Korea Inc.'s emerging champion

By Peter S. Kim

Last month, Korean investors rushed to join the IPO subscription for LG Energy Solution (LGES) depositing more than $13 trillion into brokerage accounts, the largest IPO in Korea's history by far. Since its listing, LGES is already the second-largest stock listed on South Korea's main bourse, the KOSPI, after jumping 100 percent on the first day of its listing at one point.

The performance by LGES was especially impressive considering the recent market volatility over the inflation fears sweeping the world. At the U.S. central bank, the Federal Reserve, the Federal Open Market Committee (FOMC), signaled its hawkish swing by communicating four interest rate increases this year, spooking global markets. It would seem that the "central bank put," used to describe the unlimited monetary stimulus that drove stock markets worldwide is coming to an end, at least for now.

LGES management intends to use the funds raised from the IPO for capacity expansions to fuel future growth. LGES is one of the leading battery makers globally, supplying to a growing population of electric vehicle (EV) makers led by Tesla of the U.S.

Contemporary Amperex Technology Co. (CATL) of China is the largest battery maker in the world, followed by LGES and Panasonic of Japan. For many decades, the Japanese were considered the leading nation for battery technology.

However, China's advance into batteries within a relatively short time is an example of how quickly the technology landscape is shifting, even for those with decades of experience. Fortunately for Korea, companies like LGES, Samsung SDI and SK Innovation have managed to keep pace with the fast-moving EV battery industry.

LGES is fast catching up to CATL's 30-percent global market share with its current market share of 20 percent. Despite the global growth concerns, CATL has seen a massive rally, despite the challenges from the U.S.-China standoff and President Xi Jinping's scrutiny of its national champions under the "common prosperity" campaign.

CATL's share price has risen by more than ten times since 2018, aided by China being the largest market for EV batteries. CATL has the dominant position in mainland China with its 50-percent market share, which allows it to create pricing power unmatched by its competition. CATL has also benefitted from the lack of opportunities for investors to get exposure to the hot EV theme.

Given the likely continuation of the US-China standoff, LGES could serve as an investment alternative to CATL. LGES is confident of its future growth prospects, with its partnerships and customer base spreading globally. LGES customers include Tesla and Volkswagen, which ― combined ― take up almost 50 percent of sales.

More important is its partnerships with global companies via collaboration on R&D for next-generation technology. However, for LGES to narrow the gap with CATL in terms of market share and brand value, LGES will have to prove itself on many fronts, including innovation, business execution, pricing power and investor relations.

The EV battery industry has many parallels with the semiconductor industry. In the 1990s, memory chips were dominated by the U.S., Japan and Taiwan. However, the highly cyclical nature of the memory chip business meant that prices fell below the break-even point every few years. A company or two would exit or go bankrupt with each downturn, allowing the remaining survivors to grow stronger. Even SK Hynix of Korea went into receivership, falling into the hands of the current SK group.

Its sprawling chaebol structure allowing for affiliates of the group to subsidize struggling businesses over many cycles has enabled Samsung Electronics to withstand many tough cycles and eventually achieve its current dominance. The memory chip industry now has four companies left surviving, with Korean makers Samsung Electronics and SK Hynix taking up over 70 percent of the global market share.

EV batteries have similarities with memory chips in that they require intensive investments, especially during the early stages. Much like memory chips during their early years, survivors are likely to be from companies with deep financial resources and commitment to the long term. LGES and other Korean EV battery makers like Samsung SDI and SK Innovation will have to prove to investors their resolve in tackling intense competition over many cycles to achieve long-term viability. Such a "do or die" mentality is precisely the strategy undertaken by government-backed companies from China.

For investors, LGES as a rare large-cap play in EV batteries makes it a compelling proxy for the growth theme. Listing a company with lofty valuations at a time when growth stocks are taking a beating would seem a questionable judgment or just lousy luck. However, LGES has many positives to indicate it could weather the current inflation scare. First, LGES offers a rare large-cap pure play in the EV battery sector, making it an essential exposure for passive and active funds.

With its only comparable pure-play being the CATL of China, it stands to benefit from the U.S.-China standoff.

Secondly, the ESG movement will be an intangible positive, continuing to provide LGES with an argument for premium over other manufacturing companies under attack from the intensifying ESG movement.

Finally, the Korean retail investors' irrepressible appetite for growth themes should give strong support for the stock regardless of its high valuations.

With Korea transitioning from its traditional industries like machinery, shipbuilding and chemicals, new industries with bright prospects over the long term, like EV batteries, will not have a shortage of suitors at home and abroad, very much like Samsung Electronics in semiconductors many decades ago.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.