Lotte Group's credit rating hit by cash-strapped construction unit

A red traffic light stands in front of Lotte World Tower in Seoul in this 2016 file photo. Korea Times photo by Seo Jae-hoon

Lotte Group Chairman Shin Dong-bin / Courtesy of Lotte Group

Conglomerate fails to manage risks before $2 billion acquisition deal

By Park Jae-hyuk

A persistent liquidity crunch at Lotte Group's construction unit prompted Korea's fifth-largest conglomerate to pour over 1 trillion won ($750 million) into Lotte E&C over the past month, despite a worsening credit outlook for other affiliates.

In addition to fundraising from the group's affiliates and loans from banks, Lotte Group Chairman Shin Dong-bin's personal assets were even used to rescue the cash-strapped builder.

Builders and other businesses in Korea are having a tough time raising money by issuing debt after investor sentiment in the local bond market deteriorated recently due to a default in project financing to construct the Legoland Korea Resort in Gangwon Province. But the widespread dilemma has not shielded Lotte Group from being criticized for its poor risk management.

In November, Korea's three rating agencies lowered their credit outlooks for Lotte Chemical, Lotte Corp. and the group's other major affiliates to "negative" from "stable."

Their unusual moves came after concerns emerged over Lotte E&C's financial soundness amid Lotte Chemical's plan to acquire Iljin Materials for 2.7 trillion won. Lotte Chemical is the largest shareholder of Lotte E&C with a 43.8 percent stake.

Before Lotte E&C was rumored to be facing a setback in repaying its debts for project financing, Lotte Chemical was expected to endure financial difficulties caused by the large-size acquisition deal.

The chemical firm's credit outlook worsened due to the unexpected funding for the construction subsidiary.

"Lotte Chemical's funding for Lotte E&C will weigh on its financial stability," NICE Investors Service analyst Kim Sung-jin said. "Considering financial difficulties caused by its decision to acquire Iljin Materials, it is expected to continue suffering a capital shortage in the short- to medium-term."

Within the past month, Lotte E&C raised at least 1.1 trillion won from its affiliates, including Lotte Chemical, Lotte Fine Chemical, Lotte Home Shopping and Hotel Lotte, by borrowing money from them or selling its newly issued shares.

The Lotte Group chairman also bought some of Lotte E&C's newly issued shares for 1.1 billion won.

In addition, the builder decided to borrow 200 billion won from Hana Bank and 150 billion won from Standard Chartered Bank Korea. Lotte Property & Development promised to offer up to 420 billion won in financial support if Lotte E&C fails to repay its debts.

"Despite Lotte E&C's issuance of new shares and borrowing money from its affiliates and banks, there remain risks regarding its project financing," Samsung Securities analyst Cho Hyun-ryul said. "Considering the recent market conditions, it will take time for Lotte E&C to resolve uncertainties over its financial soundness."

Lotte E&C's contingent liability caused by project financing is much larger than those of its rivals, due to the company's aggressive attempts to win construction orders.

"Lotte E&C is facing the largest contingent liability caused by project financing, and it especially promised to refinance 4.3 trillion won, which is much larger than the size of refinancing promised by other builders," Korea Ratings analyst Kim Hyun said in September, warning about the risk.

According to Korea Investors Service, Lotte E&C has to repay 3.1 trillion won by the end of this year. However, the builder had only 700 billion won in cash or saleable assets as of September.

Efforts to reassure investors

Amid the intensifying criticism of its poor risk management, Lotte E&C eventually decided to replace CEO Ha Suk-joo with former Lotte Property & Development CEO Park Hyun-chul, who was recognized for the successful construction of Lotte World Tower.

Ha, who had led Lotte E&C over the past six years, was initially supposed to lead the company until March next year. Although the builder did not mention specific reasons for the outgoing CEO's resignation, he is said to have offered to resign to take responsibility for causing group-wide financial risks.

"The new CEO is expected to bring new waves to Lotte E&C, based on his capability in risk management and structural reforms," Lotte E&C said in a press release.

Lotte Group has also tried to dismiss concerns among investors about Lotte E&C's financial soundness, emphasizing that the group has enough cash.

"Although it is difficult to disclose its specific financial conditions, Lotte E&C has already resolved most of its risks," Lotte Chemical Senior Vice President Kim Yeon-seop told investors and analysts during a recent conference call on the company's paid-in capital increase.

However, Lotte E&C's liquidity crisis still appears to be affecting the business plans of the group's other affiliates.

Lotte Group has delayed its annual reshuffle of top executives by a couple of weeks to mid-December.

Industry officials are wondering whether or not the group will carry out a drastic reorganization, to downsize its workforce and reprimand executives responsible for the Lotte E&C crisis.

Including Lotte Chemical CEO Kim Gyo-hyun, most chief executives of the group's key affiliates need approval from each of their company's boards of directors, if they want to serve another term as a CEO after March next year.