's length between the Boards of
[Page 890]
two companies?
A. Yes, um-hmm.
Q. And that rule differs to the rule applicable in
some countries, like the U.S. where the Exchange Ratio in
stock-to-stock Mergers is determined through negotiations
between the merging companies?
A. Yes.
Q. Your evidence is that (drop in audio)--your
evidence is that the timing of the Merger Announcements is
one way to manipulate the Merger Ratio?
A. Yes.
Q. And your suggestion is that the [Redacted] Family
announced the Merger at the time when the SC&T's Share
Price was particularly low relative to Cheil's?
A. The Exchange Ratio, yes.
Q. The Share Price was particularly low, and that
led to the Exchange Ratio being--
A. Yes.
So what you want--you know, what--as you
correctly explained, the Exchange Ratio is, you know, a
tautology. It's the division of one price over the other.
And so, in this time, in theory, means that what you want
is this ratio to be as low as possible to--to--for the [Redacted]
Family to transfer the maximum possible and--and keep as
large stake in the resulting NPV.
[Page 891]
Q. The timing of the Merger Announcement was
controlled by the [Redacted] Family; right?
A. I believe so.
Q. Nothing to do with Korea? Nothing to do with
the Government of Korea?
A. No--I mean, that was my understanding.
Q. Let's go to your First Report, Paragraph 52, and
Figure 4, if we could zoom in on that, please.
So here, you graphed hypothetical Merger Ratios
in the weeks preceding the Merger Announcement; right?
A. Yes.
Q. And the graph shows what the Merger Ratio would
have been had the [Redacted] Family announced the Merger earlier?
A. Yes.
Q. The movement in the graph reflects movements in
SC&T's Share Price relative to Cheil's?
A. It's the--reflects movements in the--yes, in
the--it's the average of the prices over the one month,
one week, and one day.
Q. Right.
And you say, in the second sentence at
Paragraph 52: "Consistent with this analysis, the
mandated Exchange Ratio was particularly low on May 26,
2015 as compared with the ratio that would have applied on
earlier dates."
[Page 892]
A. Yes.
Q. So, the lowest point on this figure is 0.35?
A. I think, yes. It's the--yes, that's the actual
Merger Ratio, yes.
Q. And that's about three SC&T Shares to one Cheil
share?
A. Yes.
Q. And the highest point on this graph is a ratio
of 0.42?
A. Yes.
Q. So, 0.35 is particularly low compared to the
other Merger Ratios set out here?
A. In this graph.
Q. 0.42 is not particularly low, to use your words?
A. 0.4--I mean, again, you are picking words--you
know, I have to be careful with my language. What I'm
saying, simply, is that 0.35 is lower than 0.42.
Q. Okay. And Professor Dow did a similar analysis
with the Merger Ratio, at different hypothetical
announcement dates, didn't he?
A. Um-hmm.
Q. And he used a longer time horizon?
A. Um-hmm.
Q. You discussed the results in your Report?
A. Yes.
[Page 893]
Q. And you said the results are similar to yours?
A. Yes.
Q. Let's go to Page 90 of the First Dow Report, and
if we could bring up on the screen, please, Figure 21,
which is below Paragraph 218.
So, what this figure shows you is that the
hypothetical Merger Ratio would never have been higher
than 0.42 or thereabouts, had the Merger been announced at
any other point in 2015 before May 26. You don't disagree
with that?
A. It never would have been...
Q. It never would have been higher than 0.42, which
was the peak of your analysis.
A. I'm not sure what you are asking. So, are
you--can you ask--so, is the question--can you repeat the
question?
Q. Sure. And let me elaborate so it's clearer.
A. Yes.
Q. In your analysis, you covered two months, April
and May 2015.
A. Yes.
Q. Professor Dow's analysis goes back through to
January 20, 2015.
A. Yes.
Q. The peak of your figure showed a Merger Ratio of
[Page 894]
0.42.
A. Yes.
Q. Professor Dow goes further back in time and
shows that, even if you go back to January, it would never
have gone past that.
(overlapping speakers.)
A. Yes, yes.
Q. Right. And you see the line, the dotted line in
orange at the top which is--
A. 0.35, yes.
Q. 1.35, and that's the Merger Ratio implied by
Dr. Duarte-Silva's Intrinsic Value analysis?
A. Yes.
Q. Right.
So, instead of 2.5 or three SC&T Shares to one
Cheil share, Dr. Duarte-Silva's analysis implies the
Merger Ratio should have actually been 1.35 Cheil Shares
to one SC&T Share. You agree with that?
A. Yes.
Q. So, the timing of the Merger, in the context of
the difference of opinion about Fair Market Value is
hardly a material reason, is it?
A. It is--well, it depends on what do you mean by
"immaterial." It is not--it is not the rationale that
would have taken you all the way to 1.35. I think we can
[Page 895]
agree to that.
Q. In fact, it would have taken you a very small
way--
A. It would have taken you to, you know--you know,
if you pick a random number, it would be something very
likely higher than 0.35.
So, whether it's immaterial or not, it's a
little bit subjective, you know, going from 0.35 to 0.42
is 0.7, that's a 20 percent increase, which is not
insignificant.
Q. The numbers are what they are. 0.35 to 0.42
against 1.35, and I agree, material is a judgment call.
A. Yes.
Q. But it's a very small numerical difference;
agree? You agree with that?
A. Small--again, it is a difference that might be
significant for investors, but will not take you all the
way to 1.35.
Q. Okay.
A. Whether it's small--I mean, 20 percent, it's
20 percent. I don't know what you mean by a small, what
is a threshold for something being as small.
Q. Let's move on to the second of your two reasons
in your First Report for a low Merger Ratio, and that was
potential manipulation of the Stock Price. If we go to
[Page 896]
Paragraph 53 of your First Report.
Now, in this paragraph, you say the potential
manipulation is a reason why we can't look to SC&T's Share
Price as a measure of Fair Market Value.
A. It's one of the reasons.
Q. That's one of the issues.
And you cite two Korean court decisions in
Footnote 22 for that?
A. Yes.
Q. So, one of those decisions, as you can see from
your footnote, is dated May 30, 2017.
(Witness bumps microphone.)
A. Apologies.
Q. I was just talking about the dates in your--
A. Yes, yes.
Q. May 30, 2016, is the date of one of those
decisions, and the other is June 8, 2017.
A. Yes.
Q. You reviewed both of those decisions?
A. I believe I remember looking at them, yes.
Q. And you call out two specific instances of
potential price manipulation in Europe?
A. Yes.
Q. That first is the nondisclosure of a major
contracts?
[Page 897]
A. Yes.
Q. It's the contract relating to the construction
of a power plant in Qatar?
A. Yes.
Q. And the second is the reallocation of projects
from SC&T to another Samsung Group company?
A. Yes.
Q. Right. You didn't provide any analysis of the
impact of either event on SC&T's Share Price?
A. I didn't.
Q. You're aware that Professor Dow actually did
that analysis?
A. Yes.
Q. And he did that in his First Report?
A. Yes.
Q. And he found that the disclosure of the items
that you referred to, would have had at most a negligible
impact in SC&T's Share Price? You saw that?
A. Again, yes. I saw his comments, yes.
Q. And you didn't engage with any of that analysis
in your Second Report, did you?
A. It was--I comment on it. What I said in my
Second Report is that--the fact that one reason does not
explain the full magnitude of the value transfer doesn't
necessarily mean that it's not an important reason, and is
[Page 898]
not a reason that is valid to consider.
Q. Let's see what you said in Paragraph 56 of your
Second Report.
So, you described Professor Dow's argument as
"misplaced," and you said: "I did not state and do not
consider that market manipulation alone was responsible
for the substantial undervaluation of SC&T's Shares by the
Stock Market in the run up to the Merger Vote."
That's right?
A. Yes.
Q. So, your response to the charge that you didn't
quantify any aspect--any impact of price manipulation--
A. Yes, I remember correctly that one of them--
Q. I'm sorry, let me finish the question.
A. I apologize.
Q. No problem at all.
Your response to the charge that you didn't
quantify any impact of price manipulation is that it
wasn't the only reason for SC&T's undervaluation?
A. Yes.
Q. That's your response?
A. (Witness reading) Let me read this.
Q. Yes.
A. I clearly state here that I do not consider
market manipulation alone was responsible for the
[Page 899]
substantial undervaluation. Yes.
Q. He said that you didn't try to engage with his
analysis quantifying the impact on SC&T's Share Price?
A. I didn't--I agree with his analysis on the Qatar
project, and the other--there was the other event was not
a--was impossible to quantify.
Q. Okay. So, you agree they had no meaningful
impact on SC&T's Share Price?
A. I think it was a 2 percent impact.
Q. A negligible impact?
A. 2 percent.
Q. Okay. But you wouldn't know, yourself, because
you didn't quantify it?
A. I--at the time of writing this Report, I had not
quantified it.
Q. Okay. Now, based on the mechanisms we just
discussed--
A. Yes.
Q. --timing of potential price manipulation, you
describe in your Reports that the Merger Ratio was unfair.
A. Yes.
Q. Right? That's the word you use, "unfair."
A. Um-hmm.
Q. Is that an economic conclusion?
A. Well, by--I have to say that, you know, as I
[Page 900]
described clearly in this Report, I--you know, before
preparing this Report, as you know, I had read Professor
Tiago--Professor Duarte-Silva's Report as well, so I was
aware of the fear of the merger theory.
Q. You didn't mention that in your First Report?
A. I didn't mention that in my First Report.
Q. The most important reason that you say--the
so-called most important reason you didn't mention it in
your First Report?
A. Yes.
Q. Did you know that certain SC&T Shareholders
sought to have the Merger annulled in Korea's courts on
the basis that the Merger Ratio did not reflect SC&T's Net
Asset Value?
A. Can you repeat the question?
Q. Sure.
Certain of SC&T's Shareholders applied to have
the Merger annulled in Korea's courts.
A. Um-hmm.
Q. On the basis that the Merger Ratio did not
reflect SC&T's Net Asset Value?
A. I think that that's the case that I cite here,
but I'm not sure. Yes. I mean, I was aware that there
were court cases against SC&T, yes.
Q. So, it's not either of the two cases that you
[Page 901]
cite in your Report?
A. No.
Q. So, I take it you didn't review that decision?
A. No.
Q. Did you know that it existed?
A. If you will describe it to me, I would be able
to answer.
