[SM Management War] The Inside Story of White Knights in ‘HYBE vs Kakao’

Naver, Stick Investment, Netmarble, Dunamu, and Others Allied with HYBE
Kakao Entertainment, H&Q Korea, and Others Classified as Kakao Camp

The management rights battle at SM Entertainment (SM) is heating up, drawing attention to the 'allies' who will support the two camps behind the scenes: HYBE-Lee Soo-man and Kakao-SM (current management). Among them, there is great interest in the intentions and roles of Naver, Kakao's competitor and a business partner of HYBE. From the perspective of the K-pop platform industry targeting the global market, this management rights dispute can also be seen as a proxy war between Naver (HYBE) and Kakao (SM current management).

Naver, Leading the K-pop Platform, Must Block Kakao's Entry

In the investment banking (IB) industry, it is widely believed that if the share competition between HYBE and Kakao overheats, Naver is likely to side with HYBE. This is due to the global expansion potential of K-pop content and platform industries. Naver early on invested in 'Weverse,' an online space where K-pop stars and fans meet, in cooperation with HYBE and YG Entertainment, nurturing it into a unique K-pop platform. In 2021, Naver, which has strengths in live video services, and HYBE, a supplier of K-pop content, joined forces. They integrated Naver's online fan community platform V Live with HYBE's subsidiary Weverse. Naver invested 411.8 billion KRW in Weverse and secured a 49% stake. This reflected a strong evaluation of the growth potential of powerful K-pop content and platforms backed by massive fandoms. Especially, with YG Entertainment's K-pop content joining the Weverse platform co-invested by HYBE and Naver, the most influential online fan community space was created.

For example, if a BTS member logs into Weverse on their birthday and broadcasts live for fans, tens of millions of fans worldwide simultaneously access the platform. This instantly secures a vast number of users. In this K-pop platform industry structure, if Kakao acquires SM, the pie must be divided, which is unfavorable for Naver. As the K-pop industry develops, the platform industry that delivers K-pop content to fans also grows accordingly. Having led the K-pop content platform business so far, Naver can only support HYBE. From Naver's perspective, if HYBE acquires SM, it can receive SM content first and prevent competitor Kakao from monopolizing SM's K-pop content. Conversely, from Kakao's perspective, acquiring SM means gaining not only existing webtoons, dramas, internet TV (KakaoTV), and music services (Melon) but also K-pop content. This allows Kakao to build a popular, diverse portfolio and attract users worldwide by delivering it through the Kakao platform.

[Graphic by Jin-Kyung Lee, Hee-Jin Lim]

Stick Investment Hits the Jackpot with HYBE's Listing

Like Naver, Stick Investment is also classified as an ally of HYBE. HYBE must invest over 1 trillion KRW, including 422.8 billion KRW to acquire former SM chief producer Lee Soo-man's 14.8% stake and 714.2 billion KRW for the planned public tender offer for 25% of SM shares. Moreover, if it competes with Kakao for shares, a white knight is needed to support this. In the capital market, HYBE's strong ally is private equity funds (PEF). Stick Investment, which invested early in HYBE's growth and made huge profits during the IPO process, is considered a strong ally of HYBE. Stick Investment recovered 961.1 billion KRW, 9.25 times its investment, through HYBE's listing. Its internal rate of return (IRR) reached 137.91%. It is reported that Stick Investment CEO Chae Jin-ho has maintained a close relationship with HYBE Chairman Bang Si-hyuk since they first met in 2017.

Additionally, HYBE recommended Park Byung-moo, CEO of VIG Partners, as an outside director while reorganizing SM's board. This contrasts with SM's current management recommending Lee Chang-hwan, CEO of activist fund Align Partners, as an outside director, making VIG Partners an ally of HYBE. Furthermore, major shareholders such as Netmarble and Dunamu are also mentioned as potential white knights for HYBE. Com2uS, which acquired 4.2% of SM shares last October, is also cited as part of the pro-HYBE-Lee Soo-man alliance.

Kakao Entertainment Desperately Needs M&A to Appease Existing Shareholders

Kakao's biggest ally is its affiliate Kakao Entertainment. Currently, Kakao Entertainment is in a similarly urgent situation to increase its corporate value. After expanding by acquiring Radish (web novels) and Tapas (webtoons) two years ago and preparing for an IPO, it postponed due to market deterioration, causing its corporate value to decline. It must quickly grow to appease existing shareholders' dissatisfaction. On the 7th, Kakao announced it signed a contract to acquire 9.05% (about 210 billion KRW) of SM shares through third-party allotment capital increase and convertible bond issuance. At that time, Kakao and SM included a clause allowing the transfer of contractual status, rights, and obligations to Kakao Entertainment.

