North Korea's millennial supreme leader, Kim Jong Un, has been quickly running out of allies, bitcoin and perhaps more importantly, patience. With recent volatility surrounding the upcoming summit between President Trump and Mr. Kim, investors have witnessed a flurry of jaded skepticism and emotional rhetoric by the usual hardliner pundits.
At the risk of sounding cliché — and while acknowledging the fluidity of the situation — I believe this time is different. Denuclearization is still more likely than ever before, and investors should take note.
Let's quickly recap how we got here with North Korea. In 2017, President Trump and Kim Jong Un found themselves on the brink of an all-out military catastrophe. To Mr. Kim's disbelief, the U.S. seemed ready to gamble hundreds of thousands of lives in the Korean peninsula. Astonishingly, it was Mr. Kim who seemed levelheaded enough to back off and avoid a third world war. Mr. Kim's lost gamble was costly, not only in financing the test missiles that heightened tensions in the first place, but perhaps more importantly, in losing his political capital within the international community — with China especially.
Mr. Kim's missile tests, the last of which reportedly collapsed a portion of Mount Mantap, possibly exposing nearby Chinese neighbors to radiation risks, have repeatedly antagonized China's leaders. He also made a brazen assassination attempt on his nephew, Kim Han Sol, who was under the protection of Beijing during the Communist Party's 19th Congress. For those of you who don't watch historical Korean dramas regularly, this may seem odd. However, it makes perfect sense to take out a well-educated, less volatile member of the "royal blood line" that China could use to replace Mr. Kim as the next supreme leader. In response, China, for the first time, joined the international community in genuinely enforcing sanctions against North Korea, a stinging blow to both Mr. Kim's ego and the economy he oversees.
As much as Mr. Kim may want to be the ruthless leader his predecessors groomed him to be, maintaining such extreme levels of inherited anger at events that took place two generations ago is perhaps easier said than done. So, unless he possesses unwavering resolve and a miraculous charisma that allows him to lead his country out of this economic mess, he is probably, and perhaps desperately, seeking a reasonable solution—even if it means compromise.
The only long-term win-win scenario for all interested parties is legitimate denuclearization with a sweeping removal of economic sanctions. China will be happy to resume economic trade with North Korea, while keeping their close relations with Pyongyang — a handy buffer to the West — intact. The Trump administration will mark this as a success given the removal of nuclear threat. And finally, if he plays it right with his domestic audience, Mr. Kim can solidify his position as Supreme Leader, while dramatically repairing his nation's economy and permanently transforming its trajectory, perhaps even going down in history as a hero.
Next to Mr. Kim, South Koreans should emerge as the greatest economic beneficiaries of denuclearization. In the event of a sustained and structural denuclearization of North Korea, South Korea should see its credit rating rise and may finally be included in MSCI's Developed Markets classification. After all, MSCI and international credit-rating agencies have openly attributed geopolitical risk as a core rationale for the country's lessened status.
The South Korean corporate sector will also see large near-term economic opportunities in the necessary overhaul of North Korea's infrastructure. If sanctions are lifted, joint North and South Korean projects that were discontinued should be resurrected almost immediately. At the recent inter-Korean summit, leaders discussed and agreed on several post-denuclearization infrastructure projects, including ports, railways, roads, and electric power plants, with a price tag of over $65 billion. Although there will likely be economic aid provided by strategic regional powers such as the U.S., China, Japan and Russia, South Korea will likely need to carry most of these rebuilding costs. And given the mineral resources North Korea sits on, it is natural that South Korea will volunteer to take a proactive role.
Over the medium term, the ever-persistent "Korea discount" will likely narrow. This discount versus other emerging markets has expanded amid the deepening of North Korean nuclear issues, but it would undoubtedly narrow if permanent peace and resulting economic cooperation comes to the Korean peninsula. North Korea offers an excellent source of cheap, skilled, and Korean-speaking labor, not to mention a much-desired supply of natural resources. In turn, South Korea offers its Northern neighbors world-class technology, industrial development capabilities, and access to capital.
A few of the more obvious would-be corporate beneficiaries include utilities and manufacturing firms, such as Korea Electric Power, Hyundai Rotem, Hyundai E&C, and Hyundai Elevator. Understandably, these direct plays have already had big runs, most likely due to the highly speculative nature of the self-proclaimed expert fund managers that make up a good portion of Korean equities: retail investors. Although there is potentially more upside to be had in these names, the downside would be devastating if denuclearization talks break down or even stall.
Large-cap alternatives that would also benefit, yet without the same level of inflated exuberance, would include the likes of Samsung Electronics or SK Hynix. In addition to raising the credibility of South Korean brands among global institutional investors, a denuclearized North Korea would give these tech giants — which already encourage robust investment theses — a more economical manufacturing base close to home.
Moving beyond the short-term political jaw-boning that we have seen recently and will likely see more of, the directional developments in the Korean peninsula should not be brushed off with too much skepticism. Sustained denuclearization and removal of sanctions can open the door to meaningful economic growth and investment opportunities. A once-in-70-year sustained peace transition between two countries isn't your normal M&A catalyst or new-product-launch investment thesis, but one that will likely provide alpha-generating opportunities for many years to come.
