When you go to SK Corp's 8.2 million square metre refinery complex in Ulsan, it is difficult to escape being awed by its size. Apparently, there is a refinery in Venezuela that is a little bigger, but it doesn't reside in a single location (it is really two sites connected by a 40 mile pipeline, an SK official notes).

Indeed, visitors to Ulsan quickly learn they are at the world's biggest oil refinery ‘in a single location'. And to help grasp the sheer magnitude of the plant's size and scope there is a special room where a giant model of the Ulsan Complex raises from the ground - think early Connery Bond films. A video presentation informs you that the complex has 92 state-of-the-art automated production lines, eight built-in piers, receives over 60 different types of crude oil, has a capacity of 840,000 barrels a day, and even has the world's largest underground LPG storage facility.

Having softened you up with the numbers, the video presentation continues: "Ulsan Complex is one of the world's greatest integrated petrochemical complexes… It belongs to the people that challenge the course of history… A company that represents Korea… SK Corp will now rise to the top of the world."

But who exactly this petrochemical gem "belongs to" has become a source of dispute between the two biggest shareholders. SK's slogan may be "SK - OK!" but things are definitely not OK.

One of these shareholders is very visible at the Ulsan Complex. A photograph of Chey Tae-won, whose family built the SK chaebol, is hung outside the plant's control room. He is pictured with the workers, wearing one of the plant's standard denim jerkins, his fist clenched and raised in the defiant Korean fashion.

The other shareholder, Sovereign Asset Management - a private investment vehicle controlled by New Zealand's Chandler brothers - is less visible at the plant itself. But its visibility in the media, via a barrage of press releases, has been equally defiant - routinely criticizing Chey and his fitness to run SK Corp.

Sovereign owns 14.96% of SK Corp, having purchased the stock in April 2003 at an average price of W9,293 per share. To date it has made about $1 billion in (unrealized) capital gains on its investment, plus at the end of January it was paid $34 million in dividends.

With that in mind, one might reasonably ask what does Sovereign have to complain about? Indeed, SK Corp announced in January that it made W1.6 trillion in operating profit in 2004, an increase of 141% - the highest in its 42 year history, and marking the first time a Korean energy company had crossed W1 trillion in profit. Its dividend was also the highest in the company's history.

Chey, who is Chairman and CEO, announced: "This record achievement has been produced through our continuing efforts to restructure SK into a more profitable, efficient and internationally-focused operation committed to growth for all shareholders."

Sovereign's CFO, James Fitter begs to differ: "The headline results look impressive, although it's fair to say that the results coincided with a period of unprecedented highs in refining margins - so shareholders would have been very disappointed if this had not been a record."

He adds: "The way we look at it, and the big issue we have, is that the market is not prepared to rate this company alongside its peer group. Why is it the market is only prepared to pay 4.5 times earnings for SK's results when it is prepared to pay double digit multiples for other peoples? We would all agree that corporate governance and valuation are all tied together with trust. One investment bank has ascribed a valuation to SK Corp that would be 32% higher if the management were changed."

Sovereign's favourite comparable is S-Oil, a Korean company in the same sector. S-Oil's full year profit was W941 billion, versus W1.6 trillion for SK. Yet SK's market cap in mid-February was W7.2 trillion versus W7.4 trillion for S-Oil. Fitter asks why a company in the same sector which makes only 59% of the profit of SK Corp has a higher market value?

Katherine Kho, a senior manager in SK's investor relations departments comments, "We can't really discuss the valuations of other companies. But some investors have commented to us about our share price that there does seem to be an overhang issue, because Sovereign owns a big chunk and no one doubts that sooner or later they will sell out of their position. There is concern that when Sovereign sells out it will negatively affect the share price. That seems to be the concern some of our potential investors have expressed."

Here are two utterly divergent explanations of why SK Corp's stock trades so cheaply. According to Sovereign the stock is underperforming its peers because of the management. According to the management it is underperforming because of Sovereign. Which is right?

Family problems

Sovereign promotes itself as a champion of corporate governance. It believes it has a roadmap which - if followed - would see SK Corp trade in line with its sectoral comparables. That roadmap, however, does not include a place for the Chey family. At the AGM today it is seeking to oust Chey Tae-won as Chairman, by opposing his re-election to the board.

Chey spent eight months in jail for his part in the SK Global bankruptcy. Fitter notes that Chey was also convicted in a US court in 1993 for depositing $200,000 illegally in a bank account. Says Fitter: "Sovereign has a hard time thinking someone who has been convicted in two different jurisdictions on two different charges, can properly be considered a fit and proper person to be a director of a major multinational corporation."