Q. So, it was a court case brought by SC&T's
Shareholders after the Merger, a few years after the
Merger-- well, it might have been just after the Merger
and decided a few years later, where they sought to annul
it on the basis that the Merger Ratio was unfair--
A. Then I was not aware of that Report--of that
Report.
Q. Okay. So, you cited two Korean Decisions to
support your opinion about price manipulation, but you
didn't look at every Korean Decision?
A. I didn't look at every Korean--yes, I didn't
look at every possible--every Korean Decision.
Q. And that's understandable because you're not a
lawyer, nor are you a Korean lawyer, to review all the
Korean court decisions and then know what's out there;
right?
A. I think it's evident, yes, I'm not a lawyer.
Q. I would like to take you to one of those
[Page 902]
Decisions that is out there. R-242, please.
Now, on Page 2 of this--this is the judgment I
was referring to.
A. Um-hmm.
Q. On Page 2 of this, you see it's dated 19th of
December--19th of October 2017?
A. Yes.
Q. This Decision was issued after the two court
decisions that you rely on in your Report?
A. Yes.
Q. If we could go to Page 18, please. And zoom in
on the second large paragraph, and we can start--that's
right.
Now, the Court here is addressing the
plaintiff's allegations that the Merger Ratio was unfair
because Share Prices did not reflect objective value.
A. Um-hmm.
Q. And the Court says, and I will read the relevant
passage: "However, the Share Market Price of stock-listed
companies is set by many investors involved in the
securities market after examinations of the assets by
financials, earning power and future business prospect
publicly disclosed in accordance with the relevant laws,
which means that the Share Market Price of a corporation
reflects the objective value of the pertinent
[Page 903]
corporations. Therefore, differences with the price
calculated by asset value or profit value cannot lead to
the conclusion that the above Share Market Price does not
accurately reflect the objective value of the stock-listed
companies."
A. Can you highlight it for me, please.
Q. Yeah.
Do you see that? Have I read it correctly?
A. I'm a bit slow. Apologies.
(Witness reviews document.)
A. Yes, I'm reading it. If you can ask me the
question, I am--I have to say--
Q. I haven't asked you a question yet.
A. Yes, okay. Go ahead.
I don't fully understand, in all honesty,
this--what they mean with "asset value" or "profit value."
These are not terms that I use in my professional life.
Q. Okay. Well, why don't we move to a lower part
of the paragraph, starting with the word "moreover." Let
me read that out.
"Moreover, even if the Share Market Price of
Samsung C&T's objective financial state including sales
and operating income exceeded that of Cheil, such
circumstances are insufficient to acknowledge the
appropriate Market Value is not reflected since it was not
[Page 904]
influenced by improper methods that interrupt the
functioning of the market such as the Share Market Prices
of Samsung C&T and Cheil being intentionally manipulated
by the majority Shareholders."
Do you see that?
A. Yes, I can read that, yes.
Q. So, this Korean court found that there was in
fact no price manipulation; right?
A. Yes.
Q. And this Court reached that finding after the
two courts that you cite to?
A. I'm following you.
Q. And there is no attempt by you to reconcile the
difference between what this says and the decisions that
you cite to?
A. Well, this is the first time that I'm confronted
with this Article so--you know, I wouldn't have been able
to comment on it because I didn't review it.
Q. Okay.
A. Yes.
The same way--this is, by the way, similar to
the fact that, you know, there has been other court
decisions that I was not aware of that, you know, again
documenting other, you know--I would say who relies in
these firms, and I didn't--but I did include it in my
[Page 905]
Reports, I don't know even know if it's on the record.
Q. But it was enough for you to consider the
allegations and to consider what was in those two
decisions that you cite, not analyze any price impact, and
accept that that's the reason why we could ignore SC&T's
Share Price; right?
A. As I'd said, here I looked--I was aware of these
two evidence of price manipulation. I agree with you that
I was--you know, I didn't quantify them. I reviewed the
evidence on timing, and I had read, although I see that
it's not in my Report, the "value transfer" theory. I was
not aware of this evidence at the time, you know, and I'm
not familiar with Korean courts and whether or not this is
the last word or not on these issues.
I read two court documents suggesting or
indicating that there had been price manipulation.
Q. You read two court documents, and that was
enough? You didn't feel the need to go any further than
that?
A. I didn't go any further than that, yes.
Q. Okay.
A. I thought that this was established by the
Courts, and that's what I say in my Report.
Q. I want to take you to one more passage in this
Judgment, you'll find it on the screen.
[Page 906]
Right. Towards the--seven lines up from the
bottom, and I will read from it. It says: "There is no
evidence to acknowledge this," and it's continuing from
where I was quoting before, "there is no evidence to
acknowledge this in light of the following facts. The
stock trend for major construction companies that were in
competition with Samsung C&T is similar to that of Samsung
C&T, the Share Market Price fluctuates according to the
subjective judgments and the psychological factors of the
Investors before the merger is actualized and since the
share market reflects the predictions and outlook on the
corporate governance and the consequent expectation of the
market participants, is due to the nature of the share
market."
It might be over the page that last part of the
sentence.
So, the same Court considered the evidence and
found that there were reasons SC&T's Share Price
fluctuated having nothing to do with threatened value
transfer; right?
A. That's the opinion of the Court.
Q. "That's the opinion of the Court." Okay.
A. Yes.
Q. Let's go back to the holding-company discount.
So, it's your good-faith academic opinion that
[Page 907]
we just don't apply a holding-company discount to a Sum Of
The Parts analysis?
A. Yes.
Q. It's always wrong to do so?
A. No. It's not always wrong to do so. In my
presentation today, I gave you cases where it is valid to
apply a holding-company discount; for example, if you
think that you are going to liquidate assets or Shares and
pay a capital gains tax.
Q. Now, there is a tension in what you said this
morning about illiquidity and capital gains tax, isn't
there? And I will elaborate because that's not clear.
You said that there's no discount that needs to
be applied due to potential capital gains tax because
there is no realistic chance of Samsung C&T cashing in on
its listed assets in the Samsung Group; right?
A. Yes, um-hmm.
Q. But then for illiquidity, you said that there is
at least some chance that the Company might sell and,
therefore, we shouldn't apply a discount due to
illiquidity.
A. No.
Q. That's not what you said?
A. No, no.
Q. Could you elaborate on that?
[Page 908]
A. Huh?
Q. That was my understanding of what you said this
morning, sir.
A. No. No, no.
My point about that topic is that--when we think
about illiquidity with the idea of--the idea of an
illiquid asset and the reason why it's discounted is
because, just to put it in simple terms, is because it is
difficult to sell. And let me give you an example.
If I own shares of a private firm that doesn't
trade in the market, it's complicated for me to sell that
share. Why? I cannot call a broker and sell it
immediately. I will need to spend time and resources
finding a buyer. And there are other reasons. It might
be that, for whatever reason I want to sell my share,
because I need the money at a particular point in time, I
won't be able to, so that's what I think about my
definition of what an Illiquidity Discount is,
what--illiquidity of a liquid stock is.
Now, what I said about the holdings of SC&T is
that they could sell if they wanted to. They choose not
to sell, which is very different than saying it is
difficult or costly to sell, so that's why I don't see the
contradiction that you're referring to.
Q. Okay. And I think we will hear from Professor
[Page 909]
Bae on that shortly.
I want to take you to one more Analyst Report,
if we could go to CRA-49.
So, you're familiar with this Analyst Report?
You cited it again this morning.
A. Yes, Nomura.
Q. Okay. Nomura Samsung C&T Report dated 23rd of
April 2015. You see the price of SC&T at the time is
61,400?
A. This is SC&T?
Q. Yes.
A. Yes.
Q. And the target price is 84,000?
A. Again, this is a target price, yes.
Q. Okay, if we scroll down the page under the
heading "Reiterate buy," it says--and it will be no
surprise to you this is one of the three Reports that
Dr. Duarte-Silva relies on: "We believe the stock
currently trades at a steep discount due to the merger
because of the market's concerns about SC&T's potential
merger with Cheil Industries. However, we continue to
believe that the merger will not take place."
So, this analyst didn't think the Merger would
occur; right? That's what it says.
A. Apparently.
[Page 910]
Q. Now, let's go to Page 2 of the Report.
Figure 3.
Now, I think I saw this in your presentation
this morning.
A. Yes.
Q. Okay. So, this shows that SC&T's discount has
fluctuated over the years; right?
A. Yes, yes, um-hmm.
Q. In this analysts' view, SC&T traded at a steep
discount to Net Asset Value for years before the Merger,
say for that period in 2011-2012.
A. Yes. In some periods, yes.
Q. Okay. Now, a discount that's so long entrenched
and historical can't have related to a very specific
merger that's announced only in 2015, can it?
A. Several points. Again, I don't know how is this
computed. And I guess that the discount in 2009 cannot be
related--I mean, to a specific merger, could be--I mean,
it could be that there was expectations.
I am--I'm speculating. I have to be completely
honest, I just--the case takes place around 2015, and I
provided my opinion about what was causing the discount
then. I do not know what was causing the discount in
2008-2009. I haven't studied that period.
Q. Okay. Let's go to Page 3, please, at the bottom
[Page 911]
of the page, just where it says "Valuation Methodology."
Now, it says: "We used the Sum Of The Parts
valuation to derive our target price."
A. Um-hmm.
Q. "We valued SSCT in two parts: The value of
stakes and affiliates at a 30 percent holding-company
discount."
A. Yes.
Q. "And (2) value of corporation."
So again, we see that the Sum Of The Parts
analysis is the same as the target price. That's how they
derived the target price?
A. Yes.
Q. And they apply a 30 percent discount to the
value of SC&T's holdings and listed affiliates?
A. Yes, they apply a 30 percent discount, but I
just--I want to make a point that I don't know if the
intention here is--if the intention here is to show that
analysts--some analysts apply a discount. They do. It's
not--it's not entirely clear to me why they do it. In
terms of what I think is a more reliable source, I will go
to the academic studies that I cited.
I don't know whether--I'm not sure where you're
going with this question, but I just wanted to make sure
that that's on the record.
[Page 912]
Q. Yeah.
A. So, this is SOTP methodology that would again,
as I mentioned before, I'm not sure what--I mean, I
don't--I don't even think this is relevant, but again,
not--it doesn't give clear indication as to how it's
performed, but I don't--I don't deny the fact that
analysts come up with a, you know, discounts and premiums
and, you know, yes, and that is--that is why two things.
