[Governance] Lotte Culture Misses IPO... Jeong Seong-i, Innocean Advisor, 'Suffering in Silence'

Advisor Jeong holds 13.6% via stock swap amid regulations
Value drops due to COVID-19 impact on cinema business
Capital erosion concerns make IPO cashing difficult

[Asia Economy Reporter Lim Jeong-su] The value of Lotte Cultureworks shares held by Jeong Seong-i, an advisor at Innocean and the sister of Hyundai Motor Group Chairman Chung Eui-sun, is plummeting. Two years ago, to avoid the Fair Trade Commission's regulations on internal transactions, Advisor Jeong executed a stock swap by exchanging Innocean shares for Lotte Cultureworks shares.

However, with the prolonged COVID-19 pandemic, expectations for Lotte Cultureworks' IPO have faded, and concerns over capital erosion have arisen. For Advisor Jeong, the value of Lotte Cultureworks shares, which were to be used as resources in the Hyundai Motor Group's governance restructuring process, has hit rock bottom.

Stock Swap Two Years Ago to Avoid Regulations

Advisor Jeong carried out a stock swap with Lotte Group in 2019. He contributed 10.3% of Innocean shares in kind to Lotte Cultureworks and, in return, acquired newly issued shares from Lotte Cultureworks amounting to a 13.6% stake. Lotte Cultureworks was newly established one year prior to the swap by splitting off the cinema (movie theater) business division from its parent company, Lotte Shopping.

It is believed that Advisor Jeong aimed for a twofold benefit through the swap. First, he needed to prepare for the Fair Trade Commission's regulations on internal transactions. At that time, Innocean, in which Advisor Jeong held a 27.99% stake, was at risk of being subject to these regulations.

According to the then-discussed amendment to the Fair Trade Act, the scope of internal transaction regulations for large business groups was expanded from subsidiaries with a "30% or more stake held by the controlling family" to those with "20% or more." This amendment passed the National Assembly at the end of last year and will take effect from December 30. After the swap, Advisor Jeong's stake in Innocean decreased to 17.69%, allowing him to avoid the internal transaction regulations.

He also seemed to expect to increase the value of his shares through synergies between Innocean and Lotte Cultureworks. The expectation was that collaboration with Lotte Group would simultaneously increase the corporate value of both Innocean and Lotte Cultureworks. If Lotte Shopping listed the now more valuable Lotte Cultureworks on the stock market, Advisor Jeong could sell his shares at a high price and liquidate them.

Advisor Jeong received new shares of Lotte Cultureworks at a price of 16,416 KRW per share in exchange for contributing Innocean shares in kind to Lotte Cultureworks. Based on this unit price, it is estimated that Advisor Jeong valued his 13.6% stake in Lotte Cultureworks at 126.2 billion KRW when making the swap. The total valuation of Lotte Cultureworks was estimated at 925.9 billion KRW.

Decline in Share Valuation Due to Deteriorating Performance and Financial Condition

However, with the onset of COVID-19, expectations for Lotte Cultureworks' value increase and IPO evaporated. This is because Lotte Cultureworks' performance and financial condition rapidly deteriorated after the stock swap.

Sales, which were 771 billion KRW at the end of 2019, dropped to about 266 billion KRW within a year of COVID-19, a reduction to one-third. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) fell from 216 billion KRW to 5.9 billion KRW. Net losses exceeding 300 billion KRW occurred over two years: -69.8 billion KRW in 2019 and -235.4 billion KRW in 2020.

Due to consecutive net losses, Lotte Cultureworks' equity capital, which exceeded 500 billion KRW when split from Lotte Shopping, decreased to 147.8 billion KRW by the end of last year. If the poor performance continues, capital erosion within the year cannot be ruled out. During the same period, borrowings increased from zero to 1.1708 trillion KRW. The burden of short-term debt repayment also approached 300 billion KRW.

The valuation of Lotte Cultureworks shares held by Advisor Jeong has also plummeted. An investment banking industry insider evaluated, "Considering cash flow and financial conditions, Lotte Cultureworks' valuation likely dropped to less than a quarter of the value at the time of the stock swap."

Additional Dilution of Value in Capital Increase... Difficult to Liquidate Through IPO

If Lotte Cultureworks conducts a paid-in capital increase to avoid capital erosion, Advisor Jeong's share value will further decline due to dilution. In addition to the drop in share value caused by deteriorating performance, he must also endure dilution.

A securities industry official diagnosed, "Without the inflow of new cash through a large-scale capital increase, it seems difficult for Lotte Cultureworks to improve its management and financial conditions."

Moreover, with an IPO practically impossible within several years, it is also difficult to liquidate Lotte Cultureworks shares. As the value of Lotte Cultureworks shares, considered part of Hyundai Motor Group's succession resources, declines, Advisor Jeong's cash mobilization capacity during the governance restructuring process has also weakened.

An investment banking industry insider analyzed, "Starting with the listing of Hyundai Engineering in the second half of this year, the Hyundai Motor Group's governance restructuring is expected to accelerate. However, the value of shares held by Advisor Jeong has been significantly damaged, reducing the resources available for use."