By Asian Venture Capital Journal
When Koo Kwang-mo succeeded his father as chairman of LG Corporation in 2018, Korea’s fourth-largest chaebol had never carved out a sizeable subsidiary. At the time, Koo, then only 40, was building a relationship with the Korea team at Affinity Equity Partners. The resulting deal was a test case for a broader restructuring that now appears set to deliver more similar divestments.
Affinity had been watching ServeOne, LG’s 100%-owned maintenance, repair, and operation (MRO) unit for six years before making a move in March 2019. The GP acquired a 60% stake for KRW 602bn (then USD535m) with a view to transforming the business into a global player, diversified beyond the mostly straightforward procurement and distribution activities that define MRO.
It helped that Affinity already had a successful track record with corporate carve-outs in the country. Past success stories include Loen Entertainment, the Korean equivalent of iTunes, which was acquired from SK Group in 2013 and exited three years later with a more than 6x return.
Unlike Loen, however, ServeOne is hardly being propelled by the Korean wave. MRO is strongly correlated with overall GDP with little outlook for points of inflection. According to Canadian analysis group Precedence Research, the global MRO distribution market is set to grow at only 2.6% a year until 2030, when it will be worth about USD 800bn.
LG was intrigued by the plan to transcend this market, agreeing to retain a 40% position in ServeOne and offer downside protection in the form of a long-term profit guarantee. At the time of the deal, LG accounted for 80% of ServeOne’s gross profit. That figure is set to be about 60% this year.
The overall business model has changed from a labour-intensive and practically unscalable purchasing agent approach to a hybrid retail business. Much of this can be attributed to the recent bolt-on of Office Depot Korea, which brought in new capacities in cross-selling, logistics, and B2B direct sales via online and offline platforms.
ServeOne also launched a new electric vehicle (EV) battery business and entered several new geographies across North America, Europe, and Asia. There are now 12 offices in six countries, 600 overseas staff, and more than a third of total sales are generated outside of Korea. The approximately 600 overseas clients include the likes of Johnson & Johnson, SF Express, and TDK.
“These are not easy transformations, and all of that happening at once in just 2-3 years has taken a toll,” said Samuel Kim, a managing director at Affinity responsible for monitoring ServeOne.
“But what enabled it was the resetting of the management team as well as the changing of the corporate culture. CEO [Dennis] Kim did an amazing job changing the mindset. Without that, a lot of these initiatives simply would not have been possible.”
Dennis Kim was recruited in 2019 as CEO, having spent the prior 18 years as COO of Oriental Brewery, which Affinity acquired alongside KKR in 2009 and exited to previous owner Anheuser-Busch InBev five years later for a 5x return.
His first task was to establish ServeOne as a non-LG company. This meant moving into new headquarters with a decidedly non-chaebol layout. At LG, every level of executive had a differently sized office depending on seniority. In the new premises, all staff, including executive committee members and the CEO himself, sit in identical cubicles.
The flatness of the hierarchy – along with a policy that valid ideas from junior staff can be turned into potential spinout companies – is be said to have encouraged entrepreneurialism. Meanwhile, the LG legacy and continued association helped attract top talent.
Building out cross-selling and sector-specific consulting expertise in this way is considered one of the key breaks from the traditionally passive MRO model. In addition to EV, specialisations have been built out in packaging, lab equipment, and office supplies. Meanwhile, a chief human resources officer was hired, and 12 executives were added to the LG-grown management team.
In some ways, the working environment at ServeOne has taken on a genuinely start-up flavour: costumed metaverse engagements are used for quarterly companywide presentations and performance briefings. But Dennis Kim describes investor-management alignment and speed of decision-making as the most critical cultural changes.
“If we were a larger corporation, many more people would be involved in decision making, and sometimes you can’t go anywhere,” he said, estimating that decisions that took three months under LG now take one week and decisions that took three weeks under LG can now be made in a single day.
“The most important factor was that we were able to make decisions between the deal team and the management team about what direction ServeOne should take going forward. That kind of alignment under LG was unthinkable.”
Paid on performance
Still, the idea of transforming from a static and hierarchical organisation into one that is open and meritocratic has had a direct impact on sales and customer engagement. Under LG, employees that overachieved their key performance indicators (KPIs) could be told at the end of the year that their targets were set too low and that bonuses would therefore be lowered.
The implementation of more progressive systems for incentivizing performance and seeking promotion were implemented, with one salesperson receiving a promotion in three consecutive years. This is seen as one of the key drivers of top-line growth, with revenue increasing from KRW 4trn at the time of acquisition to KRW 5trn last year. It is set to hit KRW 5.7trn in 2022.
“There was no linkage between performance and pay-outs. Now, there are measurable KPIs, and the difference between the top and bottom performers can get up to 8x in terms of bonus pay-outs,” said Charles Min, a partner at Affinity who led the initial investment.