I believe first that one needs to understand what is going
on at a particular moment in time, to the best of our
ability, and; second that, you know, these wild variations
in the discount suggests that, you know, either there is
some reason for the discount that is time bearing, right?
For example, an illiquidity discount will be something a
little bit more permanent, and would not be--the liquidity
discount that Professor Bae will discuss, for example,
will be something a little bit more permanent, and would
not explain the time series that we see.
Or it is possible that there are different
reasons why the discount is applied or arises.
But again, I'm not sure if I'm answering the
question. Perhaps you could ask me a question.
Q. That's okay. It's really just to say to you,
it's your good-faith academic opinion we don't apply a
holding-company discount in SC&T's case; correct? "Yes"
[Page 913]
or "no" answer.
A. I cannot answer "yes" or "no."
Q. Okay. Then please.
A. Because a discount is not a blind application of
a number. As I was explaining today in the morning, for
example, if you use multiples that you derive from
companies that are outside of Korea, you will be--you will
be overvaluing the holding company, and then, of course, a
multiple will vary. So, whenever you ask me should you
apply a multiple, I would say I need to see what is the
process of valuing the parts. And if I am satisfied with
the way that the parts are valued, that they are using a
holding company and so forth, perhaps even that there is
not an imminent sale of a stake, then I would--I would be
able to comment on that.
And what I was telling you or what I presented
in the morning is that, after having seen Dr.
Duarte-Silva's methodology, I believe that that
methodology incorporates the relevant reasons why a
discount could be there, and for that reason, I opine that
there was no need for a holding-company discount.
Q. Right.
And analysts who were looking at SC&T's price
evidently thought that-- they disagreed with your academic
opinion; right?
[Page 914]
A. They disagree with that opinion.
Q. And they applied a 30 percent holding-company
discount to the value of stakes and affiliates of SC&T.
That's what this says; right?
A. This particular analyst, yes. I mean, I have to
say--an analyst, you know--I have to say that, after
reading many reports, it's very inconsistent the way in
which they apply a discount. Sometimes it's lower,
sometimes it's higher, sometimes they provide the reasons,
sometimes the reasons are not consistent. Sometimes they
don't apply a discount at all.
It is possible that what they're trying to do is
they are trying to kind of match the price to some extent
and just apply a discount where the valuation is off.
Q. But that's speculative because you don't know
that?
A. That's speculative.
Q. Okay. And it wouldn't surprise you to know then
that this analyst is not alone in applying a 30 precent
discount or a significant discount to SC&T's stakes--
A. It's possible they're not doing all of the
adjustments that I described in my presentation earlier on
today.
Q. Okay. I have one last set of questions, and it
won't take long.
[Page 915]
A. I'm happy--well, not happy, but I will answer
that.
Q. You weren't instructed to opine on the
likelihood that the Merger would be approved; right?
A. I was not.
Q. You were not.
But you conducted some analysis anyway of the
Share Prices of SC&T and Cheil in the lead up to the
Merger Vote?
A. Some analysis, yes.
Q. Right, you did. Let's take a look at that
analysis. It's in your First Report, Figure 2, which is
below Paragraph 42.
Okay. You plot in Figure 2 a graph showing the
daily market capitalization of SC&T as a share of the sum
of the total Market Capitalization of SC&T and the Market
Capitalization of Cheil; that's right?
A. Yes.
Q. And we're talking about Market Capitalization
here, so you used SC&T's and Cheil's Market Prices as
inputs?
A. Yes.
Q. This graph has nothing to do with Sum Of The
Parts estimates?
A. No.
[Page 916]
Q. And the red line is fixed. That's a ratio of
the number of Shares pre-merger SC&T Shareholders would
have in the combined entity.
A. Yes.
Q. Relative to the number of Shares pre-merger
Cheil Shareholders would have; that's right?
A. Yes.
Q. The blue line is dynamic, and that represents
the relative movements in SC&T and Cheil's Share Prices in
the lead-up to the Merger Vote; correct?
A. Correct.
Q. So, Paragraph 42, the last couple of sentences.
You say: "If before the Merger Vote, values reflected the
post-merger split of value described in Paragraph 40, the
ratio plotted should be 28.8 percent."
Now, 28.8 percent is the red line.
A. Yes.
Q. "This is reflected in my findings. As the
Merger Vote approached, this ratio moves closer to
28.8 percent."
A. Yes.
Q. Now, in Footnote 12 of this paragraph, you say:
"In the last month of trading leading to the Merger Vote,
the ratio is not exactly 28.8 percent, reflecting an
expectation that approval of the Merger was possible, but
[Page 917]
not certain."
A. Yes.
Q. Is that right?
But SC&T and Cheil's Share Prices approached
28.8 percent in a relative sense; right?
A. Yes.
You can see that, at the very--of course at
the--if you want to--if you look at the very last day, it
goes up, it goes down. It's a line that is closed, yes.
Q. And it gets closer and closer as we approach the
Merger Vote? That's what you say?
A. It depends--yes, yes. Okay.
(Overlapping speakers.)
A. My apologies.
Q. Sorry about that.
You say, as the Merger Vote approached, this
ratio moves closer to 28.8 percent?
A. Yes. Now that--if you--if you look closely,
that's a statement of the general trend. But if you look
closely, there are ups and downs. I'm just--okay.
Q. The trend reflects the market's expectation the
Merger is likely to be approved; doesn't it?
A. Likely, yes.
Q. More likely than not to be approved?
A. Yes.
[Page 918]
Q. Okay. I don't have any more questions.
PRESIDENT SACHS: Thank you very much.
We go to redirect.
MS. VAZOVA: We have no redirect.
PRESIDENT SACHS: You have no redirect.
I turn to my co-Arbitrators. Do you have
questions to Professor Wolfenzon?
ARBITRATOR GLOSTER: I don't have any, thank
you, Chair.
PRESIDENT SACHS: That is not the case, I see
Professor Mayer has no questions either. I have no
questions, either.
We thank you for your presentation, and you are
now released as a witness, and we will have our lunch
break, resuming at 12:30.
MS. VAZOVA: Mr. Chairman, before we break, can
I address a very brief housekeeping issue? I think we can
let Professor Wolfenzon go.
PRESIDENT SACHS: Yes, Professor Wolfenzon, we
do not need you any more.
THE WITNESS: Shall I leave?
PRESIDENT SACHS: Yes, please.
(Witness steps down.)
MS. VAZOVA: So, very quickly, we just wanted to
revert to the Tribunal on the question of Post-Hearing
[Page 919]
Submissions, the Parties have discussed, and we've worked
cooperatively, and we have a proposal for the Tribunal we
thought it may be useful to share now, to the extent the
Tribunal finds it useful to reflect upon that.
PRESIDENT SACHS: Okay.
MS. VAZOVA: So, as to Post-Hearing Briefs, the
Parties are in agreement and propose that we do one round
of Post-Hearing Submissions limited to 50 pages, submitted
simultaneously on April 29, so about 30 days and change
after the conclusion of the Hearing.
PRESIDENT SACHS: Yes?
MS. VAZOVA: And then, to the extent the
Tribunal finds it helpful, to have further oral closings,
we would request that those be held during the week of
May 9 or May 16. I should be up front, the proposal comes
from our end of the table, due to the circumstances that
Ms. Lamb alluded to, Korea has very graciously agreed to
that request. During that two-week time period, we can do
every day except for May 10th, so obviously all this is
subject to the Tribunal's preference and availability, but
this is the proposal that the Parties wanted to put
forward.
PRESIDENT SACHS: Very good. Thank you. We
will discuss this during lunch.
(Whereupon, at 11:45 p.m. (EDT), the Hearing was
[Page 920]
adjourned until 12:30 p.m. (EDT) the same day.)
AFTERNOON SESSION
PRESIDENT SACHS: We can resume.
Very briefly, as far as your joint proposal is
concerned, we are happy with one round of Post-Hearing
Briefs, 50 pages. We would assume this is without
quotations because otherwise it would be a little bit on
the short side given the various issues you may have to
deal with. Our tendency would have been to provide for 75
pages rather than 50, but since you agreed on 50, that's
your agreement. But we think that we had, I mean, quite
important Witness Statements here of this week and also
Expert Opinions, and considering also the size of the case
and the complexity of certain issues, 75 pages would
probably be justified.
Simultaneous, yes. April 29, I think, was the
deadline that you said. We would propose May 11 in the
week of May 9 that would be suitable for the Members of
the Panel. We would propose 3:00 p.m. CET. That would be
9:00 New York time, but if you prefer to have it at 9:30
or 10:00, let us know.
And also, we arbitrators have agreed to meet
relatively shortly thereafter on 24th of May to continue
deliberating on the case.
[Page 921]
So, that's for the further proceedings. Is
there anything you would like to add?
MR. NYER: I think on the page counts, we're in
your hands, if you think 75 pages is justified, then we
are happy to go with this. And communicating by eye
contact with my colleague, I think we have an agreement
across the table.
MS. VAZOVA: We are in agreement, yes.
MR. NYER: One question is whether the Tribunal
would propose to submit questions on topics that you would
be especially interested in seeing covered.
PRESIDENT SACHS: Yes. We will do that probably
in the course of next week. I mean, already the three
questions that Professor Mayer put to you obviously are
relevant questions, and we already had your first input on
that, but there may be two or three other questions that
we will put to you.
MR. NYER: Thank you.
PRESIDENT SACHS: But the idea is please answer
them, you're not limited, of course, to answering them.
You can, in essence, in particular tell us what you think
the results of the evidentiary hearing has brought towards
your respective positions.
All right. Then we will now hear Professor Bae.
PROFESSOR KEE-HONG BAE, RESPONDENT'S WITNESS, CALLED
[Page 922]
PRESIDENT SACHS: So, good afternoon, Professor
Bae.
THE WITNESS: Good afternoon.
PRESIDENT SACHS: You teach and live in Toronto,
so you will testify in English.
THE WITNESS: Yes.
PRESIDENT SACHS: And the topic of your expert
testimony is the application of a holding-company discount
to SC&T.
In front of you should be a declaration that we
would like you to read to the record.
THE WITNESS: Okay. I solemnly declare upon my
honor and conscience that my statement will be in
accordance with my sincere belief.
PRESIDENT SACHS: Thank you very much.
You will now be given the floor for your
presentation.
