K-pop showdown amplifies shareholder voices

SM Entertainment Co

22/02/2023 13:35

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are her own.)
    By Robyn Mak
       HONG KONG, Feb 22 (Reuters Breakingviews) - Worldwide
boy-band sensation BTS may be on hiatus, but refreshing new
financial acts threaten to upend the world of K-pop, and perhaps
South Korea. The country’s largest potential hostile takeover
hangs in the balance, as music agency Hybe  352820.KS , best
known for managing the popular seven-member group vies for
control of rival SM Entertainment  041510.KQ . The saga
showcases a stubborn founder, a rising activist investment fund
and a potential white knight. Look past the spectacle, however,
and there are signs of real progress for shareholders.
    The battle over 28-year-old SM Entertainment, the $2.3
billion force behind Girls' Generation and EXO, is at heart a
family feud. Entrepreneur Lee Soo-man, K-pop's godfather and the
SM in the company’s name, squared off in a power struggle with
his wife's nephew, Lee Sung-su, SM's chairman and chief
executive. The younger Lee teamed up with small shareholder
Align Partners Capital Management, a local fund campaigning
against the elder Lee's outsized influence at SM, its bloated
corporate structure and valuation discount to rivals, among
other concerns.
    Align has a point. The SM founder until recently held an
18.5% stake, but no official title; the company's board is
stacked with his long-time associates. Last year, the fund led
by Lee Chang-hwan (no relation), an alum of KKR  KKR.N  and
Goldman Sachs  GS.N , garnered enough support from shareholders
to appoint a new independent auditor on the board after
criticising SM's opaque royalty payments to Lee Soo-man’s
private company. A few months later, SM said it was severing
ties with the founder, including terminating related-party
transactions. 
    It's a victory by a pushy investor rarely seen in a region
dominated by family-owned conglomerates. Paul Singer's feisty
U.S. firm, Elliott Management, made only limited headway
challenging local champions Samsung and Hyundai. By contrast,
homegrown Align represents a new, nimbler breed of dissidence
slowly wining over mom-and-pop investors and corporate bosses
frustrated by languishing valuations. This year, SM nominated
Align's boss as an outside board director and unveiled a new
strategic vision to boost sales and profitability; the decision
promptly won the endorsement of $22 billion internet giant Kakao
 035720.KS , which in February unveiled plans to buy a 9% stake
in SM for 217 billion won ($167 million).
LACK OF HARMONY
    The septuagenarian Lee is fighting back. He challenged
Kakao's investment in court. Moreover, he sold the bulk of his
shares to SM's top competitor, Hybe. The $5.8 billion company
has been diversifying to reduce its reliance on BTS, which
analysts at NH Investment & Securities estimate accounted for
70% of revenue in 2021. With members of the band set to serve
South Korea's mandatory military service, Hybe is now eyeing an
additional 25% stake in SM through a tender offer. The tactic
would increase its stake to roughly 40%. Last week, it proposed
its own slate of board candidates, including three Hybe
executives.
    Kakao has yet to announce its next move, but the prospects
of the super-app operator coming in to derail Hybe’s effort has
helped power a whopping 60% stock rally at SM this year alone.
The enterprise now trades at roughly 16 times forecast EBITDA
for the next 12 months, according to Refinitiv, nearly double
its five-year average, but still a discount to peers. Hybe
trades at 24 times and JYP Entertainment's fetches 18 times.
    SM and Align have both come out against Hybe's hostile
takeover. Concerns that Hybe executives will prioritise their
own shareholders over SM's minority backers have some validity.
Antitrust regulators will be watching, too: the two companies
combined account for more than half of domestic record sales,
according to Align. The fund has called for Hybe to buy all of
SM at a higher price instead of pursuing methods of creeping
control.
    Some of the fears may be overblown, however. Hybe will be
splashing out over 1 trillion won, more than half its forecast
2023 net cash pile, for the 40% shareholding in SM, so it would
be in the buyer’s interest to improve SM financially. To that
end, Hybe has also proposed other changes, including splitting
the chairman and CEO roles.
SWEETER MUSIC
    Hybe has yet to detail strategic plans for its target,
however. Park Ji-won, the chief executive, recently said the
combined company’s geographic reach would give it more clout,
without elaborating. SM, which on Tuesday reported a 70%
increase in quarterly operating profit from a year earlier,
unveiled an ambitious goal of hitting 1.2 trillion won in
revenue by 2025, a 69% rise from this year’s estimate. Moreover,
the envisioned partnership with Kakao, which operates a division
specialising in webtoons and other digital content, looks
promising. 
    The proxy battle is due for a shareholder vote next month.
In the meantime, SM's stock is trading above Hybe's tender
offer, implying that investors expect a higher bid. SM's CEO,
Lee's nephew, recently accepted responsibility for the turmoil
and said he would step down. Between a sweeter offer and a
much-needed management shake-up, shareholders should be better
off either way.
    It helps, too, that K-pop has turned into one of South
Korea’s strongest exports, thanks largely to “Butter” and
“Dynamite” singers BTS. The band alone had been generating an
extra $3.2 billion in tourism and other revenue annually for the
local economy, according to a 2018 Hyundai Research Institute
study. If SM can hit its 2024 operating profit target – a big if
– paying a 20% premium to Hybe’s tender offer would
theoretically generate an 8% return on investment for a buyer,
Breakingviews calculates, before factoring in any possible cost
savings from a deal.
    In a region where pushback from investors has experienced
some major recent setbacks, including in Japan, this musical
saga provides encouraging promise. It also exposes a major
shortcoming inside Korea Inc: directors only have a duty to the
company, unlike in the United States, where the interests of
shareholders also require consideration. South Korea’s structure
has allowed entrenched bosses to resist change. In that sense,
K-pop's new tune should be a big hit.
    Follow @mak_robyn on Twitter 
    CONTEXT NEWS
    South Korean music agency Hybe said on Feb. 10 that it plans
to buy up to a 39.8% stake in rival SM Entertainment, including
a 14.8% holding from Lee Soo-man, the company’s founder and
largest shareholder, and 25% through a tender offer.
    "We oppose all aggressive outside mergers and acquisitions,
including Hybe," SM said in a statement, according to Reuters.
Lee has been in dispute with SM's current management over issues
involving the company's business dealings with his private firm.
    As part of the deal, Hybe, best known for managing the hit
boy band BTS, has agreed to buy most of Lee's 18.5% stake for
423 billion won ($330 million) and is offering 120,000 won per
share in the tender offer, a 22% premium to SM's closing price
on Feb. 9. If successful, it would be the largest hostile
takeover in South Korea, according to Dealogic data.
    Separately, internet conglomerate Kakao said on Feb. 7 it
would acquire a 9.05% stake in SM via 112 billion won of new
shares and 105 billion won of convertible bonds. Lee has tried
to block the deal in court, saying the issuance of new shares to
Kakao is "illegal" and designed to weaken his position as the
largest shareholder.
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Graphic: K-pop charts    https://tmsnrt.rs/3xF3leh
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 (Editing by Jeffrey Goldfarb and Katrina Hamlin)
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