What does it cost to do deals in South Korea? For Lone StarFunds, a Dallas-based buyout firm, almost $3 billion.

Lone Star, which won control of Korea Exchange Bank in 2003 whenno local lenders were interested, spent more than five yearsentangled by courts, regulators and lawmakers as the fund incitedpublic backlash over the profits on its investment. After it wasconvicted of stock manipulation and two attempts to cash out wereundone by legal disputes, Lone Star agreed this month to sell itsmajority stake to Hana Financial Group Inc. for $3.4 billion, analmost 50 percent discount to HSBC Holdings Plc's offer in 2007,according to data compiled by Bloomberg.

While Lone Star still stands to double its money from theeight-year investment in Korea Exchange Bank, its experience willundermine the government's ability to dispose of a $3.8 billionstake in Woori Finance Holdings Co., CLSA Asia-Pacific Marketssaid. It also furthers the perception that South Korea, wherecompanies sell at a discount to the rest of Asia on concern overcorporate governance and North Korean aggression, is hostile toforeigners, Market Force Co.'s James Rooney said.

“Investors would look at this case as a kind of horror show,where every kind of risk that is hated by professional investorsseemed to show up and create a massive distortion of intelligentmarkets,” said Rooney, the consulting firm's Seoul- based chiefexecutive officer and a member of the investment committee atMacquarie Korea Opportunities Management. “This case has made theprospects much, much worse for Woori.”

Korea Exchange Bank and Hana Financial fell more than 2 percenttoday as South Korean shares slid after North Korea said its leaderKim Jong Il died. Woori Finance lost 1.7 percent.

Jed Repko, a spokesman for Lone Star, said the buyout firmdeclined to comment on whether it was treated fairly by the SouthKorean government during its legal disputes.

Ernst Lee, a spokesman for South Korea's Financial ServicesCommission, said “the regulator is treating foreign investorsequally with local investors. We don't discriminate or give favorsbecause of where they are based.”

A representative at Korea Exchange Bank declined to comment onwhen its sale to Hana Financial will close. Lee Jung Dae, aspokesman at Hana Financial, said it wishes to complete the dealfor Korea Exchange Bank as soon as possible so it can focus makingboth Seoul-based banks more competitive.

Lone Star, founded by John Grayken to buy distressed assets,purchased Korea Exchange Bank in October 2003 as South Korea'sbanking industry was reeling from losses caused by issuing too manycredit cards. That year, Korea Exchange Bank reported its biggestnet loss since the Asian financial crisis in the late 1990s, datacompiled by Bloomberg show.

Windfall Gain

After investing a total of 2.15 trillion won ($1.9 billion), thebuyout fund this month agreed to sell its interest to HanaFinancial for 3.9 trillion won.

The bank had originally agreed to pay 4.7 trillion won inNovember 2010, before negotiating two price cuts from Lone Star inthe midst of the fund's legal disputes.

In November, Lone Star was ordered by South Korean regulators tosell most of its stake in Korea Exchange Bank after the firm andPaul Yoo, the former head of one of its local units, were foundguilty of manipulating the share price of the lender's credit carddivision to drive down its value.

Lone Star was fined about $22 million, while Yoo was sentencedto three years in prison. The decision reversed an earlier rulingthree years ago that cleared Lone Star and Yoo of any wrongdoing,which prosecutors first alleged in 2006.

The firm decided against appealing the conviction, removing themain obstacle to its sale of KEB, as Korea Exchange Bank iscommonly known, according to Choi Jung Wook, an analyst at DaishinSecurities Co. in Seoul. Lone Star has been trying to sell itsholding in the lender since 2005.

One reason that Lone Star became a target of public ire isbecause as a buyout fund, it purchased Korea Exchange Bank to makemoney and had little interest in building up a bank franchise, saidHank Morris, Seoul-based North Asia adviser at Triple A PartnersLtd., which helps hedge funds raise capital.

“The Lone Star deal was controversial from the very beginningbecause Lone Star was not a bank,” he said. “Since no other bank,Korean or foreign, was willing to invest into KEB when Lone Starwas willing to do so, it does seem fair that Lone Star should earnits reward.”