THE WITNESS: Thank you.
PRESIDENT SACHS: Did we receive a handout?
Okay.
THE WITNESS: Can I start?
PRESIDENT SACHS: The floor is yours.
DIRECT PRESENTATION
THE WITNESS: Good afternoon. My name is
Kee-Hong Bae. I'm a Professor of Finance at Schulich
[Page 923]
School of Business at York University.
Speaking on myself, I was born and raised in
Korea, got most of my education there. After I got my
Master's degree from Korea University, I worked for local
investment banking firm for several years, and after that
I went to U.S. and got my Ph.D. in finance from the Ohio
State University. And after that, I have taught at
various universities in Asia and Canada, and right now I'm
teaching at York University.
My main research areas is in corporate
governance and international public finance, and I
published numerous articles in top finance, accounting and
economics journals, and I received several research awards
for my research.
Recently, I got the Eminent Scholar Award from
the Korea-America Finance Association for my contribution
to the Association to the Korea finance community.
Now, I have a few qualifications to be an expert
in the Korean capital market. Perhaps the most relevant
one is the tunneling paper that I published in top finance
journal as to the mergers by Korean business groups, which
I think is closely related to current arbitration. And I
have few other qualifications as shown in this slide.
Now, I was instructed to provide my expert
opinion on three issues. The first issue is whether
[Page 924]
holding company account--holding-company discount-should be applied to the SOTP value. And the second issue is whether the only reason for SC&T's discount to the Net Asset Value is so-called the "threatened value transfer," so that if the Merger had been rejected, SC&T would have traded at the Net Asset Value or SOTP Value. And the last issue is whether the holding-company discount should be applied to a legal holding company only but not to de facto holding company such as SC&T.
Now, let me start with the first issue, which is about holding-company discount.
Now, holding-company discount refers to the difference between a holding company's SOTP value, or net asset value, and the market price of that company.
Now, Dr. Duarte-Silva's and Professor Wolfenzon's opinion is that SC&T's fair market value in the counterfactual scenario should be represented by the SOTP value as computed by Dr. Duarte-Silva, and no holding-company discount should be applied to that SOTP value. Doing so would be double-counting because Dr. Duarte-Silva uses comparable conglomerates in valuing SC&T.
Now, my opinion is that Dr. Duarte-Silva's SOTP value does not correctly measure SC&T's but-for fair market value. Why is that? The reason is that his
[Page 925]
valuation approach fails to consider SC&T's two important governance problems with affect the fair market value.
Now, the first governance problem has to do with the ownership structure of the Samsung business group, and this is a generic governance problem that is present in all chaebol-related companies.
The second governance problem is more specific to SC&T, and it has to do with the affiliated holdings in publicly traded companies which I call "listed holdings."
Now, let me explain in detail why this governance problem can cause a so-called "holding-company discount."
Now, this figure has an ownership structure of Samsung business group as of 2015. This figure was constructed by Korean Fair Trade Commission. This is complex, as can you see it. It's like a subway map in New York. Now in most companies, one unit of share only carries only one vote. Now, the problem with this complex ownership structure is that you can get around the one-share-one-vote rule so you can exercise more voting power than the actual share ownership that you own.
So, this ownership structure of Samsung business group or a business group that has similar ownership structure, it creates a gap between cash flow rights or what we call "actual share ownership" and voting rights.
[Page 926]
In the context of the Samsung C&T, I explained the details in my Report. In the context of the Samsung C&T, the cash-flow rights of the controlling [Redacted] Family is only 1.4 percent whereas the voting right that can be exercised through affiliated companies is 13.6 percent. So, the ratio of voting rights to cash-flow rights is almost 10 times. What this means is that you can exercise as many 10 times voting power as one unit of share that you actually own.
So, that gap is called the "wedge." Why is that a problem? Because the large wedge creates an incentive for the controlling family to engage in self-interested transaction, which is often called "tunneling transaction," at the expense of minority investors.
Now, "tunneling" refers to an activity or transaction through which a controlling family can benefit themselves at the expense of other shareholders in the company. So the larger the wedge, the lower the firm valuation. This is well-documented in finance literature. Why? The larger the wedge the market perceives high tunneling risk, so that they demand higher risk premium, apply a higher discount rate to the other cash flow that can be generated by the company, so the firm valuation becomes lower.
Now, the second problem is more specific to the
[Page 927]
SC&T. Now, SC&T has large amount of listed holdings, and those holdings are not for sale, and it sacrificed shareholder value. Now, why is that? The next graph shows the SC&T's assets and income by asset type. Now, I constructed this figure from Dr. Duarte-Silva's SOTP valuation, so I didn't create any number here. I'm just taking his numbers in this graph.
Now, the left-hand side is the amount of assets, and the right-hand side is the amount of income generated from the asset. Notice that the blue color is the amount of asset from core business--it's hard to make use (referring to clicker)--okay. So, the blue color shows the amount of core asset, and notice that the amount of asset is $6.2 billion, whereas the amount of asset from affiliated holdings is $12.3 billion, and most of it is listed holdings; in other words, affiliated holdings in public companies, so that's about $11 billion.
Now, notice that SC&T, the main business is construction, and yet two third of the asset is in the form of affiliated holdings or unlisted holdings, which has nothing to do with the main business of Samsung C&T.
And notice also that the income generated from core business is $613 million, so return on assets from core business is almost 10 percent.
On the other hand, the income generated from
[Page 928]
affiliated holdings, which is essentially dividend income, which tends to be quite low in Korea, is only $193 million, so the return on asset from affiliated holdings is only 1.57 percent, so you can see that the presence of large amount of listed holdings depresses the profitability of Samsung C&T.
More importantly, this kind of asset composition sacrifices shareholder value. Why? Because a large amount of capital, you know, $11 billion, are tied up in the form of listed holdings, which is essentially a non-income-generating asset, and which has nothing to do with the main business.
So, this asset competition sacrifices the opportunity to generate higher return to shareholders.
So, the question is: Why is it that SC&T's management invests such large amount of assets in affiliated holdings that create little value to shareholders? If the SC&T's management acts in the best interests of shareholder, they have no reason to invest such a large amount in the affiliated holdings.
So, why do they do that? Because the listed holdings are not to generate profit but to provide control power for the controlling [Redacted] Family. In other words, Samsung C&T's management makes an extremely inefficient investment decision to benefit the controlling family;
[Page 929]
and, by doing so, they hurt the minority shareholder value. Now, that is tunneling. It is a corporate decision that benefits controlling family at the expense of the other shareholders in the company.
So, knowing this governance problem, the market values the listed holdings significantly lower than their market prices. Now, this is the key governance problem causing a huge discount by the market on SC&T.
And notice also that this governance problem has existed for a long time, long before the proposed Merger. That is why you see a huge discount long before the Merger.
Now, Dr. Duarte-Silva talks about the double-counting problem. His argument is that his valuation approach already considers the governance problem because he used similar chaebol companies as peer companies so that applying a holding-company discount is double-counting.
Now, remember that his valuation approach valued the core business and listed holdings separately, okay? So, even if he's right, his argument applies to the valuation of core business only, not to the valuation of the listed holdings.
Now, he values listed holdings at the market prices, and I argued that approach is wrong because it
[Page 930]
doesn't consider governance problem associated with the huge amount of listed holdings, so discounting listed holdings has nothing to do with double-counting.
And notice that the proportion of listed holding of Samsung C&T is much higher than the peer companies as shown in the next slide.
As you can see, the proportion of listed holdings to total asset for SC&T is as much as 60 percent, whereas the other companies, the peer companies, at best is only 5.2 percent. So, SC&T is, in fact, de facto holding company; the other companies are not. So, holding-company discounts should be significantly higher than SC&T than for the other peer companies.
So, in sum, Dr. Duarte-Silva's SOTP value does not correctly measure SC&T's fair market value in the counterfactual scenario because his valuation, even though the governance problems which I just discussed, which caused a large discount. In fact, by ignoring this governance problem, he overstates the but-for fair market value significantly on the Merger voting date.
Now, let me turn to the second issue which is about the threatened value transfer.
Now, Dr. Duarte-Silva's opinion is that the only reason for SC&T's discount is due to so-called "threatened value forever" from SC&T to Cheil due to Merger, so that
[Page 931]
if the Merger had been rejected, SC&T would have traded at the net asset value.
Now, if his theory is right, okay? If threatened value transfer is the only reason for the discount, then one should see neither discount nor premium for the New SC&T. Why is that? Because the Old SC&T's discount and Cheil's premium should cancel out each other in the New SC&T. In New SC&T there is no value transfer, so you should not see any discount.
So, I look at the analyst reports to see whether there is no discount for the New SC&T because, according to Dr. Duarte-Silva, there is no value transfer for New SC&T, so I examined the analyst reports for three months right after the Merger, from October to December of 2015.
So, what's the evidence? The evidence shows that there is a significant discount in all analyst reports.
Now, according to Dr. Duarte-Silva, the market expected the Merger starting from the IPO of Cheil company, which took place in December 2014. So, if there is no expectation of the Merger, then there is no value transfer, so you should not see a discount.
So, I examined the analyst reports during the time period in which the market would not have expected the Merger. Particularly, I examined the first quarter of 2014, time period which the market was not likely to have
[Page 932]
expected the Merger.
So, what's the evidence from the analyst reports? Again, you can see that a significant discount from all analyst reports. So, the evidence from the analyst report suggests that the "threatened value transfer" story or theory is not consistent with the evidence. You see significant discount long before the Merger and after the Merger.
Now, let me talk to the other question of whether SC&T would have traded at the SOTP value if the Merger had been rejected. Now, I argue that it is highly unlikely. Why? Because the reasons to discount SC&T's Net Asset Value, which is two governance problems that I discussed earlier, would have persisted, even if the Merger had been rejected.
The first problem of tunneling risk would have continued to exist. Let me explain why that could be the case.
In the next slide--in the next slide, I calculated the wedge ratio, which I discussed earlier, which measures the tunneling risk in SC&T from 2010 to 2020. So, as you can see, from 2010 to 2015, the magnitude of the wedge ratio is around 10 times. Now, after the merger, the wedge ratio dropped to 1.2 times. In other words, the interests of controlling family is
[Page 933]
more aligned with the minority shareholders.
