Korean Securities Industry at Cross-Road
The Korean securities industry is at a crossroads where the signs to profitable growth are as confusing as Seoul's street signs. Here, choosing the path of continuing business as it is will lead straight to a dead end while growth through consolidation and eventual alignment with other financial services will be the only road to the highway.
A bumpy ride getting bumpier
The Korean securities industry is at a critical time where hard decisions need to be made and soon. Despite Korea's explosive online trading which surpasses all other countries in terms of percentage of total transactions, the commissions on these trades are at an all-time low and currently average a loss of 28 won for every 1000 won trade within the industry.
Exacerbating this is the industry's over-dependence on these brokerage commissions as their main source of revenue, primarily due to unprofitable attempts through other revenue channels such as securities and futures trading, IPO underwriting, and valuation of securities, in comparison to their foreign counterparts.
Currently, all Korean securities firms show return on equity (ROE) figures below the industry average cost of equity. Essentially, this means that the securities industry is destroying shareholder value and is unable to meet the minimum hurdle rate that is essential for continuous growth and profitability.
This hurdle rate, once calculated, comes out to be roughly 14.4 percent for the industry, meaning that all shareholders should receive at least this return rate from their investment based on the risk they are taking.
Shareholders should clearly understand what this means. On average, the shareholders of the top four Korean securities companies are receiving only 68 won for every 1000 won they have invested -- far shy of the 144 won they should be getting.
Although performance during the past three years has been up and down for most firms, a few conclusions for future profitability can be made from recent financial numbers and industry trends.
First, such heavy reliance on brokerage commissions in this new era of online brokerage is risky and even unprofitable without scale. Second, trading revenue is highly risky without higher quality research capabilities and even riskier in the Korean stock exchange. Lastly, the skills needed to generate revenue from alternative sources such as IPO underwriting or asset management must be built or acquired.
The explosion of online trading in Korea and the subsequent competition in this arena has given consumers the benefit of lower brokerage fees but increased the burden of information technology (IT) investments on all securities companies. Moreover, enhanced research quality as well as effective marketing and branding to distinguish oneself from the rest of the pack will be crucial in the future. All of this will require economies of scale that most Korean security firms do not currently have. And not possessing this scale will only mean that most firms will be left behind.
This is clearly shown in the U.S. where the top three firms capture 51 percent of the market whereas in Korea, they possess a mere 30 percent.
The big question is then, whether and how the current top three, Samsung, Daeshin, and Hyundai, will achieve such greater market share and whether or not they will remain in the top group if they fail to do so.
The answer can be found in horizontal integration. Mergers or close alliances among security firms will bring synergies along IT investments and upgrades, enhanced research quality through larger research teams, and marketing and branding cost synergies.
With cyber trading growing at an astounding rate per year since 1998, and now capturing over 60 percent of all transactions, IT training and operations costs have been growing significantly. In 1999, Samsung spent nearly 25 billion won on IT operations while Daeshin and Hyundai spent 13 billion won and 12 billion won respectively. …