Commentary

Navigating through regulatory challenges in South Korea

November 3, 2021

Investing in Emerging Markets (EM) equities never gets boring. One of the main reasons why we love our job is that every day presents us with a dynamic set of challenges and opportunities. In our September 16 commentary, we discussed the crux of the ongoing regulatory changes in China from a local perspective, the impact on different sectors of the economy, and the steps we are taking to position our portfolio accordingly. However, China is not the only country in our investable universe where the government decided to step in and attempt to fix some areas where the free market’s invisible hand allegedly failed.

In August, we witnessed a regulatory crackdown on technology companies spread to South Korea. Many investors in that country reacted rapidly and rushed for the exits, likely spurred by their wounds sustained in China, where tech giants lost 30-50% of capitalization from their peak levels. As a result of the low tolerance of undergoing the same experience, they wiped tens of billions of United States dollars (USD) off the local tech titans’ market value.

Unlike the Chinese government ambitiously reshaping nearly every sector of their economy, the Korean regulators appear to be highly focused on addressing issues in the technology business. Leading internet platforms, both foreign and domestic, have been thoroughly scrutinized and repeatedly criticized by politicians from different parties for abusing their dominant market position and hurting competition in the pursuit of profits, aggressive expansionary business practices, personal data usage, and high commission rates, putting pressure on small and medium-sized enterprises (SME). For instance, Kakao is one of the leading Korean big tech companies, and until not so long ago was the third domestic company by market capitalization. Kakao started as a messaging platform and expanded into consumer finance, payments, gaming, and ride-hailing businesses, among others; with nearly 120 affiliates Kakao has been compared to an octopus by critics. While commenting on the topic, the leader of the ruling Democratic Party of Korea said, “Kakao must not follow the steps of the country’s other conglomerates that ignored fairness and coexistence in the sole pursuit of profit.”

Furthermore, some critics and lawmakers have advocated to adopt measures to prevent big tech companies from monopolizing online services, making it more difficult for larger platforms to acquire smaller peers. Senator Chung, from the People Power Party, suggested further enforcing the Telecommunications Business Act to restrict larger platforms’ M&A activities. He also pointed out that Korean internet is a winner-take-all market with quite grim consequences for the vanquished, likely reminiscent of the Netflix show Squid Game, as larger platforms have over 90% market share. Other lawmakers are pushing to allow smaller companies to gain access to user data accumulated by dominant platforms, creating an ecosystem where big tech companies and emerging operators can grow and innovate together and ultimately benefit consumers and the economy as a whole.

Let’s review the chronology of the main regulatory events:

One can argue that the upcoming March 9, 2022 presidential election in South Korea is the main reason why politicians are bringing up issues and bills targeting big tech companies. Coincidentally or not, five years ago, it was the family-run conglomerates (also known as “Chaebol”) that came under attack, and were accused of enriching themselves by abusing their dominance and applying unfair practices. Also, lawmakers traditionally pressured telecom companies on pricing plans as an efficient way to gain publicity.

Amid growing scrutiny and accusations from lawmakers and regulators, several big tech names pre-emptively announced action plans to appease critics by abandoning some business segments, providing support to SMEs and scrapping plans to compete with small mom-and-pop businesses. For example, Kakao announced their plans to withdraw from the hair salon, flower, snack, and salad delivery businesses. The company also created a $255 million fund for suppliers’ support in addition to other steps aimed at strengthening its corporate social responsibility.

Although the new rules announced by the government so far have limited impact on business fundamentals, the concerns of further regulatory tightening affected the market sentiment and put pressure on the technology sector. By and large, small-cap companies are less prone to the current regulatory headwinds as they usually do not exercise overwhelming market dominance, nor do they employ aggressive expansionary business practices similar to Kakao and Naver, and remain out of sight from the politicians and general public. Moreover, we believe some of our holdings are in a relatively safer position or can even come out as net beneficiaries when the dust settles.

NICE Information Service (030190 KS)

NICE Information Service is the leading credit bureau (CB) in Korea, providing consumer and corporate credit information, risk management consulting, and debt collection services. It has the largest number of members in both the financial and non-financial sectors. The company is poised to benefit from structurally higher demand for retail credit checks due to the ongoing expansion of near- and sub-prime markets, increased competition among Korean lenders (leading to higher turnover of existing loans), a greater focus on unsecured lending, deregulation (enabling more product launches), and retail customers (who are becoming increasingly careful about their credit scores).