“Before, there wasn’t much variance between the bottom and top performers. There was no real incentive to really accel. Politics played an important part, which is a typical chaebol dynamic. Now, it’s purely about performance.”
One of the core operational shifts under Affinity included the implementation of a “store platform” concept, whereby staff with expertise in specific industrials areas convince customers to switch to ServeOne-preferred products. Affinity claims this achieves meaningful margin improvement through economies of scale.
Additional scale has been achieved with the establishment of the so-called mega-deal strategy for new account acquisitions. Rather than pursuing open tenders, ServeOne approached non-captive conglomerates at the management level to pitch group-level value propositions and partnerships.
Several large corporates have come on as clients as a result, including Hyundai Motors, Hyundai Heavy Industries, and Hanwha Group. The Hyundai Motors contract alone is said to be worth around KRW 1.5trn.
Some of the biggest coups in terms of customer acquisition have come in the EV battery business, perhaps especially because many traditional carmakers are unaccustomed to outsourcing MRO duties. Hyundai notwithstanding, the standout here is a February 2022 tie-up with General Motors that will see ServeOne service an EV battery factory in the US.
The EV segment has arguably been ServeOne’s most ambitious expansion, with operations expanding across Korea, the US, China, Indonesia, Hungary, and the business unit’s nerve centre in Poland.
The challenge has been enhanced by the meteoric rise of all things EV, the strain on relevant talent supply, and rabid competition for contracts. This context came into focus in 2019, when LG claimed the EV unit of fellow chaebol SK Group was poaching its talent and thereby accessing proprietary knowhow. SK agreed to pay a USD 1.8bn settlement last year.
“You’re literally looking at in excess of USD 150-200bn of investment that’s happening over the next 5-6 years in this sector. We were able to get expertise in the beginning because we were an integral part of energy solutions ramping up and launching their new businesses overseas,” said Min.
“Because of all the changes that need to happen, we really had to work side by side with [energy clients] in the actual manufacturing line. Through that, we were able to obtain the knowledge and at the same time be a valued service provider.”
The EV business also adds to ServeOne’s environmental, social, and governance (ESG) credentials, and not only because of the industry’s presumed reduction in greenhouse gas emissions. ServeOne provides refurbishing services for EV battery parts, pallet and tray cleaning, and repair services to extend replacement cycles.
This has been a learning process for Affinity, which held its first-ever ESG workshop with ServeOne in 2019. The investor has worked closely with management to develop an ESG strategy and roadmap, which is now considered one of the core areas of future development of the business.
One early initiative aims to promote ESG when providing purchasing recommendations. For example, ServeOne Packaging Quality Lab claims to focus on the three Rs of reduce, recycle/reuse, replace when recommending packaging materials.
Last year, the company pledged to promote eco-friendly products in the supply chain of Yuhan Kimberly, a leading supplier of daily health and hygiene products in Korea. This includes items such as wet napkins certified by the Forest Stewardship Council, oil-absorbent hand towels, and water-saving toilet paper. Similar consulting work was brought to LG Electronics to reduce waste in its refrigerator boxes.
The agenda to build up technical and ESG expertise in various industries is designed to be about more than sales team smarts. The goal is to warehouse data in a systematic way so that it can be passed down and kept in-house, even if star employees leave the company. In some ways, this is the crucial differentiator between ServeOne’s new model and traditional MRO.
At the time of Affinity’s investment, ServeOne had a 43% market share in Korea. That figure is now estimated to be more than 50%, but no formal study has been pursued – largely because it’s seen as moot. Affinity believes the company, in terms of scope and operations, has evolved beyond comparison with the likes of China’s JD MRO, otherwise its closest competitor in Asia.
ServeOne is also the only MRO player in Asia that has made serious strides in overseas operations, inviting comparisons with the industry’s global leaders. “ServeOne is smaller than Grainger and Fastenal, but we are much more futuristic and have more upside,” said Dennis Kim. “ServeOne is truly diversified, so we can survive any market in the future.”
EBITDA was KRW 130bn at the time of investment, KRW 175bn last year, and expected to be KFW 200bn this year. This enabled the company to distribute US$ 192 million in cash proceeds back to Affinity’s fifth pan-Asian fund, representing about 60% of the firm’s investment cost.
The focus on building up sector knowledge and warehousing that knowledge digitally could also prove a deciding factor at the time of exit. The idea here is that most of the large conglomerates in Korea are ServeOne customers, providing would-be buyers with a window into details about their production facilities and processes.
“We can put together a profile of that customer in a B2B context, so this becomes a very powerful data profile regarding the business. This type of database opens a door into a lot of different business lines, especially in B2B,” said Min.
“Naturally, the global MRO players could see ServeOne as a very attractive asset, but any company that wants to expand and have access to this database could potentially take a look at the business. A lot of it is still changing, but hopefully once it’s fully built out, there will be a lot of different interesting angles for our exit.”