Now, the important question is: If the Merger had been rejected, what would happen--what would have happened to this wedge ratio? Okay. That's the counterfactual scenario. What would have happened? Now, given the history of the wedge ratio and given that the [Redacted] Family had strong incentives to keep affiliated holdings for control purposes, the reasonable assumption is that it would have stayed the same. The ratio would have remained the same at the magnitude of around 10 times. In other words, tunneling risk would not have changed if the Merger had been rejected.
Now, what about the second governance problem associated with the listed holdings? Again, this problem would have continued. Now, notice that, as long as SC&T keeps the listed holdings as their assets, then the governance problems associated with the listed holdings would continue, and controlling [Redacted] Family had very strong incentives to keep listed holdings regardless of the Merger outcome. To maintain control power, the [Redacted] Family is going to keep the listed holdings, particularly those in Samsung Electronics. Now, this is the point that Dr. Duarte-Silva pointed out yesterday with which I completely agree.
Now, another important reason why I think SC&T
[Page 934]
share value is not going to be net asset value in the case of Merger rejection is because of the canceled Hyundai Merger in 2018.
Now, Hyundai proposed a merger between Hyundai Glovis and Hyundai Mobis in 2018. Now, this proposed merger from Hyundai business group is quite similar to Samsung Merger in many respects.
Now, first, Hyundai Group is the second largest business group in Korea. The Samsung Group is the largest business group, and Hyundai Glovis is to Hyundai Mobis as Cheil is to SC&T.
Now, the mergers were for purpose of family succession from father to son, and both mergers were opposed by Elliott. The difference is that Hyundai Merger was canceled due to a petition by Elliott and other investors, and Samsung Merger was completed. So, by looking at what happened to the Hyundai Mobis stock price when the Merger was canceled, we can make an informed inference as to what would happen to Samsung C&T share price in the case of Merger rejection.
So, what happened? When the Merger was canceled, the left-hand side shows the magnitude of stock price changing. The horizontal axis shows the trading day relative to the event day, event day zero, event date of the Merger cancellation announcement.
[Page 935]
Now, you can see that right after the cancellation announcement, the price of Hyundai Mobis, which is like Samsung C&T, dropped by as much as 13 percent by 20 trading days after the announcement.
So, this evidence suggests that if Merger had been rejected, if the Merger between Samsung C&T and Cheil had been rejected, the market reaction would have been negative, so the SC&T share price would have dropped. So, if anything, the discount would have become even wider.
Now, let me turn to the last issue that holding-company discount should be applied to legal holding company only but not to a de facto holding company like Samsung C&T. That's Professor Wolfenzon's opinion, and that claim is based on two studies on Korean companies. One study is by Professors Park, Suh & Kang, which I call "PSK Study," and this study shows that legal holding companies undervalued relative to other companies but not to de facto holding company. The other paper is by Professors Almeida, Park, Subrahmanyam, and Professor Wolfenzon, which I call APSW Study, they show that some chaebol companies, which they call "central firms," are undervalued.
Now, Professor Wolfenzon claims that this finding that some companies are undervalued is mostly driven by legal holding companies only, not de facto
[Page 936]
holding companies.
Now, I list three reasons to disagree.
First of all, de facto holding companies selected in the PSK Study are very different from SC&T. Furthermore, the PSK Study did not include SC&T in their study. It's not in the 18 de facto holding companies sample. So, one cannot generalize the study's findings to the context of SC&T because it's not in the sample.
The second reason which I think is more important is that the PSK Study is subject to what we financial economists call "endogeneity bias." Now, in layman's terms, what it means is that you compare oranges and apples, which are not comparable. And by doing so, you make a wrong conclusion such as the one that only legal holding companies are at discount.
Now, to see how the endogeneity bias played the role in the PSK Study, I got the exactly same data from them, and I replicated their study, and I confirmed their findings, and then I used a sample which is subject to less endogeneity bias, and I ended up with a very different conclusion.
So, my new finding is that, as common sense will suggest, the legal status has nothing to do with undervaluation. It is equity stake in other companies; in other words, affiliated holdings or listed holdings are
[Page 937]
related to the undervaluation. And that evidence makes more intuitive sense because equity stakes in other companies are related to the chaebol governance problem as I discussed earlier, whereas their legal status says nothing about the governance problem.
The legal holding companies are undervalued because they hold a large amount of the affiliated holdings, and that's why they are at discount, not because of their legal status.
Now, the last reason is that Professor Wolfenzon argues that their findings are largely driven by the legal holding companies. Now, this study by Professor Wolfenzon is actually a very good study. I have a high respect for this study, but his claim I have to disagree because his claim is not correct. The sample in the APSW Study includes a total of 47 chaebols and more than 1,000 companies during the time period of 1998 and 2004.
Now, by 2004, which is the last year of the sample period, there are only 20 holding companies in Korea, and only one chaebol adopted the holding company structure, legal holding company structure, according to Korea Fair Trade Commission. So, it has to be the case that the discount is likely to be driven by de facto holding companies like Samsung C&T because there were not many legal holding companies in this sample period.
[Page 938]
So, to conclude, SC&T's share price is at discount because of the governance problems, and the apparent discount has nothing to do with the legal status but has more to do with the listed holdings. And the prevalence of listed holdings is the result of the governance problem, which is that SC&T's management and controlling shareholders prefer to hold large stake in affiliated companies for control purpose, not for maximizing shareholder returns. And these governance problems would have persisted even if the Merger had been rejected because controlling family has no incentive to liquidate them.
So, the SC&T's Fair Market Value would have been significantly lower than the SOTP Value as computed by Dr. Duarte-Silva in the counterfactual case of the Merger rejection.
Thank you very much for your attention.
PRESIDENT SACHS: Thank you very much, Professor Bae, and we will now go to cross-examination.
Ms. Burack?
MS. BURACK: Yes. Thank you, Mr. Chairman.
BY MS. BURACK:
Q. Good afternoon, Professor Bae. Thank you for being here.
[Page 939]
Do you have a copy of your report with you? If not, we can give you one.
A. I have.
Q. Okay, excellent.
Let's start with just a few questions on your background.
A. Um-hmm.
Q. You currently sit on the Corporate Governance Research Committee for the Korea Corporate Governance Service; is that right?
A. Yes.
Q. And the Korea Corporate Governance Service, or "KCGS," that's a non-profit group that provides corporate governance and proxy research services in Korea?
A. I believe so. It is a sister organization of the Korean Stock Exchange.
Q. And you consider that to be a reputable organization?
A. I believe so.
Q. And it's knowledgeable about the research and the topics which it works in?
A. You mean the staff members there or who are knowledgeable?
Q. You would consider reports issued by the KCGS to be credible and knowledgeable?
[Page 940]
A. Well, I mean, generally credible, but that doesn't mean what they are saying is always correct.
Q. Let's talk about some of the materials you rely on in your Report.
So, in your Report, you criticize Dr. Duarte-Silva's use of the Sum Of The Parts valuation on the basis that that valuation can be influenced by a valuator's interests or it might be affected by biased estimates; is that right?
A. Yes. And that is the opinion of the Professor--the NYU Professor of Finance who is well-known for his valuation.
Q. Yes. I believe you cite actually in your Report an article by Professor Damodaran?
A. Yeah. And I agree with him.
Q. And Professor Damodaran is a recognized expert on valuation topics?
A. Yes.
Q. He's the world's leading authority on the subject, would you say?
A. I would--I would think so, yeah.
Q. Sometimes called the "Dean of Valuation"?
A. Okay, yeah. But when it comes to the valuation of Korean companies, I don't think he is as well-informed as I am.
[Page 941]
Q. Understood.
And we can actually just look--I want to orient you. You cite to Professor Damodaran's Article in Paragraph 67 of your Expert Report.
A. 67, yes.
Q. 67.
And that is on Page 28.
A. Yes.
Q. And the Article you cite, it's in Footnote 56, Aswath Damodaran, "What is valuation?" And it's cited here as Exhibit KHB-25. I believe that might be a typographical error. I would like to pull up KHB-24 and just confirm that's the Article that you're referring to.
And is this, in fact, Professor Damodaran's Article that you were citing to in your Report?
A. Can you increase the font?
Q. Sure.
A. So, I cannot find this sentence, that we almost never stock value in company. Where is it? I don't see that--
Q. I believe it's on Page 2 of this document. It's right under that second heading "Value First, Valuation to Follow."
A. Yeah.
Q. So--
[Page 942]
A. That's the statement,-- I cite it. My apology, sorry.
Q. And in this Article, Professor Damodaran is discussing potential sources of bias in valuations and how to mitigate them; correct?
A. Yes.
Q. And if we go to Page 4, the paragraph at the bottom of that page, one source of bias that Professor Damodaran identifies is attributed to institutional factors. He writes: "A significant portion of bias can be attributed to institutional factors."
Do you see that?
A. Yes.
Q. Okay. And he then goes on in that same paragraph to discuss an example where equity research analysts have to grapple with demand from their employers that they bring in investment banking business; is that right?
A. Yes.
Q. And in other words, Professor Damodaran is arguing that companies subject to these equity analyst valuations, they may be actual or potential investment banking clients of the analysts' own employer; correct?
A. Yes. This is a well-known problem.
Q. And as you say, it's a well-known problem, and
[Page 943]
so what the Professor is saying here is that, when looking at sell side firm analyst reports, we need to be cautious and attuned to potential bias in those reports; correct?
A. Yes.
Q. And so, for example, when looking at a sell side analyst report, we might be hesitant to fully embrace the conclusions of that report if it was coming from the trading house of the very same company that stood to benefit from the proposed transaction; right?
A. Yes.
Q. Because that would, in fact, be a classic example of institutional bias affecting valuation within Professor Damodaran's cautionary framework?
A. Can you repeat the last comment?
Q. Sure.
A. I got lost.
Q. Apologies.
Because, in fact, that situation where a sell side analyst from a trading house affiliated with the same company that's involved in the transaction--
A. Yeah, so that's why they create Chinese wall between Research Department and the Sales Department.
Q. Sticking on this page, if we could go back up now, I want to turn to the second full paragraph in this report.
[Page 944]
And in this paragraph, Professor Damodaran is considering how use of discounts can infect a valuation with bias; correct?
A. Where is it? The use of the--
Q. Yes. He writes: "The use of discount, illiquidity and minority discounts, for instance, are more typical in private company valuations for tax and divorce court, where the objective is often to report as low a value as possible for a company."
Do you see that?