He adds: "The key issue for us is this notion that in Korea we have a different set of standards for executive directors and outside directors. You cannot be an outside director if you have a criminal conviction. But you are allowed to be an executive director. That just doesn't pass the common sense test. Executive directors have access to cashflows. It doesn't make a lot of sense. From our perspective it is very difficult to fathom how anyone who has been convicted of defrauding his own shareholders, should be considered a fit and proper person to perform a stewardship function, let alone have access to cashflows."

Chey's supporters riposte that his case is under appeal, and that prosecutors have found no evidence that he made any personal gain from the SK Global fraud. Indeed, as will be shortly explained, the Chey camp characterize his involvement in the debacle as an inherited problem rather than one of his making. As for the 1993 conviction, it is explained by those close to Chey as the result of error not intent. The money that was deposited was a wedding gift and it was thanks to his inexperience that he didn't file the correct forms. (The $200,000 was confiscated by the US government, but there was no prison sentence.)

SK's management - which very firmly supports Chey - has become more proactive in its IR efforts in recent months. To combat Sovereign's successful PR strategy, the management has organized a series of investor roadshows to communicate its side of the debate.

The central point the management wants to stress is that SK Corp has made dramatic improvements in its corporate governance. Indeed, the company has arguably instituted the most sweeping corporate governance reforms of any Korean company.

A new board was elected last March, with seven out of 10 board members deemed ‘independent' or ‘outside directors'. These seven were selected from an initial pool of 500 nominated names and include some of the most respected individuals in Korea. Outside director Cho Soon, for example, is a former Governor of the Bank of Korea, and was the first Mayor of Seoul. SK's head of investor relations, Lee Seong-Hoon stresses his nickname in Korea is "Mr Integrity". Lee also cites the good reputation of Suh Yoon-suk - he chairs the Accounting Standards Association of Korea and is also an independent director of POSCO.

The board meets every fourth Thursday, and the attendance rate of outside directors has been 96%. Each independent director has an office at SK's headquarters in Seoul and there is even an Office of the Board of Directors that caters to their secretarial needs. They are distributed with materials five days prior to board meetings - a big improvement over many other major Korean corporates which give materials out just the day before. These extra days give the independent directors more time to fully master their brief and take a view.

"All the board meetings are being recorded and documented," says IR head, Lee, "and so if anything goes wrong [in the future] they might be taken to court."

The board has already overruled management proposals twice. On the first occasion a sales and leaseback programme proposed by the finance department was vetoed - since the board's accounting expert, Suh recognized that while it would be helpful in debt reduction it would negatively impact earnings. On the second occasion the management's choice of an outside consulting firm - to work with the audit committee - was rejected. The board insisted on holding its own beauty parade, and eventually selected KPMG.

Most critically - especially since SK Corp is at the core of a chaebol - any related party transactions worth more than $10 million (ie loans or asset sales) must get majority board approval. This means that the independent directors have the power to block any dealings with other parts of the SK Group.

These are all substantial changes. "We are now living in a new paradigm," says IR head, Lee. In fact, Lee is a former head of equity research at UBS and admits it will take a while to change perceptions of the company's commitment to good corporate governance.

Nam Dae-woo holds a fairly unique status on the board. That's because his name was put forward for election last March by both Sovereign and SK's nomination committee. A former chairman of the Shinbo Investment Corp and head of the National Investment and Treasury Management Division of the MOF (responsible for assets such as POSCO), the 66 year old is considered a model of probity. Given he was nominated by both sides, his views carry added weight.

In an interview with FinanceAsia Nam explained the weight of responsibility he feels. "All the discussion of the board meeting's agenda are fully reflected in the minutes," says Nam. "That's important, because it makes us more responsible, and it also means we will come prepared."

He points over to the wall where a five-point "Code of Conduct of Outside Directors" is hung. This notes that the board of directors is the "ultimate decision-making body of SK Corp" and that its goal is the "maximization of corporate value through transparent management."

Nam notes that an important measure of independence is the conduct of board meetings themselves. He says he has been pleased by how free the discussion in the board is. "In the past months I feel the discussions have been very active, especially among the outside directors. I have also noted that Chairman Chey has been selective with his words, and really supportive of the free discussion. Mr Chey is no more than one voice on the board."

He says the new board has worked hard and he finds himself in his SK office several days a week.

