[Funding] Lotte Culture Issues Perpetual Bonds to Lower Debt Ratio... Effect Is Minimal

Lotte Cinema Logo

[Asia Economy Reporter Lim Jeong-su] Lotte Cultureworks, the operator of Lotte Cinema, has slightly lowered its debt ratio by issuing hybrid bonds (perpetual bonds) amid deteriorating financial conditions due to prolonged poor performance caused by COVID-19. As a result, the major shareholder can avoid the burden of capital increase while escaping the early redemption pressure of existing private bonds. However, as the recovery of performance has been slow due to COVID-19, the financial situation is rapidly worsening, highlighting the need for fundamental financial improvement.

According to the investment banking (IB) industry on the 24th, Lotte Cultureworks recently issued private hybrid bonds worth 40 billion KRW. The bond maturity is 30 years, and from 2023, two years after issuance, Lotte Cultureworks can exercise a call option for early redemption. If the call option is not exercised, the interest rate will step up by more than 200 basis points (2 percentage points) from the initial issuance rate of 4.20%. Although interest payments can be deferred, the deferred interest must be cumulatively paid to investors on the next interest payment date.

Lotte Cultureworks issued hybrid bonds with such a structure to reduce its debt ratio. Hybrid bonds have characteristics of borrowings in that interest is paid to raise funds, but they also have capital-like features such as perpetual maturity and the ability to defer interest payments. Considering this, under International Financial Reporting Standards (IFRS), they are recognized as equity in accounting.

Lotte Cultureworks’ debt ratio has been rapidly increasing due to poor performance in the cinema business caused by COVID-19. The consolidated total equity, which exceeded 500 billion KRW in 2018, was reduced to 147.9 billion KRW by the end of last year, a drop to one-third. During the same period, liabilities increased more than fivefold from 161.7 billion KRW to 1.0384 trillion KRW. The debt ratio surged from 32% to a staggering 885% in just two years. If the worsening management trend continues, the company could soon face capital erosion.

If there is no significant change in liabilities or total equity in the first half of the year, Lotte Cultureworks can reduce its debt ratio to below 700% through the issuance of hybrid bonds. Hybrid bonds serve as a good means to partially improve the financial structure without imposing a capital increase burden on the major shareholders, Lotte Shopping and Jeong Seong-i Innocean Advisor.

It is also interpreted as an effort to defend the credit rating. Some private bonds issued by Lotte Cultureworks include a covenant that requires early repayment of borrowings if the credit rating falls below BBB+. If creditworthiness declines, the burden of loan repayment could increase significantly. Currently, Lotte Cultureworks’ credit rating is A, but the outlook is ‘negative,’ making a downgrade difficult to rule out soon.

Despite the issuance of hybrid bonds, it is evaluated that it will be difficult to expect a significant financial improvement effect as the performance deterioration continues. An IB industry official commented, "Due to the worsening cinema business, an annual net loss of 100 to 200 billion KRW is expected, so the issuance of 40 billion KRW in hybrid bonds will have a minimal financial improvement effect."

A credit rating agency official said, "Although hybrid bonds are recognized as equity in accounting, credit rating agencies view them as having strong borrowing characteristics and consider part of the issuance amount as debt," adding, "Without a capital increase from the major shareholder, it will be difficult for Lotte Cultureworks to defend its credit rating for a long period."