NICE Information Service is the only CB in Korea with exposure to consumer and corporate fields, with the most robust financial big data capabilities accumulated over 30 years (database of 43 million consumers and 2.2 million corporates). It has also secured non-credit and non-financial data, such as telecommunication, rental, and social info by collaborating with numerous partners. Consumer CB and big data businesses are expected to be the primary growth drivers of the company. We believe NICE Information Service should be one of the primary beneficiaries of the lawmakers’ initiatives to allow smaller companies to gain access to user data from dominant tech platforms.

NKN KCP (060250 KS)

NHN KCP (“Korea Cyber Payment”) is the leading online Payment Gateway (PG) service provider with a 24% market share. PG is a settlement service that authorizes credit card payments for online retailers. It encrypts credit card information and sends transaction data directly to credit card companies, bypassing merchants’ systems, and thus keeping credit card information confidential. PG also withholds payment until the merchant fulfils the transaction, allowing online shoppers to avoid fraudulent sellers. NHN KCP also runs online and offline Value-Added Networks (VAN) and Online-to-Offline (O2O) businesses. Online VAN service, connects online merchants with credit card companies through secure communication networks to approve credit card transactions. Offline VAN service, connects offline merchants with credit card companies through secure communication networks to approve card transactions. The O2O business empowers SMEs and facilitates payment processing in offline channels.

NHN KCP serves over 150,000 domestic and global merchants. The company is one of the key beneficiaries of the ongoing structural growth of e-commerce and digital content consumption, credit cards’ share gains from other payment methods, and growing overseas transactions. NHN KCP provides Korean merchants with frictionless payment processing capabilities by charging highly competitive take rates (e.g., in the range of 0.10-0.12% for domestic PG). In general, the current PG take rates in South Korea are among the lowest globally and do not catch the eyes of lawmakers as being predatory. For instance, in the e-commerce business, Coupang charges its merchants take rates as high as 8-10%, which has been seen as taking advantage of mom-and-pop companies with no alternative. Also, the food delivery platforms charge take rates of 8-12% of total transaction volume. One of the main market concerns in the investment case of NHN KCP is the risk of its largest clients following the suit of eBay Korea and Naver Pay, to build their in-house PG capabilities and bypass third-party PG companies. The government push against big tech’s aggressive expansion in different verticals might cool down these potential intents and lower the risk of clients’ attrition for NHN KCP. Moreover, the company can gain extra business if one of the tech giants decides to outsource PG capabilities.

AfreecaTV (067160 KS)

AfreecaTV (“anybody can freely broadcast”) is the most prominent Korean live streaming platform, where anyone can broadcast gaming, sports, and various entertainment content free of cost. Instead of paying a subscription fee, the viewers show their appreciation by donating virtual gifts (Star Balloons) to broadcasters (Broadcast Jockeys or BJs). AfreecaTV takes 35% commission from these gifts donated to its BJs. In addition, it sells advertising products (branded content, banner ads, video ads and other solutions) to various brands. The platform has over 17,000 active BJs and hosts over 20,000 live streams per day. AfreecaTV is one of the few available options in the EM universe, providing exposure to e-sports. Gaming content drives over 60% of traffic, while around 30% of its gifting revenue and 50% of advertising revenue are derived from e-sports content.

The company enjoys a substantial supply of top BJs while supporting them financially and via collaboration in creating unique content and providing facilities for professional production and e-sports events. A BJ support department is available 24/7 and top BJs are locked in through exclusive agreements with AfreecaTV. A deep bench of highly popular broadcasters and exclusive content keeps its viewer base sticky. We expect the platform monetization to improve on the back of investments in content and BJ support. Rising content quality should drive a steady user base growth, enhance engagement, and lift the proportion of paying users and average revenue per paying user. In addition, AfreecaTV ad revenue is becoming the long-awaited second source of growth. It is poised for solid expansion, from nearly 20% of the mix to 50% in five years, primarily driven by branded content. Democratization of the data accumulated by large platforms can bring new opportunities for AfreecaTV’s ad business.

Have a great day.

The Global Alpha team