[SM Management War] Why Did Lee Soo-man Leave a 3.6% Stake?

Possibility of Preemptive Measures Against Management Disputes and Other Contingencies to Avoid Fair Trade Commission's Prior Merger Notification
Interpretation of Buyout and QCM Holdings as Financial Burden on HYBE

[Asia Economy Reporter Lim Jeong-su] Lee Soo-man, former Chief Producer of SM Entertainment (SM), is transferring 14.8% (3,523,420 shares) of SM shares to HYBE while retaining 3.6% (868,948 shares). Some speculate that his remaining shares, which were not transferred to HYBE, could allow for his involvement in management. In response, HYBE stated, "The share acquisition is not a 'white knight' role but a '(strategic) corporate acquisition' purpose," dismissing the possibility of Lee Soo-man's management participation through the remaining shares.

Various interpretations have emerged regarding the remaining shares Lee still holds. The dominant analysis is that HYBE's circumstances, such as corporate merger notification and the financial burden of share acquisition, are fully reflected. However, there is also an interpretation that this move considers multiple variables, including HYBE's failed public tender offer and Kakao's counterattack.

On the 10th, HYBE signed a contract to acquire 14.8% of shares held by Lee Soo-man for 422.8 billion KRW (120,000 KRW per share). Upon execution of the share acquisition contract, Lee will hold approximately 3.6% of the remaining shares after excluding the sold shares from his existing holdings.

HYBE's Official Position: "Considering Fair Trade Commission's Prior Corporate Merger Notification"

HYBE granted Lee Soo-man a put option on the remaining shares. A put option is the right to sell shares held to a designated person (HYBE) at a predetermined price. HYBE disclosed that the exercise period for Lee's put option is within one month from the earlier of the date when corporate merger approval is obtained or the transaction closing date.

If the Fair Trade Commission's corporate merger approval process is completed within one year, the one-month period starts from that point; if the review process takes more than one year, it starts one year after the share transaction is completed. The decision to acquire slightly less than 15% of shares can be seen as a move considering the corporate merger notification.

In its statement, HYBE also said, "If we acquire all shares from the largest shareholder, the shareholding ratio would exceed 15%, which is the threshold for prior corporate merger notification, making simultaneous public tender offers for minority shareholders' shares impossible. Therefore, we signed a sales contract for the maximum number of shares purchasable from the largest shareholder and simultaneously proceeded with a public tender offer for minority shareholders' shares to secure sufficient shares before proceeding with corporate merger approval."

‘Put Option’ is Lee Soo-man’s Right... A Strategic Move for Contingencies?

Despite HYBE's firm stance, the possibility of Lee's management participation or interference continues to be raised because the put option is Lee's right, not HYBE's. An investment banking (IB) industry insider said, "According to the disclosed contract, whether to exercise the put option is decided by Lee's will," adding, "Even after HYBE's corporate merger approval process is completed, it is difficult to rule out the possibility that Lee may not exercise the put option." This means Lee could continue to hold the shares depending on the situation.

There is also an interpretation that this is a strategic move to prepare for unforeseen circumstances. Depending on the results of HYBE's public tender offer or corporate merger approval, or Kakao's injunction application against a capital increase, another dispute phase could arise. The possibility of Kakao launching a counterattack through a public tender offer must also be considered. An IB industry insider evaluated, "Holding more than 3% is quite significant in a management rights dispute situation."

Minority shareholder rights differ depending on thresholds such as 1%, 3%, and 10% shareholding. Shareholders with more than 1% can file derivative lawsuits. Holding more than 3% allows exercising rights such as requesting inspection of accounting books, calling (extraordinary) shareholders' meetings, and demanding cumulative voting. Although shareholders' meetings are generally convened by the board of directors, shareholders holding more than 3% can also request the board to convene a meeting. If the company (board) refuses to hold the meeting, shareholders can file a lawsuit to request the court to hold an extraordinary shareholders' meeting.

Minority shareholders can combine these rights or secure friendly shares to enter or dismiss the board. Regarding auditor appointments, the largest shareholder's voting rights are limited to within 3%. An industry insider said, "The management rights dispute at SM is complicated, so it is difficult to definitively say what role Lee's remaining shares will play," adding, "There is room for strategic use depending on the success of the public tender offer, corporate merger approval, and Kakao's counterattack."

Key Stakeholders of HYBE and QCM

There is also an analysis that HYBE's financial situation was taken into account.

HYBE decided to raise a large-scale loan during the process of acquiring Lee Soo-man's shares. Purchasing 14.8% of Lee's shares costs 422.8 billion KRW. HYBE plans to borrow 320 billion KRW short-term from affiliates for this. With this borrowing, short-term loans have increased to 440 billion KRW, adding to the 120 billion KRW previously borrowed from financial institutions.

Did HYBE’s Financial Situation Influence the Decision?

HYBE must also invest a large amount of money in the public tender offer. Acquiring 25% of shares at 120,000 KRW per share requires over 700 billion KRW. Additionally, HYBE must inject 339 billion KRW in capital increase funds into its U.S. subsidiary HYBE America to acquire QC Media Holdings (QCM), a U.S. hip-hop label company. HYBE America is currently pursuing a third-party allotment capital increase targeting HYBE to raise funds for the QCM acquisition.

HYBE has aggressively pursued mergers and acquisitions (M&A) to expand domestic and international labels. In this process, borrowings from financial institutions have also increased significantly. In 2019, HYBE acquired Source Music, home to GFriend and LE SSERAFIM, and in May 2020, acquired Pledis Entertainment, which manages groups like fromis_9 and Seventeen. HYBE borrowed 200 billion KRW from the Korea Development Bank for the Pledis acquisition. In April last year, HYBE invested 1 trillion KRW to acquire U.S. label Ithaca Holdings, home to Justin Bieber and Ariana Grande. During this process, HYBE borrowed 554.5 billion KRW from the Korea Development Bank and KEB Hana Bank's New York branch. The remaining acquisition funds were sourced internally.

With the increased financial burden, acquiring Lee's remaining 3.6% shares would require about 104.3 billion KRW more. If HYBE succeeds in acquiring Lee's shares and the 25% public tender offer, it is expected to secure over 40% of SM shares, enabling smooth exercise of management rights. Since the necessary shares for management control are sufficient, it is interpreted that there was no need to invest additional funds to acquire the remaining shares.

An IB industry insider said, "Financial burden may have been partially considered," but added, "Considering HYBE's healthy cash flow, the financial burden of acquiring the remaining shares was probably not a major factor in deciding the acquisition volume." However, the insider explained, "In a situation with high capital requirements, HYBE can temporarily ease liquidity pressure."