Ssangyong had an active portfolio of projects from power plants and oil refineries to highways and hydroelectric dams and was booking revenues in the billions of dollars. It was the same for peers Samsung Engineering and GS Engineering, which had focused on winning bids internationally, with a particular focus – in hindsight, disastrously – on the Middle East.
Then things began to go wrong for Ssangyong in 2013 along with the rest of the South Korean construction industry. Cut-throat price competition in the bidding process pushed down margins, as did the engagement of these companies in projects where they lacked crucial experience, leading to cost overruns, particularly in the construction of Middle East hydrocarbon power plants.
in essence, the South Korean Middle East construction bonanza was based on offering low fees, greater flexibility than proffered by foreign competitors, and a willingness to engage in risky fixed-price EPC business.
For example, in 2009 SK Engineering & Construction won the bid to install compression chambers at the Adco oil field in Abu Dhabi, undercutting the bid of the lowest competitor by US$100m. The final US$800m fixed-price contract produced shock-waves among the international construction and engineering community.
But the hubris that South Korean EPC contractors had shown in 2008 and 2009 cracked when their aggressive pricing and calculated risk-taking backfired. Big hits on offshore projects caused these firms to post operating losses in 2013 and despite optimism that once these low margin projects had been completed the South Korean construction industry would move back into the black, it has yet to turn the corner.
In April, Moody’s affiliate Korean Investors Service cut the ratings of GS Engineering & Construction, KCC Engineering & Construction and Hansin Engineering & Construction.
The one notch downgrades came alongside a move to negative outlook on Samsung Engineering and on SK Engineering & Construction, with the ratings agency citing their sluggish overseas portfolios as well as a moribund domestic market.
There were also some regional idiosyncratic factors that soured the portfolios of some South Korean construction firms. For example, Daelim, which reported a US$205m operating loss in the final quarter of 2014 (adding to the US$296m loss it made in the same period the year before and contributing to a US$250m annual operating loss for 2014), blamed strict labour regulations in Saudi Arabia for losses on four construction projects.
The company said in a statement: “The Saudi government’s workforce localisation policy, which encourages foreign firms to hire more local workers had a major impact on Korean builders’ performance.” It referred to a lack of local skilled manpower, an increased cost of labour, construction delays, reduced productivity and construction defects as all contributing to its losses on these projects.
In all this, the South Korean government must take part of the blame. It set a target for the country’s construction industry in 2009 of US$40bn in global construction orders, with barely half that total reached, as a string of Middle East sponsors cancelled planned projects, most notably the Kuwait Al-Zour refinery, which was earmarked at around US$15bn.
“The gung-ho ambitions of the South Korean government undoubtedly contributed to what may best be described as a reckless bidding policy, which the South Korean construction industry is paying for to this day,” said a Singapore-based debt restructuring adviser.
Another factor that came into play in the bidding frenzy was the strengthening South Korean won, which allowed bidders to lock in fixed contract prices and then see considerable cost savings made as the won appreciated during the procurement and construction period.
Of course, the opposite has proved true, to the detriment of South Korean construction companies, as the “Abenomics” policy of Japanese prime minister Shinzo Abe and its central plank of yen depreciation has prompted a round of competitive currency devaluations in Asia from which the South Korean won has not been spared.
The won has depreciated to 1.19 to the US dollar from around the 1.09 mark at the end of 2014 and following interest rate cuts by the Bank of Korea is expected to depreciate further over the next few years as competitive devaluation continues to be an explicit BoK policy. This puts strain on capex for project contractors and constrains margins.
But the blame for the problems of South Korean contractors is not just to be laid at the door of their foreign endeavours. A protracted slump in the domestic property market has sapped resources at home, leading to a double whammy for the industry.
Reduced orders on the back of South Korea’s property market downturn prompted a severe cash crunch in early 2013 and as a result a staggering 21 construction companies have been undergoing debt workouts or placed under court receivership.
Many names in the industry have been unable to raise funds in the domestic bond market due to a slump in sentiment following the heavy losses announced at the end of 2013 by Samsung and Daewoo Engineering.
And the once swaggering Ssangyong filed for bankruptcy protection in Seoul in December 2013, although the company continued to operate after its creditors decided, having conducted credit risk evaluations on its subcontractors and suppliers, that the company did not warrant winding up.
Ssangyong’s bankruptcy underlined the severe stress that South Korea’s construction industry is undergoing, although following proactive steps by the country’s Financial Supervisory Service to examine the creditworthiness of Ssangyong’s subcontractors the company continued to operate as normal.
It won three public works projects, including a highway connecting Miryang in the province of Gyeongsang with industrial hub Ulsan while bankruptcy proceedings were ongoing under the supervision of the Seoul courts. And none of the company’s 18 overseas construction projects were halted as a result of the bankruptcy.
Nevertheless, in the face of severe liquidity problems, the company was in January sold to sovereign wealth fund the Investment Corporation of Dubai.
ICD was reported to regard Ssangyong as a suitable investment given the fund’s ambitions to expand its portfolio beyond the US and Europe and into Asia. In turn, Ssangyong is hoping that its new ownership will give it access to building projects sponsored by ICD, including work on construction for the planned 2020 Dubai Expo.
Meanwhile, Dongbu Engineering & Construction filed for court receivership in January, in a move that underlined to many South Korea watchers the sense of urgency that problems in the construction industry have brought to bear on the country’s big conglomerates or chaebol.
“There is a sense of crisis in the big conglomerates, a fear of losing competitiveness to rival companies from China, and therefore there is a need to restructure and change focus. In many ways, what is happening now is reminiscent of the Asian financial crisis of the late 1990s, which hit South Korea particularly harshly, and the memories remain,” said a Hong Kong-based loan banker.
As a result, there is a wave of consolidation under way in South Korea, with some key chaebol having moved to merge their construction affiliates in a bid to rationalise their businesses. For example, South Korea’s second largest chaebol Hyundai Motor last year merged its construction affiliate Hyundai Amco with Hyundai Engineering.
Samsung, South Korea’s largest chaebol, successfully merged Samsung Construction & Trading with the chaebol’s holding company Cheil Industries in June after vocal opposition from shareholders, principally US hedge fund Elliott Associates.
It might just be that the worst is over for the South Korean construction industry and observers point to a number of factors that give cause for optimism.
The domestic residential segment has probably hit the bottom and various government initiatives to kick-start the sector beyond reducing short-term interest rates, such as increasing the loan-to-value and debt-to-income ratios for mortgage borrowers, are expected to be effective.
And the country’s energy and utilities construction sector is expected to benefit from the South Korean government’s aim of doubling its nuclear power generation capacity by 2030. Two reactors with a projected contract value of US$14bn and a combined 1,400MW capacity have been approved for construction.
Perhaps the broader picture is that the government is now committed to acting on the lessons that the country learned from its painful forays into the international construction markets. In late 2013 a “U-Turn Company Support Law” was approved.
This enables construction and manufacturing companies to claim subsidies and various incentives in the purchase of land and equipment in a bid to bring back the focus of the country’s industrial base to domestic shores.
“The South Korean construction sector got stung on its foreign adventures and the government has taken this experience to heart. The turnaround might be slow, but once the debt workouts and corporate rationalisation have taken place, you would have to imagine that with full government support, the sector can look forward to brighter times,” said the Hong Kong loan banker
