[SM Management Battle] Why Kakao Finds It Difficult to Launch a Counter Public Tender Offer

HYBE to Accept Tender Offers Starting the 10th
Concerns Over Kakao's Weakened Justification: 'Not a Management Dispute'
"Securing Shares at a Price Higher Than HYBE" Is the Only Way

[Asia Economy Reporter Lim Jeong-su] As HYBE has launched a tender offer for SM Entertainment (SM) shares, attention is focused on why Kakao is not responding swiftly. Although Kakao has yet to make an official statement, the investment banking (IB) industry views the provisional injunction application filed by former SM Chief Producer Lee Soo-man against Kakao for new share allocation as a key background. Analysts suggest that if Kakao proceeds with a tender offer or announces plans to acquire additional shares, the court is more likely to grant Lee Soo-man’s injunction request. In that case, Kakao would find it difficult to secure the 9.05% new share stake.

Tender Offer Clock ‘Tick-Tock’... Increasingly Unfavorable for Kakao Over Time

According to Samsung Securities, the lead manager of SM’s tender offer, the company has been accepting tender offer applications for SM shares through branch counters since the 10th. The purchase price is 120,000 KRW per share. HYBE’s tender offer was announced last Friday. After the two-day weekend, tender offer orders are effectively being accepted in earnest starting this week. The tender offer closes on the 1st of next month. Since that day is a public holiday for the March 1st Movement Day, shareholders wishing to sell their shares must apply by the 28th of this month. The cash settlement date is the 6th of next month.

Partial email from Samsung Securities sent to branches regarding the public tender offer for SM shares by HYBE.

HYBE’s tender offer target is a 25% stake in SM. If applications exceed the target volume, shares will be purchased on a proportional basis. For example, if applications double the target volume, only half of each shareholder’s application will be purchased. If HYBE secures the shares as planned, combined with Lee Soo-man’s already held 14.8% stake, HYBE will hold about 40% of SM shares. Adding Lee’s remaining 3.6% stake, HYBE will have a solid voting stake exceeding 44% at the March shareholders’ meeting. With some friendly shares secured, it could even surpass the majority.

As of the end of last year, the shareholder registry was closed, so in principle, HYBE would find it difficult to exercise voting rights as a shareholder at this shareholders’ meeting. However, Lee Soo-man is likely to delegate his voting rights to HYBE, setting up a showdown at the shareholders’ meeting against the camp of ‘current SM management + Kakao + Align Investment.’ The confrontation will revolve around the appointment of SM board members.

SM’s co-CEOs Lee Sung-soo and Tak Young-joon’s terms expire in March. They have announced plans to recommend Lee Chang-hwan, CEO of Align, as a non-executive director and to newly appoint three outside directors recommended by Align. HYBE is expected to propose Chairman Bang Si-hyuk and Min Hee-jin, CEO of ADOR.

As HYBE intensifies its tender offer, the confrontation increasingly disadvantages Kakao over time. Even if Lee Soo-man’s injunction is dismissed and HYBE secures up to 9.05% of SM shares through a paid-in capital increase and convertible bonds (CB), and brings in friendly forces such as the National Pension Service (NPS) (8.96% pre-dilution) and KB Asset Management (5.12%), HYBE remains at a disadvantage.

An IB industry insider said, "It will be difficult for the National Pension Service to side with either party in this dispute," adding, "For Kakao to gain an advantageous position in this dispute, the only way is to launch a tender offer at a higher price than HYBE." The insider predicted, "The later the tender offer decision is made, the more advantageous HYBE will be in this fight."

Kakao Faces a Dilemma Over Whether to Launch a Tender Offer

The IB industry points to the ‘injunction application’ as the main reason Kakao is hesitant to launch a tender offer. Under the Commercial Act, in a management rights dispute, allocating new shares to a third party on one side is strictly prohibited. New shares can only be allocated to a third party in cases strictly necessary for management, such as strategic alliances listed in the articles of incorporation. Both sides are expected to dispute in court whether the new share allocation to Kakao was decided during a management rights dispute and whether it was a necessary management decision for SM.

For this reason, Align and others have emphasized that the new share allocation to Kakao was for strategic alliance purposes to create synergy in the entertainment sector, not for a management rights dispute. Lee Chang-hwan, CEO of Align, responded to related questions after Lee Soo-man’s injunction application by asking, "Between whom is the management rights dispute?" and stressed, "The new share allocation to Kakao is not a decision for a management rights dispute."

However, with HYBE’s tender offer being defined as a hostile takeover attempt of SM, if Kakao counters with its own tender offer, the argument that this is not a management rights dispute weakens. A capital markets lawyer from a major law firm said, "It is difficult to predict the court’s decision," but added, "If Kakao launches a tender offer, the court is more likely to interpret the situation surrounding SM as a clear management rights dispute and grant the injunction." If this happens, Kakao will not be able to secure 9.05% of SM’s new shares at 90,000 KRW per share.

Additionally, the fact that the new share allocation price to Kakao is 90,000 KRW weakens Align’s argument of ‘shareholder value equality’ in alliance with Kakao. Align pressured HYBE by saying, "HYBE’s tender offer price is too low." In response, SM’s legal affairs vice president Cho Byung-kyu, who sided with Lee Soo-man, sent an email to employees stating, "If Align, which claims to represent shareholders’ interests, opposes HYBE’s tender offer price of 120,000 KRW as too low, then it should oppose Kakao’s new share subscription at 90,000 KRW even more," and criticized, "Align’s double standard is not activist fund behavior but that of a management rights fund."

An IB industry insider said, "With the argument that ‘this is not a management rights dispute’ weakened, the only way for Kakao to gain the upper hand is to launch a tender offer at a higher price than HYBE, regardless of the injunction result." Given the uncertain moves of the National Pension Service and KB Asset Management, it is expected that Kakao would need over 2 trillion KRW to launch a tender offer at a higher price than HYBE.

Kakao Entertainment raised 1.2 trillion KRW from Singapore’s GIC and Saudi Arabia’s Public Investment Fund (PIF) through a paid-in capital increase in January, recognizing a corporate value of about 11 trillion KRW. While it has some financial capacity, it would need to invest more funds than HYBE to secure a sufficient stake at a higher price. An industry insider analyzed, "The key issue is whether Kakao is willing to bear the huge financial burden to acquire SM’s management rights."