Kakao Entertainment's financial strength is solid. In January, it raised 1.2 trillion KRW from Singapore's Government Investment Corporation (GIC) and Saudi Arabia's Public Investment Fund (PIF). The first tranche of 890 billion KRW will be received on the 24th, with the remainder due on July 20. Although the funds are intended to be used half for operating expenses and half for acquiring other companies, they could all be used for acquiring SM. The funding purpose includes a clause stating it may change according to the company's business strategy. Kakao Entertainment is also reportedly discussing raising up to 200 billion KRW from private equity fund H&Q Korea.

The identity of another entity that bought 2.73% of SM shares in one day on the 16th is also a topic of interest. The securities industry speculates this entity is Kakao or its affiliate, acting to thwart HYBE's public tender offer. Align Partners Asset Management (Align), which holds about 1% of SM shares, is also considered an ally of Kakao. Align is known to coordinate strategies with SM's current management-Kakao alliance and act together.

Public Tender Offer Outcome Is the First Turning Point

In the IB industry, it is believed that both HYBE and Kakao need to secure at least 30% of shares to consolidate SM as a subsidiary. If the injunction filed by Lee Soo-man is accepted, Kakao will find it difficult to compete with HYBE. If the injunction is dismissed, Kakao has hope. It could launch a counter public tender offer against HYBE's or purchase shares in the market. According to the securities industry, Kakao is currently in contact with a major securities firm to review SM M&A plans, including a public tender offer. Both Kakao and the securities firm say nothing is decided yet. However, the industry expects Kakao to review and execute a public tender offer as soon as the injunction result is announced.

SM's stock price has been volatile. It soared to 133,600 KRW on the 16th, well above HYBE's public tender offer price of 120,000 KRW, then closed at 121,800 KRW on the 20th, down 6.38%, as HYBE maintained its stance not to change the offer price.

The market views HYBE's public tender offer as effectively failed. HYBE offered to buy up to 25% of shares from general shareholders at 120,000 KRW per share by March 1, but the stock price has exceeded 120,000 KRW. If HYBE fails, Kakao will have an opportunity to acquire SM. The injunction result filed by Lee Soo-man is a variable, but at least a chance to acquire shares separately will open.

HYBE stated it will not raise the public tender offer price. HYBE needs to invest about 1 trillion KRW for acquiring Lee Soo-man's shares and the public tender offer. As of the third quarter, HYBE had 903 billion KRW in cash and cash equivalents, so there is no immediate problem, but raising the offer price would be a burden. Park Sung-guk, a researcher at Kyobo Securities, said, "Usually, bids concentrate on the last day, so we need to watch, but it is unlikely to reach the target quantity of 25%. If the offer price rises above 140,000 KRW, the required funds would increase to 900 billion KRW, risking the winner's curse."

Kakao is distancing itself from the possibility of a public tender offer for SM. Although there were talks about selecting an underwriter to review various M&A options including a public tender offer, the official stance is "nothing decided." However, the market sees it differently. It believes Kakao is holding back until the injunction lawsuit result comes out but has the intention to make a public tender offer. If the court judges that SM is in a management rights dispute, Kakao cannot secure 9.05% of SM shares. If Kakao confronts HYBE-Lee Soo-man with a public tender offer, it would create a management rights dispute itself. Therefore, it is expected Kakao will only conduct behind-the-scenes work until the lawsuit result is announced. A securities industry official said, "Due to the injunction lawsuit, they cannot make an official statement but are not denying it either. It is interpreted as keeping the possibility open to block HYBE's public tender offer success."

Kakao's financial situation is better than HYBE's. Kakao Entertainment's raised funds include the first tranche of 890 billion KRW and 560 billion KRW invested in webtoon platform affiliate Kakao Piccoma by Anchor Equity Partners and others as reserve ammunition. Kakao also has 1.24 trillion KRW in cash and cash equivalents. Kim Jin-gu, a researcher at Kiwoom Securities, estimated, "If Kakao buys the combined 43.4% of the largest shareholder's stake and public tender offer shares to gain a competitive edge in acquiring SM, the maximum price it can offer is 141,000 KRW."