Kakao's Major M&A Leads to Business Restructuring Crisis 'Boomerang'

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The giant Kakao, which grew through mergers and acquisitions (M&A), is facing an unprecedented crisis due to M&A. During the acquisition process of SM Entertainment (SM), Kakao was accused of market manipulation, casting a red light on its entertainment business. Not only has the plan for the initial public offering (IPO) of its affiliate Kakao Entertainment become uncertain, but the entire Kakao business faces a need for restructuring.

Due to suspicions of market manipulation, Kakao Entertainment’s IPO plans have come to an abrupt halt. Key executives are entangled in legal risks, causing decision-making to come to a complete stop. Bae Jae-hyun, Kakao’s Chief Investment Officer who led major M&As including Loen Entertainment and SM, has been detained, while Lee Junho, Head of Investment Strategy at Kakao Entertainment, is under reinforced investigation without detention. Kim Sung-soo, CEO of Kakao Entertainment, appeared for questioning at the Financial Supervisory Service on the 24th.

Before the expansion of legal risks, Kakao Entertainment was moving forward with its IPO at a fast pace. This year, it streamlined management by liquidating subsidiaries or shares such as Tapas Korea, the story division subsidiary Legendary, and Soundist Entertainment. Kakao Entertainment itself also initiated voluntary retirement for senior employees to trim excess. Since March, CEO Kim stepped down as chairman of the Kakao board to focus on Kakao Entertainment. In June, Choi Yong-seok, former head of Kakao’s Growth Support Office, was appointed CFO of Kakao Entertainment, separating financial management from the general management support division. However, this momentum quickly cooled off once the market manipulation issue surfaced.

In the worst-case scenario, there is a possibility that Kakao could lose control of SM Entertainment. Financial authorities are pressuring Kakao daily, stating they will confiscate illegal gains obtained through unlawful transactions in the capital market. On the 24th, Lee Bok-hyun, Governor of the Financial Supervisory Service, said, "If there is a corporate or economic structure that aims to be achieved through illegal transactions, preventing that goal aligns with social justice." Although the Financial Supervisory Service does not have the authority to nullify Kakao’s acquisition of SM, Lee’s remarks have been interpreted as pressure on Kakao to voluntarily sell SM.

If Kakao gives up SM, the IPO of Kakao Entertainment itself will become uncertain. Earlier this year, Kakao Entertainment secured an investment of 1.2 trillion won, recognizing a corporate value of 11.3 trillion won from the Saudi Arabian sovereign wealth fund and Singapore’s investment agency. Kakao had hoped to alleviate the burden of this high valuation through the acquisition of SM, but that now faces the risk of collapse. Hyun-yong Kim, a researcher at Hyundai Motor Securities, said, "With the acquisition of SM, the music business ranks second, the media business including drama production ranks third or fourth, and webtoons rank first or second domestically. Without a clear number one sector, losing SM would be like a steamed bun without filling."

This incident is being seen as a boomerang effect of Kakao’s growth strategy, delivering a shock to the company. Until now, Kakao has expanded its size through M&A. When it merged with Daum nine years ago, it had only 26 affiliates, but by last August, the number had grown to 144. The group expanded aggressively in new business areas through M&A, and affiliates with independent viability pursued IPOs. The funds raised through IPOs were then reinvested into new ventures.

Kakao Entertainment also grew through M&A. It started from Podotree (KakaoPage), a content company acquired by Kakao. Later, Kakao merged Loen (KakaoM) and KakaoPage to rename the company Kakao Entertainment. Subsequently, Kakao Entertainment acquired film and drama production companies, entertainment agencies, and music labels one after another. Overseas, it acquired North American webtoon platform Tapas and web novel platform Radish. In March this year, it even acquired SM, one of the top three entertainment companies.

Facing the backlash from M&A, Kakao as a whole is at risk of losing its global growth momentum. Kakao initially expressed ambitions to combine its own IT technology with SM’s content to create synergy in the global market. The plan was to enhance the group’s overall profitability through entertainment business expansion and shed the label of a "domestic-only company." To this end, Kakao Entertainment and SM launched a joint North American entity as a first step, but business expansion has now been stalled. Achieving the goal of increasing overseas sales to 30% by 2025 has also become more difficult. An industry insider analyzed, "If the entertainment business, one of Kakao’s growth pillars, is shaken, a comprehensive business restructuring will be inevitable."