[DECODED] Shin Dong-bin’s ‘Global Lotte’ in jeopardy

The year 2016 had been set to become a major turning point for Lotte chairman Shin Dong-bin to build up a “Global Lotte.”

From the much-anticipated initial public offering of its hotel unit to a flurry of new mergers and acquisitions to be set in motion, the country’s fifth-largest conglomerate had been on track to fulfill its ambition to expand its business empire beyond its domestic boundaries.

Yet, all came tumbling down on June 10. 

Seoul prosecutors kicked off a record-scale probe into the country’s fifth-largest conglomerate and its major affiliates over allegations of embezzlement and the creation of a multibillion won slush fund.

The Seoul Central District Prosecutors’ Office has executed two rounds of raids on Lotte’s headquarters and major affiliates including Hotel Lotte and Lotte Chemical, the group’s two main pillars, and sending the group’s into its biggest crisis to date.

The probes have dealt a major blow to Lotte’s core agenda for the year.

The retail giant pushed for public listing of its hotel unit, valued at up to $4.5 billion, touted as the largest IPO in the world this year. Lotte has also been stepping up efforts to become a global corporation through the strategic acquisition of foreign companies. 

However, both the IPO and overseas M&A talks have been postponed indefinitely, as uncertainty continues to grow in light of the ongoing probes.

The investigation has already pushed Lotte Chemical, suspected as a key Lotte unit which engaged in the creation of a slush fund, to abruptly withdraw its bid to acquire U.S. chemicals producer Axiall Corp., now under the wing of U.S. rival Westlake Chemicals Corp.

“Given the ongoing investigation, Lotte will not be able to partake in M&A talks with companies abroad or push forward its global expansionist agenda as it did before the start of the investigation,” a Lotte Group spokesperson told The Korea Herald.

Hotel IPO thwarted

With the widening probes, Hotel Lotte scrapped its mega IPO last week, derailing the group’s envisioned plans to use the newly-generated funds to actively pursue major M&As of duty-free and hotel operators based abroad.

The Hotel Lotte IPO had stood at the center of incumbent group chairman Shin Dong-bin’s vision to expand Lotte’s operations beyond Korea and into other parts of the world including the West, where his aging father and Lotte founder Shin Kyuk-ho were reluctant to do business.

Lotte Group, which generated roughly 84 billion won ($71.5 billion) in sales last year, derives most of its profits from its retail business, which made up around 43 percent of its total profits as of 2014, according to the group.

Unlike most other export-driven Korean conglomerates, Lotte’s retail-centered operations are largely limited to Korea and Japan, limiting its growth potential and opportunities for continued expansion into new markets.

As traditional department stores and supermarkets continue to lose their appeal in face of fast-advancing online and mobile shopping businesses, Hotel Lotte had been betting on the aggressive expansion of its lucrative duty-free and hotel business to secure a new source of growth.

In its regulatory filing made ahead of the IPO, Hotel Lotte said it would “set aside at least 1.79 trillion won of the newly raised capital for the acquisition duty-free and hotel operators based abroad, treading toward its goal to “become the world’s second-largest duty-free operator and one of Asia’s top three hotel business operators.”

However, the ongoing probes and the cancellation of the Hotel Lotte IPO have led the Korean retail giant to abandon its ongoing negotiations with key M&A candidates in North America and Europe and to indefinitely push aside its goal to transform itself into a global corporation.

For one, the group has given up on the potential acquisition of Duty Free Americas Inc., the largest duty-free operator in the U.S. valued at $1.5 billion, a Lotte official told The Korea Herald on condition of anonymity.

Had the DFA acquisition been successful, it would have enabled Lotte Duty Free, run by Hotel Lotte, to expand its business beyond Asia and into the Western hemisphere and to shake up the landscape of the global duty-free market.

According to The Moodie Report’s 2015 Top 25 Travel Retailers rankings, Dufry was the world’s No. 1 duty-free operator with sales of 4.85 billion euros ($5.46 billion) in 2014, followed by LVMH-owned DFS Group with sales of $4.5 billion and Lotte Duty Free with sales of around $4.23 billion.

In addition to its abandonment of the U.S. duty-free acquisition deal, Hotel Lotte said it had given up on plans to acquire or assume operational rights to two major hotels each in France and the U.S., alongside a number of other deals under review.

“Among other negotiations, we had made the most significant progress on a deal with two hotels in France and the U.S. As of now, we are unable to continue reviewing such M&As, given current circumstances,” a Hotel Lotte spokesperson said.

