[SM Management Battle] New Phase in SM Crisis with HYBE's Entry... Direct Confrontation with Kakao

BTS's HYBE Acquires Partial Stake in Lee Soo-man
Kakao Aims to Secure SM Shares, Launches Counterattack
Individual Investors Smile Holding Winning Cards

[Asia Economy Reporters So-yeon Park, Jeong-su Lim, Hee-yoon Kim] HYBE, the agency of the group BTS, is acquiring 14.8% of the 18.46% stake held by Lee Soo-man, the general producer and largest shareholder of SM Entertainment (SM), a leading K-pop entertainment company in South Korea, for 422.8 billion KRW. HYBE announced this on the 10th, becoming the single largest shareholder of SM.

In response, on the morning of the same day, SM issued a statement signed by its co-CEOs and management regarding the injunction application filed by the largest shareholder of SM and the acquisition rumors involving HYBE. SM stated, "We oppose all hostile M&A attempts from external parties including HYBE, and the strategic partnership with Kakao is a company decision to accelerate the execution of the SM 3.0 strategy and has nothing to do with the management dispute claimed by the largest shareholder."

As a result, the internal conflict between SM’s current management and founder Lee Soo-man has escalated into a complex battle for management rights. Kakao fired the starting signal. On the 7th, Kakao announced that it would secure a 9.05% stake in SM through a paid-in capital increase and convertible bond (CB) issuance. The very next day, on the 8th, Lee Soo-man opposed this and filed an injunction with the court to prohibit the issuance of new shares and convertible bonds.

Align Partners Asset Management (Align), an activist private equity fund holding 1.1% of SM shares, sided early on with SM’s current management. SM’s management accepted Align’s demands for governance improvements after about two years, which caused conflict with Lee Soo-man. Until then, the confrontation was essentially Lee Soo-man versus anti-Lee Soo-man (current management + Kakao + Align).

On the afternoon of the 9th, a new variable emerged. HYBE revealed in a disclosure response that it was considering acquiring SM shares. HYBE stated in the response, "We are continuously reviewing matters related to the acquisition of shares in SM Entertainment, including a public tender offer, and as of this disclosure, no definitive decisions have been made. We will re-disclose within one month or when specific details are finalized." Then, just one day later on the 10th, HYBE made a sudden public announcement of the share purchase agreement with Lee Soo-man.

An Align representative said at the time of HYBE’s disclosure, "(There were rumors about a deal between Lee Soo-man and HYBE) We don’t know HYBE’s true intentions, but since SM is such an attractive asset, it would have been difficult to issue a denial disclosure. However, considering the reputational risk related to Lee Soo-man, we need to watch whether HYBE will portray itself as joining hands with Lee Soo-man’s side."

With HYBE’s official entry, Align’s stance also shifted somewhat. On the 10th, Lee Chang-hwan, CEO of Align, stated: ▶ Align sides with SM’s current management ▶ Kakao’s move is not a hostile M&A, but HYBE’s is ▶ Future stance will be decided based on whether HYBE pursues a public tender offer.

Lee Soo-man had been pushing to sell his shares since 2021. However, he remained silent on acquisition proposals from CJ ENM and Kakao Entertainment during negotiations at that time. Some critics argued that he was merely trying to gauge his market value and had no real intention to sell. It is known that Kakao Entertainment offered him the authority to oversee its music business and opportunities for equity investment for five years even after purchasing the shares during the negotiations.

HYBE can be classified as a pro-Lee Soo-man company, but it is reported that Lee Soo-man was reluctant to sell his shares to HYBE, which had emerged as a strong competitor. However, as the management and board he appointed turned their backs and Kakao also began securing SM shares, his options narrowed.

If HYBE gains control of SM’s management rights, it is expected to cause a seismic shift in the K-pop market. HYBE boasts K-pop stars such as BTS, Seventeen, Tomorrow X Together, Enhypen, NewJeans, and Le Sserafim. SM also holds powerful stars like TVXQ, Super Junior, SHINee, EXO, NCT, and aespa, so the synergy effect is expected to be extraordinary.

HYBE’s next step is to purchase shares from minority shareholders to secure a stable stake for exercising management rights. If HYBE moves in this way, the confrontation will shift dramatically from 'Lee Soo-man versus anti-Lee Soo-man (current management + Kakao + Align)' to 'HYBE versus anti-Lee Soo-man (current management + Kakao + Align).' Since Kakao will not sit idly by, the ultimate scenario is likely to be a 'HYBE versus Kakao' showdown. It will truly be a battle for management rights.

Before HYBE acquired Lee Soo-man’s shares, SM’s shareholding structure was: Lee Soo-man 18.46%, National Pension Service 8.96%, KB Asset Management 5.12%, registered executives including co-CEOs Lee Sung-soo and Tak Young-jun 0.66%, with the rest held by minority shareholders. Currently, it is HYBE 14.8%, National Pension Service 8.96%, KB Asset Management 5.12%, Lee Soo-man 3.66%, etc. If Kakao secures shares as announced, the structure will change again to HYBE 13.5%, Kakao 9.1%, Lee Soo-man 3.3%.

If HYBE secures a significant portion of SM shares through a public tender offer, the management battle could end quickly. A senior securities official predicted, "In the Lee Soo-man versus anti-Lee Soo-man scenario, the National Pension Service and KB Asset Management are likely to side with anti-Lee Soo-man, but if HYBE gains control, they may turn to HYBE or at least remain neutral." If HYBE fails to secure a majority, it may have to face a vote battle with the anti-Lee Soo-man camp at SM’s March regular shareholders’ meeting (scheduled for March 31) or an extraordinary meeting.