Nam feels there is a higher goal behind what he and the other independent directors are trying to achieve. "If this board succeeds then it could become a role model for other Korean corporations," he says.

New SK

The company, which in almost Blairish fashion refers to itself as New SK, has been correcting many of its past mistakes. It has reduced its net debt from W8 trillion in 2000 to W4.9 trillion in 2004. The net debt to equity ratio has come down from 133% in 2001 to 72% - and the company estimates it will be 62% in 2005 as it pays down more debt. In December, Moody's even upgraded SK Corp's Ba2 long term rating to positive (from stable) on the basis of "1) the continued strengthening in SK Corp's operating fundamentals 2) progress made on reducing financial leverage 3) signs of ongoing improvements in corporate governance practices."

Meanwhile the company has made strides in improving shareholder value. For example, SK Corp's return on equity has gone up from 1.6% in 2001 to 24.1% in 2004. In 2001 the company - whose core activity is oil refining - was EVA destructive to the tune of W575 billion. In 2004 it created positive EVA of W725 billion.

All good stuff, but inevitably the discussion must return to Chairman Chey himself. For while the company has unquestionably made progress on a number of fronts, there is still the problem of his role in SK Global's massive W5 trillion accounting fraud.

Investor relation's boss, Lee portrays Chey - who graduated in economics from the University of Chicago - as a man who inherited a bad legacy and has been trying to mend it ever since.

"The Sovereign guys say several trillion is missing and Chairman Chey is guilty of accounting fraud," says Lee. "That's not true at all. Chey never created the accounting problem. It came from problems created in the mid-70s through to the mid-90s. SK Global was a trading company that followed the old Korean industrial policy during this period and its overseas projects failed. All the projects were done based on high leverage and the interest burden increased in the wake of the Asian financial crisis. The won moved from 700 to 1500 to the dollar, and the burden increased to W5 trillion. Chairman Chey's father passed away in August 1998 and Chey took over in September. But prior to his taking charge SK Global was already sitting on these problems."

He adds: "There is a major difference between SK Global's accounting problems and Worldcom/ Enron's accounting problems. Even the Korean prosecutor's office - after very thorough investigations - could not prove there was any embezzlement by Chairman Chey." And as previously stated, an appeal is underway. If successful - and according to the Korean practice - his criminal record will be expunged.

Lee says Chey spent the first couple of years of his tenure trying to find a way to plug the SK Global problem "that he inherited". Says Lee: "He wanted to resolve the problem between 1999 and 2001 by selling a stake in SK Telecom to NTT DoCoMo. At the time SK Telecom's stock traded at W500,000 [per share]. The deal would have raised more than enough to clean up the problems at SK Global."

This would, of course, have been a very chaebol solution to a very chaebol-created problem. However, it never materialized. A mixture of government regulatory intervention in the telecom sector and DoCoMo's decision to curb its (mostly disastrous) foreign M&A activity, scuppered the deal.

The lid could not be kept on the SK Global problem indefinitely and when it blew up, it created a massive scandal that had wider ramifications for Korea inc and its banking sector. After an independent audit of SK Global by Samil (affiliated to PricewaterhouseCoopers), the lead creditor bank, Hana organized a restructuring and a workout. A new entity was created out of the ashes of SK Global called SK Networks and through a debt-equity swap the creditor banks took joint ownership of it with SK Corp (which owns 41%).

SK Networks lost W4.4 trillion in 2002, but returned to profitability in 2004 (it made W421 billion), and SK Corp's IR department forecasts it could graduate from its workout programme ahead of the 2007 timetable. The company's core asset is its 3,700 petrol stations in Korea - indeed, it was the need for SK Corp to retain control of this distribution network (for the petrol it refined) that necessitated its participation in the SK Global/Networks bailout.

But SK Networks was not the only bailout. SK Corp also had to step in to rescue SK Shipping for similarly strategic reasons (Korea imports all of its oil and gas, and so ships are required). SK Shipping also returned to profitability in 2004, after three straight years of losses. SK Corp owns 72% of SK Shipping.

It is a fact therefore that Chey has bailed out two affiliates during his period in charge. This is obviously one of the chief reasons his leadership has been criticised. But head of IR, Lee says Chey remains the right man to run SK Corp, and points to his oft-neglected achievements.

"The Sovereign guys always try and say Chairman Chey has done nothing and just sits there," he says. "But that is not true. Basically one of the reasons we had such a record profit last year is because we have strengthened our exploration business. We purchased stakes in three different oil and gas blocks after September 1998. All these purchases were made under his leadership. And one of the key things behind the rising share price last year was this, because we started production in some of these blocks in July and August 2004."