A. Okay, yes.
Q. Okay. Do you agree with Professor Damodaran's statement?
A. Well, again, it depends on the bias. You may have an incentive to inflate the valuation of private company, so it's all about the incentive.
Q. Correct. And in fairness, the preceding sentence talks about the use of premiums, control and synergy are good examples being used in acquisition valuations where the bias might be to purchase--
(Overlapping speakers.)
A. Exactly. So, because of this biases from the valuators, the most reliable of the valuation is the market price, as Professor Dow claims, which I agree.
Q. Okay. We will get to Market Price, don't worry,
[Page 945]
but I would like to just stick with this language from Professor Damodaran for a few more moments.
A. Um-hmm.
Q. So, he states that illiquidity discounts are more typical--more typical in private company valuations; correct?
A. Um-hmm.
Q. And neither SC&T nor SEC are private companies; right?
A. They are public companies.
Q. And he goes on to say that these illiquidity discounts are typically used where the objective is to report as low a value as possible; right?
A. Yes.
Q. And he gives a particular example of tax and divorce court proceedings.
Do you see that?
A. Yes.
Q. So--sorry, I didn't mean to cut you off.
So, what he's saying here is that the reason why he identifies bias in those particular contexts, tax and divorce court proceedings, is because the very purpose of using the discount is to reduce the liability in, for example, a litigation context; right?
A. Yeah, in this context.
[Page 946]
Q. Okay. And now, in your Report, you opine that a liquidity discount or an illiquidity discount, perhaps, should be applied to Dr. Duarte-Silva's Sum Of The Parts analysis; right?
A. Can you point me to that paragraph?
Q. Sure.
Why don't we go to Paragraph 76 of your Expert Report.
A. Yes.
Q. And you're discussing the discount throughout this section, and you're welcome to look at it.
I want to direct your attention to, in Paragraph 76, excuse me, you write that "discounts for illiquidity can be as large as 30 to 50 percent."
Do you see that?
A. Yes.
Q. And to support that statement in Footnote 64, you cite to an article on valuing thinly traded assets; right?
A. Um-hmm.
Q. And that is cited as KHB-17.
A. Yes.
Q. Can we pull up that Article, please.
This is just the cover page, if we go to the second page of the Article. The first line of the
[Page 947]
introduction defines thinly traded assets as investments for which there is no liquid market available; right?
A. Yes.
Q. And we can agree--right?--that SEC is the largest company on the Korean Stock Exchange?
A. Um-hmm. Yes.
Q. And you will agree with me that there is a difference between not wanting to sell shares and not being able to; correct?
A. Yes.
Q. Okay. And would you also agree with me that if I own shares in a holding company that itself may have illiquid assets, I can still sell shares in the holding company; right?
A. Yeah, but the holding company is at discount. You're not going to get the full value of the Intrinsic Value. You're going to have to trade at the, you know, price which is much lower than the SOTP value or net asset value.
So, I don't see the point of this line of question or what is the question?
Q. The question was just simply I can buy or sell my shares in a holding company; right?
A. Yes, any time. It's a public company.
Q. Elsewhere in your Report and in your
[Page 948]
presentation this afternoon, you describe the phenomenon called "tunneling"; right?
A. Can I elaborate on this illiquidity issue here?
Q. I think if your counsel would like to ask further questions on it, they may return.
PRESIDENT SACHS: You will be given the opportunity later in redirect.
BY MS. BURACK:
Q. Returning to my questions, you earlier in your presentation and in your Report, you were describing a phenomenon called "tunneling"; right?
A. Yes.
Q. And, broadly speaking, that refers to the extraction of value by controlling shareholders from minority shareholders; right?
A. Extraction is a pretty strong word. I'm saying is that, it is an activity that benefit controlling shareholder and by doing so, it can damage the shareholder value of other minority shareholders.
Q. Okay. Let's go to Paragraph 54 of your Expert Report, which is on Page 24.
A. Yes. Yes.
Q. And you see that you--you're describing a study that you co-authored some time ago, and you mentioned that, "in that study we examined two competing views about
[Page 949]
business groups in emerging markets, the value-added view and the tunneling view. The term "tunneling" was originally coined to characterize the extraction of value from Minority Shareholders in the Czech Republic."
A. Yes.
Q. So, extraction was your word in your Report?
A. No, it's not my word. It's the other word given by the Professors who wrote the paper called "tunneling," Simon Johnson, Andre Schlipol, and I forgot the other author's name. That is not my expression. It is the expression I took from their study.
Q. Okay. You don't caveat it or qualify it in this paragraph of your Report, do you?
A. Pardon me?
Q. You don't caveat it or qualify it or say this isn't, sort of, the right way to think about it in this paragraph of your Report, do you?
A. No. Why should I?
Q. In Footnote 39 in the same paragraph, you go on to elaborate a bit on the tunneling view, and in the last full sentence of that footnote, you write: "The tunneling view of business groups is that the structure of business groups can create conflicts of interest between controlling families of business groups and minority investors and controlling families have incentive to
[Page 950]
siphon (tunnel) the firm's assets out of the firm to increase their wealth at the expense of minority investors."
A. Yes.
Q. And do you agree with that characterization of "tunneling"?
A. Yes.
Q. And if we could just go to Paragraph 88 in your Report, briefly. That's on Page 37.
A. Yes.
Q. And here, you're referring to an earlier section in the Report as discussed in Section 3(c) and you write: "The larger the wedge is the more investors perceive there to be a tunneling (value extraction risk)."
Right?
A. Yes.
Q. And once again, value extraction in this sentence there is no citation, so can I take that to be your words?
A. This is the standard terminology we use in the finance literature, so I have no reason to deviate from that practice.
Q. Okay. Understood.
And in your Report, you described two event studies of stock market reactions to Merger Announcements
[Page 951]
of Korean companies; correct?
A. Um-hmm, yes.
Q. And the first of those--sorry.
A. Sorry.
Q. And the first of those studies looked at reactions to Korean merger announcements between 1981 and 1987; right?
A. Yes.
Q. And then the second one looked at stock market reactions to Merger Announcements more recently from 2000 to 2019; correct?
A. Yes.
Q. Okay. And in both cases you looked at the reaction of stock prices after Merger Announcements in order to determine whether they were consistent with this tunneling thesis. That is, you looked at them to determine whether the Merger was being perceived as extracting value from minority shareholders?
A. In my first paper, in the paper that I published in 2002.
Q. Okay. And it was your thesis in that paper that falling stock prices indicated the market perceived a risk of value extraction from minority shareholders; correct?
A. Not--not for all mergers. The mergers by the largest chaebol companies.
[Page 952]
Q. So, in those cases, in mergers between large chaebol companies, falling stock prices in the wake of a Merger Announcement reflected the market's perceived risk that value would be extracted from Minority Shareholders?
A. Yes.
Q. Is that right? Okay.
And that first study, that was a very highly regarded study; correct?
A. Yeah. It's well cited and then recognized by finance scholars.
Q. And it was published in the Korean Journal of Finance?
A. No. It's published in Journal of Finance which we argue is top finance journal.
Q. My apologies. I stand very much corrected.
That's a peer-reviewed journal?
A. Yes, absolutely.
Q. And the study, just so we're clear, concluded that price movements following Merger Announcements between these chaebol companies we have been discussing indicated that the market perceived mergers within those chaebols as value destructive; right?
A. Yes, that was our interpretation.
Q. Okay. And then the second event study, the one that covered the more recent period from--sorry, the
[Page 953]
second study that you conducted in the more recent period from 2000 to 2019, that's something that you conducted for purposes of this Arbitration; correct?
A. Yes.
Q. It hasn't been published anywhere yet?
A. No.
Q. Has it been peer-reviewed?
A. Which one are you talking about?
Q. I'm talking about the study that you conducted for purposes of this Report.
A. I only look at the announcement returns, which is in Appendix Figure 5.
Q. And that work that you did reflected in Appendix Figure 5, that's not published work; correct?
A. This figure--yeah. At that time I didn't write the paper.
Q. Okay. And if you didn't write a paper, I presume it hasn't been peer-reviewed?
A. I mean, I don't have a paper, so...
Q. Understood.
And according to this second study that you conducted, you concluded that the market no longer perceived mergers to be value-destructive, at least not on average; right?
A. Which paragraph are you referring to?
[Page 954]
Q. Sure.
I believe Paragraph--it would be 56 of your Report, which is on Page 24 and 25 of the Report.
A. 56, yes.
Q. And specifically, I'm looking at--well, on Page 25, but still that same paragraph, 56, you write: "From 2000 to 2019, the market generally held the same positive perception of mergers of companies in the top 30 largest chaebols and smaller non-chaebol companies and no longer generally perceived chaebol mergers to be value-destroying at least on average."
Correct?
A. Yes.
Q. I had a few questions about what you mean because you have a few caveats, they're no longer "generally perceived" and "at least on average." And my question is what did you mean by those caveats?
A. If you look at the figure, which I think was Appendix Figure 5 on Page 86. The figure above is copied from my Journal of Finance paper which I published a long time ago.
PRESIDENT SACHS: I'm sorry, Operator, can we put there figure on the screen?
BY MS. BURACK:
Q. It's on Page 86, sir.
[Page 955]
A. As you can see, the red line, red dotted line, shows the price reaction of top chaebol-acquiring companies. And right after the Merger Announcement, stock price started going down. So, the market perceived that news as bad news.
Now, if you look at the figure below, I did exactly the same thing, simply using more recent time period. The red dotted line, the pattern is quite different. The stock price started moving up well before the Merger Announcement; and then, after the Merger Announcement, it kind of stabilized. It doesn't move.
So, if the market learned of the news of the Merger Announcement, then they reacted positively. They thought it's goods news, so it's quite different from the--my earlier, you know, evidence. That's what I mean.
Q. Thank you, Professor Bae.
I want to go back now to Paragraph 57 B, unless the Tribunal cares to look at these charts any longer, I'm gong to move on back to the language of the Report.
PRESIDENT SACHS: No, no, we can move on.
BY MS. BURACK:
Q. So, in Paragraph 57 B where you're discussing this study, again you wrote: "And no longer generally perceived chaebol mergers to be value-destroying, at least on average."
[Page 956]
So, does that mean that in some cases that you looked at in this more recent period from 2000 to 2019, the stock price fell after the Merger Announcement and in some cases it rose?