Once the largest foreign investor in South Korean financialassets, Lone Star is now exiting the country entirely with itsdisposal of Korea Exchange Bank.

Opportunity Cost

Today, Lone Star's Bi-Lo LLC agreed to acquire Winn-Dixie StoresInc. for about $560 million to expand the supermarket operator'spresence in the U.S. South.

While the $3.4 billion price tag for Korea Exchange Bank willinflate Lone Star's profit, including dividends and prior sharesales, to more than $4 billion over the life of its investment, itsfive-year legal dispute with the government has cost the firmopportunities for an even bigger payoff.

In November 2006, as regulators investigated whether KoreaExchange Bank's financial strength was deliberately understated tolet Lone Star buy the stake, a sale to Kookmin Bank, South Korea'slargest bank, collapsed. London-based HSBC, Europe's biggest bankby market value, dropped its $6.3 billion proposal after regulatorsheld the deal in limbo for more than a year.

With politicians using Lone Star's windfall to criticize thebuyout fund's investment strategy in South Korea and sway publicopinion, foreign investors may stay out of the bidding for WooriFinance and undermine the government's effort to sell the nation'slargest financial company by assets, according to Shaun Cochran,head of Korea research at CLSA in Seoul.

“It is unlikely that a foreigner would bid aggressively, if atall” for Woori Finance after Lone Star's experience, he said.“Obviously, long protracted legal battles to exit a position willgive foreign investors reasons to be cautious.”

The ruling Grand National Party, which faces a national electionnext year, characterized Lone Star's approach as “eat and flee,” ina Dec. 5 posting on its website.

The government has already failed twice to sell its 57 percentstake in Woori Finance, which was created in 2001 as a holdingcompany for lenders rescued after the Asian financial crisis. SinceSouth Korea first announced its plan to dispose of Woori Finance inJuly 2010, the bank has lost about a third of its market value, orabout $2 billion, through last week.

The Public Fund Oversight Committee, in charge of state assetsales, gave up its most recent attempt to offload the lender inAugust, saying the sole bid it received from a private equity-ledgroup didn't constitute “valid competition.”

Buyer Beware

Lee Jae Sool, appointed as a member of the Public Fund OversightCommittee in September, also said this month the government shoulddiscourage buyout firms from bidding for Woori Finance to avoidrepeating the mistake it made with Lone Star.

“It's time to let Lone Star leave and keep our national image,and learn the lesson that private equity funds won't benefit thelong-term development of banks,” he said.

For overseas investors, Lone Star's experience may instead serveto reinforce the view that South Korean companies aren't receptiveto the demands of foreign ownership, said Pruksa Iamthongthong, aSingapore-based investment manager at Aberdeen Asset Management,which has about $75 billion of assets in Asia.

Many of South Korea's largest companies, including SamsungElectronics Co. and Hyundai Motor Co., are or were part of familyowned conglomerates known as “chaebol.”

“It's a land of home-grown giants,” Iamthongthong said. “Thelevel of corporate governance in Korea is lower relative to therest of the region.”

In the past five years, foreign institutional investors haveunloaded $30 billion worth of shares in South Korean companies on anet basis, more than in any other country in Asia, according todata compiled by Bloomberg.

That's reflected in the “Korea discount,” where investorconcerns over corporate governance, a lack of accountability and anarmed conflict with North Korea have left South Korean companiesundervalued relative to the rest of Asia.

The Kospi index, the benchmark gauge for South Korean commonequity, sells for 8.5 times next year's earnings, according to datacompiled by Bloomberg. That's the lowest of Asia's 10 biggestequity markets.

While the discount also makes South Korean companies some of theregion's biggest bargains, few foreign buyers will want to followin Lone Star's footsteps, Market Force's Rooney said.

“Why would any new investor want to get involved in anothersimilar social, political, governmental, financial, taxation,economic and emotional conflict?” he said. “Most investors braveenough to attempt acquisitions in Korea have already been here andI do not expect many more to come.”

What happened with Lone Star is “one part of the reason forthat,” he said.

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