SK Corp operates oil and gas E&P (exploration and production) in 12 countries and has 300 million barrels per day of oil equivalent reserves. The E&P business currently accounts for about 10% of profits, but Lee is correct to identify it as one of the company's key growth drivers. "And it is Chairman Chey that has driven our E&P business's growth," he stresses.

Chey controls 15.6% of SK Corp's stock through a personal stake of 1.4% and via other SK Group companies. Foreign investors hold 57% of SK Corp stock.

SK Corp's management say this sizeable foreign equity presence is a vindication of its efforts to reform and restructure the business. Another ‘vindication', argues the management, was recent piece of equity research by Merrill Lynch. Published on March 9, it states: "We believe there is a huge gap between perception and reality. We rate the SK Corp board of directors as among Korea's best in terms of influence and independence."

With a current price of W62,500 Merrill rates SK Corp a "buy" with a 12 month price target of W80,000 based on an NAV of W107,000 per share. Merrill's report notes: "SK Corp is probably the most misunderstood stock in Asia, owing to the offhanded, sensation-seeking media coverage on the conflicts between CEO Chey and its vocal shareholder, Sovereign."

It adds: "SK Corp topped its peers in deleveraging and in its dividend hike (from W750 to W1,800). It is the only Korean refinery posting monthly turnover in detail… Governance risk? What governance risk?"

SK and Sovereign's troubled history

Sovereign invested in SK Corp in April 2003 and by November had made clear that it wanted to change the companies articles of incorporation and install new directors. At last year's AGM it failed to obtain the requisite two thirds majority required to change the articles - the main purpose of which was to prevent convicted criminals from sitting on the board as executive directors (such as Chey).

Sovereign obtained a majority at the AGM - indicating that many shareholders agreed with its position and were keen on the corporate governance initiatives it was pushing for.

The Dubai-based vehicle - which was relatively unknown in Asia before it invested in SK Corp - then found itself in a quandary about its next move. Korean law states that any item put forward at an AGM - but not carried - cannot then be put forward again for three years. It was in no mood to wait three years.

Its lawyers, however, discovered that the law said nothing about putting forward the same item at an extraordinary general meeting. Since Sovereign owned more than 5% of the company it had the legal right to request an EGM, and formally requested one last October.

In a move that Sovereign regarded as an affront to its rights, the SK Corp board voted unanimously against the EGM on the basis that it would involve " unnecessary time and energy."

Sovereign then filed an appeal with the Seoul Central District Court seeking an EGM. In December the court rejected Sovereign's case - and Sovereign put out a press release saying it would appeal at a higher court (this is still pending). Meanwhile it has shifted its attention to the AGM and the possibility of ousting Chey from the board.

The decision is in the balance.

Counting the chads

Ahead of the vote, a number of influential bodies have made their voting preference clear.

Korea's National Pension Corporation has stated it will vote its 3.07% with management on the basis that SK Corp had reformed its corporate governance and improved shareholder value. Meanwhile Korea's Centre for Good Corporate Governance announced its support for ousting Chey as a director. Institutional Shareholder Services, based in the US, likewise advised shareholders to vote to oust Chey, stating: "ISS believes that the charges of which Mr Chey were convicted raise serious doubts about his fitness to serve on the board of a publicly-traded company." (In many other jurisdictions, for example Singapore, Chey would be legally forbidden from serving on the board as a result of his current conviction.)

Should Chey fail to get re-elected to the board he would remain as CEO, but would automatically cease to be Chairman.

"We haven't found any other shareholders, Korean or foreign, who actually think having convicted criminals running the company is a good thing," says Sovereign's CFO, James Fitter.

Fitter is optimistic that the AGM vote will go against Chey, although he concedes "it's neck and neck". At last year's AGM, 43% of the stock was held by foreign investors versus 57% this time - meaning foreigners will decide the outcome.

In spite of his optimism, Fitter fears the Korean establishment has "ganged-up" on Sovereign and rallied around Chey out of fear of change. "If we are successful," he says, "the whole system will be held to account. The issue here is the precedent. We are really challenging the whole fabric of Korean corporate society. According to our analysis, there are 20 convicted criminals sitting on the board of major public companies in Korea." (Most have been convicted of making political bribes.)