A. Yeah, probably that's the case, but on average, it went up.
Q. Okay, understood.
Did you look into whether there was any rhyme or reason to why the price might fall sometimes and rise others?
A. No, at that time I didn't do any analysis.
Q. And did you consider the individual characteristics of any of the mergers included in that study--
(Overlapping speakers.)
A. No. I said all I have done is just to look at the market reaction. That's all.
Q. Okay. And then you just averaged it out?
A. Yeah.
And that evidence is not really relevant to my Expert Report because my Expert Report is about the holding-company discount, so.
Q. With respect, sir, you included it in your Report--
(Overlapping speakers.)
[Page 957]
A. --which in retrospect I don't know why I did that.
Q. And I believe you say in your Report that you have not done any additional research to determine why the results from your earlier study are different from the results of this more recent study; right?
A. Yes. At the time of the writing.
Q. And just so I'm clear, neither of these two studies that I have been talking about looked at reactions in market price after the Mergers at issue were actually approved or rejected; right?
A. I'm sorry, I didn't catch your question.
Q. So, neither study that we've been talking about, the earlier one or this more recent one, neither one looked at what was happening to the Merger Price after the Merger at issue was actually approved or rejected?
A. No, we didn't look at the stock price pattern at the Merger Voting date.
Q. Right.
A. Because the event study--in particular whatever information is available--I mean, revealed to the market, it is revealed at the time of announcement.
Q. And so, you focused just on the Stock Price--
A. That's a standard practice in our profession.
Q. So, would the market price after a Merger either
[Page 958]
passes or fails be a relevant datapoint for your analysis?
A. No, not really.
Q. Okay. Earlier this afternoon, you discussed a merger involving Hyundai.
A. Yes.
Q. Two companies of the Hyundai Group?
A. Yes.
Q. And you also discuss this in your Report, and in your Report you talk about various ways in which the Hyundai Merger was comparable to the Merger at issue in this case; right?
A. Yes.
Q. And you note that the difference between the two Mergers is that the Hyundai Merger was canceled whereas the Samsung Merger went ahead and was approved; right?
A. Yes.
Q. And then--and I believe--I don't know if you can pull this up. It was Slide 26 of Professor Bae's presentation.
And you noted that the stock price of the Hyundai company dropped sharply after the announcement that the Merger in that case was canceled; right?
A. Yes.
Q. And I believe in your Report, when discussing the same Stock Price, you said that was evidence that the
[Page 959]
market devalued Hyundai's stock after the Merger was called off; right?
A. Yes. That's why price dropped.
Q. Okay. Did you look at what happened to SC&T's Stock Price after the Merger was approved on July 17, 2015?
A. I believe it dropped.
Q. And doesn't that then tell us, to use your words, sir, that the market devalued SC&T's stock upon news of the Merger's approval?
A. Yes.
Q. And then, wouldn't that evidence be consistent with tunneling or the potential for majority shareholders to extract value from the minorities?
A. You have to understand that the stock price is determined by millions of different factors. That's why we don't really make money in the stock market. It's very difficult to predict.
Now, in my view, the reason why you see a big drop in stock prices of Samsung C&T on Merger Voting Date, is because the proxy war was over. So, there is no, you know, room for further price appreciation. And then, those who have participated in the proxy war, they p--you know, they liquidated their--their investment to take profit or for those who lose money, they cut their loss.
[Page 960]
So, the game is over, so you get out of the market.
So, in my view, it is the liquidated trading, which pressured down the other stock prices.
Now, proxy war is a--is essentially good for shareholders because price tends to go up. But if the war is over, then you're going to have to get out the market. So, price dropped. Just supply and demand.
Q. Do you conduct any analysis of the affect of a proxy--
A. No. I don't--I don't have to. I mean--
(Overlapping speakers.)
PRESIDENT SACHS: Let counsel first finish.
THE WITNESS: I apologize.
(overlapping speakers.)
THE WITNESS: I'm not used to this.
BY MS. BURACK
Q. It's very easy to feel like it's a conversation.
A. Yes. Sorry.
Q. No problem. Did you conduct any analysis on these proxy effects in the case of the drop in SC&T share price after the Merger was approved?
A. No, I did not.
Q. Okay. And did you conduct any analysis of possible proxy effects in the case of the Hyundai Merger?
A. No, I did not.
[Page 961]
Q. But, in the case of the Hyundai Merger, you felt confident in concluding that that Merger, or the cancellation of that Merger, the drop in stock price reflected the market devaluing Hyundai's stock; right?
A. Yes.
So, my interpretation is that the market devalued Hyundai Mobis stock because if the Merger is rejected, then the tunneling risk is brought back to the table again.
Now, if you look at my presentation slide as to a wedge ratio--can we see the wedge ratio.
Q. Respectfully, Professor Bae, if it's responding to my question, because if not--we will get to the wedge ratio, I promise.
A. I'm answering your question.
Q. Okay.
A. I'm explaining why price dropped on the Merger cancellation date in the Hyundai case.
Q. Okay, understood.
MR. NYER: Can we show the slide on the other screen? It's, I believe, Slide 23 of Professor Bae's slides. Is that--
THE WITNESS: Now, in many ways, as I said, the Hyundai Merger is very similar to Samsung Merger, so the wedge ratio of the Hyundai Mobis was quite high just like
[Page 962]
the Samsung case.
So, if the Merger went through, the wedge ratio would have dropped just like the Samsung case, but then if the Merger is canceled, then it's going to be the status quo, the tunneling risk would have remained the same. So, that's bad news for Mobis Shareholders, so they devalued Shares of Hyundai Mobis, so price dropped.
So, that's why I believe if the Merger had been rejected in the Samsung case, a similar thing would have happened. Price is likely to have dropped because the risk of tunneling would have remained the same.
BY MS. BURACK:
Q. Well, since you want to talk about the wedge ratio, I suppose we can go there.
So, in your Report, one of the things you opine on is that SC&T is subject to a high governance risk due to the large wedge between cash-flow rights and control rights; correct?
A. Yes.
Q. Okay. And just to recap, the wedge you've been describing this afternoon, that's the difference between the [Redacted] Family's cash-flow rights and its control rights; correct?
A. Yes.
Q. And the existence of that wedge leads to--leads
[Page 963]
to the market discount on a company like SC&T?
A. Because of that, the wedge. Because wedge--it creates the, you know, conflict of interest between controlling shareholder and minority shareholder. The market perceive high risk and discount. That's why you see undervaluation.
Q. Okay. And you have a figure in your Report that illustrates this, but we can also use the figure--the chart that you used in your presentations. That is Slide 23 of the presentation you gave this afternoon.
And I believe what you're saying, Professor Bae, is that this chart shows that the wedge ratio for Samsung C&T decreased after the Merger occurred in 2015; right?
A. Yes.
Q. And you conclude from the decrease in that ratio that, therefore, the threat of value extraction is lessened from 2016 onward; correct?
A. I don't think I said that.
Q. Well, you would agree--right?--that the--the--the lower wedge ratio after 2016 and onward, reflects less tunneling risk because investors will perceive there to be less of a risk of the value extraction?
A. Yes. Yes.
Q. All right. And that's because the interests now
[Page 964]
will be controlling shareholders, they have control and cash-flow rights more aligned?
A. More aligned, yes.
Q. So, looking at this chart, is it possible that the wedge ratio decreased in the case of Samsung C&T, the wedge ratio decreased after the Merger because the threatened value extraction, in fact, already happened?
A. That's a very interesting interpretation, but--so, the wedge ratio decrease because there is no value transfer?
Q. Well, if, in fact, the [Redacted] Family had already stolen the value from SC&T's minority shareholders, then there wouldn't be as much of a forward-looking risk that that would continue to happen because the value had, in fact, already been taken.
A. No. I think I'm going to have to disagree with that interpretation. No.
PRESIDENT SACHS: Sorry. And why would you disagree?
THE WITNESS: Well, this--the wedge ratio change is a result of the restructuring combining two companies into one, where the [Redacted] or the [Redacted] Family has higher ownership in Cheil, whereas the Samsung C&T, as I said before, the [Redacted] Family had only 1.4 percent of ownership, so you combine them into one company, then there is, you
[Page 965]
know, the--
PRESIDENT SACHS: I understand counsel saying the damage has been done, so--
THE WITNESS: The damage has been done.
PRESIDENT SACHS: That was the question.
THE WITNESS: Yeah. Damage has been done.
So, it's not--okay. So, the reduced wedge ratio is not because of the damage--it is because of the restructuring.
MR. NYER: I don't know if there is a typo in the Transcript, but I heard you say that the damage hasn't been done, and I see the Transcript shows that the damage has been done.
MS. BURACK: I believe he did say that the damage has been done.
THE WITNESS: Yeah.
So, if there--I mean, speaking--I think I'm going to have to stop there. Go ahead.
BY MS. BURACK:
Q. Professor Bae, did you consider any other developments that occurred in Korea post-2015 that might have impacted an investor's perceived risk of value extraction from SC&T?
A. After 2015?
Q. Correct.
[Page 966]
A. You mean, New SC&T?
Q. Yes.
A. Was there any value extraction?
Q. Just did you consider any developments in Korea from 2015 onward after the Merger?
A. No, not that I'm aware of.
Q. So, you didn't consider the fact that, for example, Samsung was first publicly investigated in connection with the corruption scandal underlying this case in late 2016?
A. Well, I saw the news once in a while, but I don't really closely follow that.
Q. And didn't factor into your opinions at all.
A. No.
Q. And likewise, did you consider the fact that President [Redacted] was impeached and then later tried and convicted for her role in the Samsung scheme in considering--when considering events that might impact investors' perceived risk of value extraction from SC&T?
A. I think that's not relevant because the news was revealed to investors after, long after this event, so that is not relevant.
Q. And did you consider the fact that [Redacted] was convicted and imprisoned for bribery in 2017 when evaluating whether investors would have an increased or
[Page 967]
decreased risk--perceive an increase or decreased risk value extraction in the New SC&T post-2015?
A. Again, I think the--it's a legal issue. It's after the Merger.
Q. Okay.
A. So, it cannot possibly affect the market's perception.
Q. Well, just to be clear, Professor Bae, I'm not so much talking about the market's perception at the time of the Merger. I'm asking, you know, following the Merger there's this decreased wedge ratio that you pointed out. You said this led to a decreased perceived risk of value extraction, and I'm simply asking if you considered other events in Korea that might also have contributed to a perceived decrease in the risk of value extraction.
