Activist fund Quad Asset Management has called on Daeyang Electric to buy back and cancel 30 billion won ($21.6 million) of its own shares over the next three years and to raise its dividend payout ratio above 30%. After raising concerns last year about transactions with a related party, the fund is now pressing the company to deploy its excessive cash holdings for shareholder returns and improve capital efficiency.
Quad Asset Management sent a second open letter to Daeyang Electric's board titled "Proposal for a Mid- to Long-Term Shareholder Return Policy to Enhance Corporate Value" and asked for a response by Oct. 16, according to investment banking sources on the 29th. In its first open letter in November last year, the fund demanded that the company resolve related-party transactions by acquiring and merging with affiliate Daeyang Jeonjang and raise its total shareholder return ratio above 50%. Daeyang Electric later disclosed a plan to acquire a stake in Daeyang Jeonjang in January.
The latest letter escalates the fund's demands from "normalizing profits" to "normalizing capital allocation." Quad Asset Management said Daeyang Electric held 122.7 billion won in cash and financial assets as of the end of the second quarter, equal to about 44% of total equity and roughly 70% of its market value as of the previous day. Its price-to-book ratio, meanwhile, stands at just 0.6. The fund said the excessive buildup of non-operating assets is depressing return on equity and leading to a discount in the company's valuation.
Daeyang Electric posted record results last year, with revenue of 230.1 billion won, operating profit of 27.1 billion won and net profit of 24.8 billion won. In the first half of this year, it recorded revenue of 121.7 billion won, operating profit of 13.8 billion won and net profit of 14.9 billion won. Yet its return on equity fell to 9.6% last year from 13.1% in 2011. Over the same period net profit rose 2.4-fold, but the earnings were not returned to shareholders and instead accumulated as equity, according to the fund's analysis.
Quad Asset Management proposed that Daeyang Electric target a price-to-book ratio of 1.5 and buy back and cancel 10 billion won of shares each year for the next three years, for a total of 30 billion won. If the ratio exceeds the target, however, the buyback and cancellation for that quarter would be suspended. The fund also called on the company to raise its payout ratio above 30% this year and to 40% over the longer term, and to adopt a policy of paying a minimum dividend of 500 won per share regardless of earnings swings.
Quad Asset Management analyzed 4,508 share buybacks by listed Korean companies from August 2016 through August this year. Where the buyback exceeded 5% of market value, shares rose an average of 22.8% during the buyback period, outperforming the market index by 10.4 percentage points. Cumulative returns reached 37.1% through six months after the buyback ended, beating the index by 16.3 percentage points, showing that larger buybacks produced stronger share price gains.
The fund again questioned the effectiveness of the company's audit function. Quad Asset Management said it had requested access to and copies of board minutes on past transactions with Daeyang Jeonjang but had not yet received them. It also said it appeared that the largest shareholder, who should have been barred from voting on the matter due to a conflict of interest, nonetheless cast a vote on the agenda item setting the cap on director compensation at this year's annual shareholders meeting. "The audit function has failed to work as a substantive check on directors' execution of their duties," the fund said. "We believe a more active role is needed."