At that time, Align could play a casting vote role. Although Align’s stake is less than 1%, its influence could be significant. Last year, Align received overwhelming support (81% approval) from multiple institutions and minority shareholders including the National Pension Service during SM’s auditor appointment process. This reflected a consensus on improving SM’s governance and maximizing shareholder value.

Align could cause a split in the anti-Lee Soo-man camp. Align initially opposed SM’s paid-in capital increase due to concerns about shareholder value dilution but ultimately decided to follow SM management’s (board’s) decision. Align also agreed to align with SM in responding to HYBE’s acquisition of Lee Soo-man’s shares. However, since Align will eventually sell its shares, it is likely to side with whichever party maximizes shareholder interests.

Individual Investors Holding the Winning Card Expect Stock Price Rise

In any case, if a vote battle occurs at the March shareholders’ meeting between HYBE and the anti-Lee Soo-man camp or between HYBE and Kakao, the outcome will likely depend heavily on minority shareholders’ votes. Regardless of how the SM share acquisition battle unfolds, individual investors are in a favorable position, holding the winning card. The stock price is likely to rise in any scenario. SM’s stock price, which was in the 60,000 KRW range in December last year, closed at 98,500 KRW on February 9 (it hit an intraday high of 103,300 KRW before slightly falling). On the 10th, when HYBE’s disclosure was made, SM’s stock opened at 117,000 KRW, up 18.78% from the previous day. Securities firms expect entertainment stocks like SM to rise further due to China’s reopening and other factors. The ongoing share acquisition battle adds to the positive factors.

If Kakao’s counterattack intensifies, individual investors could benefit even more. Kakao plans to secure a 9.05% stake in SM through new shares and convertible bonds and might change the acquisition entity to the financially strong Kakao Entertainment. Last month, Kakao Entertainment signed an investment contract worth 1.154 trillion KRW with the Saudi Arabian sovereign wealth fund and Singapore’s GIC. Kakao could engage in a public tender offer battle with HYBE. Especially if the court dismisses Lee Soo-man’s injunction, SM can proceed with the paid-in capital increase and convertible bond issuance on the scheduled date (March 6), giving Kakao momentum in the share acquisition battle (if the injunction is accepted, Lee Soo-man could file a main lawsuit to invalidate the issuance).

The fate of co-CEOs Lee Sung-soo and Tak Young-jun, whose terms expire on March 27, will also depend on who secures more SM shares. If HYBE, close to Lee Soo-man, wins, the two could become isolated.

Lee Sung-soo, Lee Soo-man’s nephew-in-law, first connected with SM Planning in 1998 when Shinhwa debuted, working on fan trend monitoring via PC communications, and officially joined in 2005. Since 2015, he has held positions such as department head, group leader, head of the production division directly under Lee Soo-man, and registered director. In March 2020, he was appointed co-CEO alongside Tak Young-jun.

The Crisis of Lee Sung-soo and Tak Young-jun Who Turned Their Backs on Lee Soo-man

It is analyzed that Lee Sung-soo, long considered a Lee Soo-man loyalist, changed course because he had to take management responsibility as a registered director. Lee Soo-man resigned as a registered director in 2010 and declared his withdrawal from management but maintained control through his personal company Like Planning. This arrangement, where he avoided legal responsibility but reaped benefits, created a rift between the two. The situation became irreparable when Lee Sung-soo accepted Align’s demands for governance improvements at SM. An entertainment industry insider familiar with the scene said, "The bond between the two weakened further after Lee Soo-man’s wife, Kim Eun-jin, who was the link between them, passed away in 2014."

Tak Young-jun, a former manager of Super Junior, has long served as Lee Soo-man’s butler and reportedly took care of Kim Eun-jin for a considerable period. However, like Lee Sung-soo, he parted ways due to differing views on the company. An entertainment agency official said, "It is known that Lee Sung-soo, Tak Young-jun, and most employees want to break away from the Lee Soo-man regime and start anew."

Align plans to closely examine whether internal transactions between SM and its affiliates violate laws. While ostensibly a shareholder action for management transparency and corporate value enhancement, it is also calculated to pressure Lee Soo-man to sell his shares. Lee Chang-hwan, CEO of Align, plans to join SM’s board and convene an internal transactions committee to scrutinize major controversial internal transactions and take necessary measures. SM plans to recommend Lee Chang-hwan as a new non-executive director at the March shareholders’ meeting. Lee Chang-hwan said, "We have terminated contracts with Like Planning, but if Align sells its shares and leaves, similar issues could arise again, so we intend to restructure subsidiaries to be 100% owned."

SM entrusts concert planning and artist merchandise businesses to affiliates Dream Maker Entertainment and SM Brand Marketing. Lee Soo-man holds 41.73% of SM Brand Marketing. The internal transaction sales between this company and SM amounted to 26.1 billion KRW from January to September 2022. The SM Entertainment Group has a total of 40 affiliates: 5 listed companies, 14 unlisted, and 21 overseas affiliates.

Align claims that SM continues to pay royalties under a settlement agreement even after early termination of the contract with Like Planning and insists that payments should stop. Align argues that SM’s board’s compliance with the post-settlement agreement may constitute unfair support to a related party under the Fair Trade Act, breach of fiduciary duty, and violation of directors’ duty of care (obligation to act in the company’s interest). If the post-settlement agreement continues, it is estimated that SM will have to pay Lee Soo-man over 40 billion KRW in royalties in the first three years and more than 50 billion KRW over the next ten years.