A. I don't know.
Q. Going back to your critique of Dr. Duarte-Silva's Sum Of The Parts analysis, one thing you think he did inappropriately was value SC&T's listed holdings at their market price; right?
A. No, I don't think that that is right.
Q. Look at Paragraph 63 of your Report.
A. Are you saying that they are valuing listed holdings at Market Prices is right?
Q. Well I--
[Page 968]
A. Did I say that is right?
Q. I'm simple pointing you to Paragraph 63 of your Report. It's on Page 27, and you write--you're critiquing Dr. Duarte-Silva's valuation. You note that he valued SC&T's listed holdings at their market prices, and you say: "This assumption is flawed and generates an overestimated SOTP values because SC&T's listed holdings are non-tradable stocks and do not generate any benefits to SC&T's shareholders other than to the controlling [Redacted] Family." Is that right?
A. Yes, I said that.
Q. So, we've been talking about market prices quite a bit over the course of this arbitration, and with Professor Dow yesterday, and so I just want to make sure I understand. You do not think that SC&T's listed holdings should be valued at their Market Price; right?
A. No. It's not matter of should or should not. The market doesn't value listed holdings at the market prices because the market doesn't see any benefit of listed holdings.
So, it's not about whether I believe it should be valued or it shouldn't be valued. It's just that the market does not value listed holdings at their market prices. That's my point, because of the governance problem associated with the presence of huge amount of
[Page 969]
listed holdings.
Q. And the reason you believe the market does not value listed holdings at their market price is because, in the case of SC&T, the [Redacted] Family held those holdings for purposes of control and, therefore, never would have sold them; is that right?
A. Yes.
Q. Okay. And you go on, you characterize the listed holdings as non-tradable assets; correct?
A. Yes.
Q. And because they're not tradable, I believe you say they--
(Overlapping speakers.)
A. No, it's not--it's not--okay. Maybe non-tradable could be a mis-expression. The [Redacted] Family has no incentive to sell listed holdings, and with that Dr. Duarte-Silva agrees.
Q. Let's go to 75 of your Report. That's on Page 31. And you refer in that paragraph to the affiliated holdings as non-tradable assets; right?
A. Affiliated holdings that are held for control purpose are non-tradable assets.
Q. Okay.
And because they are not tradable, you go on to say they cannot generate profits; correct?
[Page 970]
A. Where did I say that?
Q. Well, perhaps I'm not following correctly. Let's make sure I understand.
You say if the listed holdings or portfolio holdings held by an investment company that actively trades them for profit, Dr. Duarte-Silva is right.
A. Yes. It should be valued at market prices.
Q. Okay. But here they can't be traded for profit, so they shouldn't be valued at market price. Is that what you're saying?
A. Yeah, because the listed holdings by Samsung C&T is for the purpose of controlling by [Redacted] Family.
Q. Understood.
I just want to understand what kind of profits specifically we're talking about. The listed holdings or the affiliated holdings or the non-tradable holdings, whatever we want to call them, they can still issue dividends; right?
A. Yeah. Dividend income is pretty low in Korea.
Q. Okay.
A. So that's not going to be many benefits.
Q. And so, in fact, I take it from the rest of this paragraph that you're actually not talking about dividend income because you go on to talk about profit in the event of liquidation. So, am I right that you're really
[Page 971]
referring more to profits in the sense of capital gains?
A. Um-hmm.
Q. And under your theory--
REALTIME STENOGRAPHER: I need a verbal answer.
THE WITNESS: I'm sorry. Yeah. Yes.
BY MS. BURACK:
Q. And so, if non-tradable assets can't generate capital gains, they're also not going to be the subject of any corporate tax on those capital gains; right?
A. I think it--it can still--I mean, I guess you're talking about here the contingent tax liability that Professor Dow discussed yesterday.
Q. I'm just simply asking more as a general matter. If an asset is, as you say, not tradable or not going to be sold because it's being held for control purposes, then it seems to me that it can't generate capital gains or taxes on those capital gains because the whole point is that that asset would not be liquidated.
A. If there is hundred percent certainty that this will never be liquidated, then yes, but, you know, although I used the term "non-tradable asset," I mean, there is--in the case of the company going liq--bankrupt, this asset should be liquidated, so there is, however small that is, there is a chance that they can be liquidated.
[Page 972]
If the Company goes bankrupt, all assets will be liquidated.
Q. In the ordinary course, however, is it your view that these non-tradable assets will not generate any capital gains and, therefore no taxes on those capital gains?
A. Yes.
Q. So I believe you've said a couple of times this afternoon that you agree that the purpose of SC&T's holdings in SEC was to benefit the [Redacted] Family; right?
A. Yes.
Q. Okay. And would you agree that the Merger was a mechanism for the [Redacted] Family to solidify its control over SEC?
A. Yes.
Q. But you think that the [Redacted] Family's motivation to obtain control would have persisted even if the Merger had been voted down; right?
A. Yes.
Q. But what if, Professor Bae, the NPS had voted down the Merger? Wouldn't that have sent a very strong signal that the Korean Government was not willing to tolerate value extraction to the detriment of other Shareholders?
A. Yeah, it could have sent such a signal.
[Page 973]
Q. Okay. And, in that scenario, with the strong signal from the NPS, isn't that another way that the risk of this continued governance deficit could be removed?
A. No. I disagree with that.
As I have shown, the wedge ratio would have remained the same. In other words, the [Redacted]'s incentive and the minority shareholders' incentive are not aligned. So, why would the market believe that the [Redacted] Family will be a good citizen? No.
Q. You're aware that NPS was a significant shareholder in SC&T; correct?
A. Yes.
Q. It had over an 11 percent stake, I believe?
A. Yes.
Q. Okay. And in this case it was the swing vote on the Merger; right?
A. That I don't--I cannot make any comment because I haven't really analyzed the NPS decision, and that isn't scope of my Expert Report.
Q. Okay.
A. So I cannot make any informed comment on that issue.
Q. Fair enough. But it was certainly--it had a large shareholding at over 11 percent.
A. Yeah, I agree.
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Q. Okay. And NPS is a public institution in Korea that manages the pension contributions of Korean citizens; correct?
A. Yes.
Q. Okay. And if the NPS's vote was decisive--
A. If?
Q. If. I'm just asking you to go with this assumption. If it was, in fact, the case that the NPS's vote was decisive, then whatever motivation or incentive [Redacted] might have to obtain control, that might persist if the Merger was voted down, but he wouldn't have the means to execute on it; right?
A. Can you be more specific?
Q. Sure.
A. He doesn't have any means to execute what?
Q. Well, so, I understand you to be saying that if the Merger had been voted down, that this problem created by the wedge ratio would have persisted because the [Redacted] Family would still be looking for a way to solidify its control--
A. Yeah.
Q. --over Samsung.
A. Yes.
Q. So, what I'm asking is, if the NPS had the swing vote in that scenario and the NPS said no, then the fact
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that the [Redacted] Family wants control doesn't mean they can get it; right?
A. Yeah, but that doesn't mean that they're going to give up their intention to solidify their control power.
MS. BURACK: I have no further questions. Thank you. That was it.
PRESIDENT SACHS: Redirect?
BY MR. NYER:
Q. Just one question to give Professor Bae a chance to elaborate on the points that you wanted to elaborate on, on the illiquidity issue, if you have any additional comments that you want to offer.
A. Yeah, the illiquidity issue is one interpretation of the governance problem. The holding company discount of Samsung C&T is essentially governance discount.
Now, I discussed the illiquidity issue because that's one interpretation of the discount, but that's not the main problem. The main problem is: it is a governance problem. That's why you see a huge holding-company discount in terms of Samsung C&T, which has serious governance issues as I explained in my presentation. So, I'm just simply saying that the Illiquidity Discount could
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be just another interpretation, and then I think I wrote down just one paragraph on that. So, that's not the main focus of the discount. The main focus of the holding-company discount should be the governance issue.
Q. Thank you, Professor Bae. Nothing more.
PRESIDENT SACHS: Okay. That's clear. Your position is clear on that point.
I turn to my two co-Arbitrators. Do you have questions to Professor Bae?
ARBITRATOR MAYER: I don't. Thank you.
ARBITRATOR GLOSTER: I don't. Thank you very much.
PRESIDENT SACHS: Neither have I, so we thank you, Professor Bae, for your expert testimony. You are now released as an expert--
THE WITNESS: Thank you very much.
PRESIDENT SACHS: --and may leave the room.
(Witness steps down.)
PRESIDENT SACHS: I think we could dispense of the coffee break and just wrap up and see where we stand.
So, we've dealt with the Post-Hearing Briefs.
An item I should still mention is the Transcript. You've seen the high quality of the Transcript as usual, provided by David, so we would invite you to contact each other with respect to the issuance of
[Page 977]
a final Transcript and get back to us earlier if there is a serious problem; and we would not expect this, but if there is, we will, of course, assist.
So, from our perspective, this is it. So, we will close the Hearing unless you have further observations before I thank all the participants. But housekeeping matters or observations on the further proceedings?
MS. VAZOVA: Nothing from Claimant, Mr. Chairman.
PRESIDENT SACHS: Okay. Thank you.
And Respondent?
MR. NYER: Nothing from the Respondent, other than thanking you, Members of the Tribunal, PCA, and counsel for Claimants.
PRESIDENT SACHS: Yes.
And it's reciprocal. We want to thank counsel for very professional conduct of these proceedings in a civilized manner, which is not always the case, so thank you very much. That makes the task easier for the Tribunal.
We thank David, of course. We thank FTI and Scott. They did a great job, I think. We thank the Centre here, PCA in person of Levent, and so we're looking forward to hearing from you, and possibly having the May
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oral argument, but remotely we would propose, so that we can control the costs of the proceedings.
So, thank you very much. Have a safe journey back for those who have to travel and, so, goodbye.
(Whereupon, at 1:57 p.m. (EDT), the Hearing was concluded.)
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I, David A. Kasdan, RDR-CRR, Court Reporter, do hereby certify that the foregoing proceedings were stenographically recorded by me and thereafter reduced to typewritten form by computer-assisted transcription under my direction and supervision; and that the foregoing transcript is a true and accurate record of the proceedings.
I further certify that I am neither counsel for, related to, nor employed by any of the parties to this action in this proceeding, nor financially or otherwise interested in the outcome of this litigation.
Signature
DAVID A. KASDAN