Incredibly enough, Fitter claims Sovereign almost couldn't vote in the AGM due what he terms ‘anti-Sovereign' legislation that was rushed through parliament in December. A new law was passed that required investors who own more than 5% to state their investment purpose. The act of refiling would mean Sovereign's voting rights would be suspended for 5 days (after filing). "What was quirky," comments Fitter, "was that the legislation was due to be enacted 70 days after it was signed which just happened to coincide with March 11, ie right in the middle of the AGM season. We would have been ineligible to vote our shares."

In the end this didn't happen. "They didn't count on the fact that they had to get the President's signature and he didn't sign it until 17 days after. So as it happens it won't influence this AGM."

Fitter points out that the share register (ie who gets to vote) is determined by scrip holdings as of December 31. "One of the interesting issues in the run-up to Christmas," says Fitter, "is that both Pantech and Curitel, who are one of SK Telecom's leading handset suppliers, and Samsung Electronics took it upon themselves to buy some shares in SK Corp. Pantech and Curitel committed over 50% of their shareholder's equity to buy shares in SK Corp. One has to ask what prompted these publicly-listed companies to do this? SK Corp is the single largest shareholder in SK Telecom with a 21% stake. It concerns us greatly that these guys think it will be good for their business relationship with SK Telecom to buy shares in SK Corp."

Fitter says that this is not the only transaction that troubles him. "SK Construction sold its 3.4% stake in the lead up to the record date (December 31) via a convertible note structure that was parked with hedge funds. The voting rights were separated from those shares and parked in trust with the KITC."

He believes the KITC will vote for Chey.

SK Corp's investor relations department says it knows nothing of this transaction, and adds that the company had no influence on Pantech, Curitel and Samsung Electronic's decision to buy SK Corp stock. It regards this suggestions by Sovereign as a "conspiracy theory".

Saving Seoul's soul

Fitter sees this as more than just an investment. It's about changing Korea inc for the better: "We've put three years of very hard work into this and the more we learn about Korea the more we are motivated to catalyse the debate about what is right and what is wrong. We can't find any other country in the world, where there are so many world class companies trading on single digit PE multiples.

"People say foreign ownership is at record highs so it can't be that bad. We look at it and say, Korean ownership is at record lows - why are Koreans so afraid to own shares in their own public companies? We contend that they understand that being a minority in a chaebol is not a good place to be."

However, Sovereign has made it clear that it supports good Korean managements. In late February it invested W1 trillion in LG Corp and LG Investments, praising the company's management, its transparency and its move to a holding company structure. In its statement to the press it noted: "Our involvement [in Korea] has allowed us to better understand and identify those companies that are committed to reform and those that pay lip service to a reform agenda - governance separates great companies from the mediocre. LG is a great company and a role model for corporate Korea." Sovereign bought 6% of both LG companies and stated it had no intention to nominate directors, or amend articles of incorporation and gave its support to existing management.

The whole exercise was - probably by design - the diametrical opposite of its acrimonious relationship with SK. Sovereign also launched a multi-million dollar advertising campaign in Korea to convey its philosophies on corporate governance entitled "Stand up! Korea".

Chey's date with destiny

On the subject of Chey himself Sovereign's position has remained resolute throughout: "This issue that he inherited his problems is really troubling to us because there seems to be a pattern of behaviour over a long period of time that doesn't give us a lot of confidence. Is this gentleman the best candidate to run this business? It's a question of ethics and confidence in our view."

On the subject of the corporate governance improvements and the new board, Fitter notes: "They have set up a lot of committees and they meet on a regular basis. The question is: do they have teeth?"

Fitter says the new board did not respond to a letter that it sent last March, which raised nine issues that it viewed as critical. "After seven months of waiting we did not receive a satisfactory answer, which is why we decided to call an EGM."

However, independent director, Nam says that the outside directors of the board offered to fly to Dubai in September and discuss some of the corporate governance issues with Sovereign. Fitter admits the offer was made, and declined by Sovereign - because it had decided to call an EGM and thought the Dubai meeting would be a waste of time.

What is clear is that both sides have built strong cases and after taking a beating from the Sovereign PR machine, SK's management has come out fighting. Investor relations boss, Lee is as forthright as Fitter. "In fact, a lot of foreign investors are upset by Sovereign's attitude - because they are attacking a company they chose to invest in. Sovereign is hurting the value of the company through its behaviour."

The vote today will determine who has the better handle on what "foreign investors" really think.


The result of the vote (article update)

Chey was re-elected to a three year term with 55.3% of the vote.