Moreover, the public listing of Hotel Lotte had also been widely perceived as a test of the self-appointed chairman’s ability to successfully manage the retail conglomerate and a fulfillment of his pledge to improve the transparency of the group’s murky governance structure.

Lotte is still reeling from a bitter fraternal battle that broke out last year over control of the group. By removing his father and Lotte founder Shin Kyuk-ho and his older brother Shin Dong-joo from power, Shin Dong-bin effectively made himself the sole leader of Lotte Group both in Japan and Korea — a move that the elder brother has been continuously working to overturn.

Although Lotte Group chairman Shin Dong-bin told the media last week that Hotel Lotte would refile for an IPO again by the end of this year, the group said the move should be taken as more of “a show of determination” rather than a concrete promise, given current circumstances.

Dim prospects for chemicals

The ongoing probes have also jeopardized Lotte chairman Shin Dong-bin’s vision to nurture its petrochemicals business as a new sector to propel the group’s growth in the long run — a vision that local critics have questioned from the beginning.

The incumbent chairman is widely known to hold a special fondness for the group’s petrochemicals business, which together with its construction portion accounted for roughly 29 percent of the group’s net sales as of 2014, according to the group.

On several occasions, Shin, the only member of the Lotte founding family to own a stake in the company, 0.3 percent, had vowed to increase Lotte Chem’s share of the group’s businesses to match that of its retail arms through strategic mergers and acquisitions.

Lotte Chemical took a step backward from such vision when it pulled out from the bid to acquire Axiall Corp., delivering another critical blow to Shin’s vision to nurture Lotte Chem as one of the world’s top 10 petrochemicals producers.

“Though opinions vary, it’s unfortunate that Lotte Chemical lost its opportunity to acquire Axiall, as it would have enabled the company to significantly expand its business in the U.S. in the long run,” Hana Financial Investment analyst Yoon Jae-sung told The Korea Herald.

Lotte Chem, which recently began constructing an ethylene cracking plant in Louisiana through a joint venture with Axiall, “could have added new production capabilities in the downstream with the acquisition of the U.S. chemicals firm,” Yoon said.

Despite the failed acquisition, the incumbent chairman reiterated his pledge toward expansion while attending the plant’s groundbreaking ceremony last week -- “Lotte Group will spare no expense in helping Lotte Chemical expand globally and grow into a crucial part of the group’s business,” Shin said.

However, as Lotte’s petrochemicals unit stands at the center of the current investigation — it is suspected of embezzling funds in the process of importing raw materials from overseas vendors using the group’s unlisted Japanese units — industry watchers expect it will be some time before the firm can normalize its operations, let alone pursue overseas expansion.

“It’ll be difficult for Lotte Chemical to actively push forward M&As in the near future, though it will vary on the outcome of the investigation,” the Seoul-based analyst said.

Meanwhile, other corporate experts raised fundamental doubts over Shin’s pursuit of the petrochemicals business as one that can safely ensure conglomerate’s future in the competitive years ahead.

“Lotte’s two major pillars consist of retail and petrochemicals led by Lotte Chemical, yet their long-term growth outlook remains uncertain,” said Yun Deok-kyun, an honorary professor of industrial engineering at Hanyang University and an expert on Korea’s corporate landscape.

Lotte chairman Shin Dong-bin has set his sights on nurturing the group’s chemicals business, currently doing well thanks to low crude oil prices and favorable market conditions that have led to high margins, Yoon said.

Earlier this year, Lotte Chemicals completed the acquisition of a 90 percent stake in Samsung SDI’s chemicals business, a 31.5 percent stake in Samsung Fine Chemicals and a 49 percent stake in Samsung BP Chemicals — perceived in the industry as a successfully M&A that boosted the firm’s profits and expanded its business portfolio.

“However, the petrochemicals business is one that was abandoned by Samsung recently, because its vice chairman Lee Jae-yong saw it as a declining business,” Yun pointed out, questioning whether Shin is making the right bet on an industry that others have dismissed as unpromising.

The success of Korean petrochemicals firms largely hinge on China. However, the world’s second-largest economy has been increasingly driving up its own petrochemicals production capabilities, while cutting down its dependence on imports.

“The traditional chemical industry is dependent on economies of scale, meaning Lotte Chemical essentially cannot compete with their significantly larger Chinese counterparts,” Yoon said.

The same goes for Lotte’s retail sectors, particularly its duty-free business that is highly dependent on Chinese tourists to Korea.

As the Chinese government steps up its efforts to encourage domestic spending, the duty-free business may “lose its appeal.”

“Lotte may need to look into other niche markets to ensure sustainability in the long run.”

By Sohn Ji-young (jys@heraldcorp.com)