[Why&Next] Duty-Free Shops Overcoming Boritgogae... Hotel Shilla's Emergency Management and Secret to Interest-Free Fundraising

Hotel Shilla Issues 130 Billion KRW Convertible Bonds
Debt Repayment and Investment in Incheon Airport Duty-Free Shop
"Reducing Financial Costs with Zero Interest Rate"

Hotel Shilla has raised over 100 billion KRW in interest-free funds, increasing expectations for a recovery in the duty-free market. The duty-free industry, which has experienced continued poor performance amid the COVID-19 pandemic, has entered emergency management one after another and launched intensive financial restructuring efforts, drawing attention to whether it can enhance corporate value.

According to the Financial Supervisory Service's electronic disclosure system on the 10th, Hotel Shilla recently issued exchangeable bonds worth 132.8 billion KRW secured by its treasury shares. Exchangeable bonds are bonds that grant the right to exchange for shares held by the issuing company. They have characteristics of both stocks and bonds, similar to convertible bonds and bonds with warrants, but since the number of shares does not increase through new stock issuance and the exchange is made with treasury shares, it has the effect of selling treasury shares. As it is accounted for as a capital account, it is a financing method chosen to improve the financial structure by lowering the debt ratio.

Hotel Shilla Royal Guest House exterior. [Photo by Hotel Shilla]

Exchangeable Bonds with 15% Premium... Raised Over 130 Billion KRW at Zero Interest Rate

The coupon rate of the exchangeable bonds issued by Hotel Shilla is 0.0%. There is no separate interest payment date, and the maturity date is July 5, 2029. The exchange target is 2,135,000 common shares of Hotel Shilla, with an exchange price of 62,200 KRW per share, which is a 15% premium on the weighted arithmetic average stock price. A Hotel Shilla official said, "We have entered an emergency management system while raising funds at zero interest rate," adding, "This decision focuses on improving the financial structure by reducing financial costs."

Due to continued sluggishness in the duty-free business, Hotel Shilla's operating profit in the first quarter of this year was 12.1 billion KRW, down 65% compared to the same period last year. Net loss also turned to a deficit of 1.6 billion KRW. In particular, the TR division, which operates the duty-free business, saw its operating profit plunge 80.6% to 4.5 billion KRW from 23.2 billion KRW in the same period last year. Previously, Hotel Shilla recorded an operating loss of 18.3 billion KRW and a net loss of 36.3 billion KRW in the fourth quarter of last year. The decline in profitability led to financial burdens. Hotel Shilla's debt ratio rose from 394.1% last year to 426.8% in the first quarter of this year, and its reliance on borrowings expanded to 59.6%.

Hotel Shilla plans to use the funds secured through this exchangeable bond issuance to repay part of the 150 billion KRW borrowed from Kookmin Bank in July last year and invest in the Incheon Airport duty-free store. The goal is to reduce interest expenses by repaying borrowings and strengthen competitiveness at airport duty-free stores. Shilla Duty Free has been carrying out major renovations after being selected as the operator of the Incheon Airport departure hall duty-free store last year.

Duty-Free Stores Hit Hard by COVID-19... Emergency Management Continues

The domestic duty-free industry was hit hard as overseas travel was completely halted during the COVID-19 pandemic. Even after the transition to endemic, the recovery of the market has been slow. According to the Korea Duty Free Shops Association, total sales of domestic duty-free stores reached 24 trillion KRW in 2019, marking the highest performance ever. Of this, 20 trillion KRW came from foreign visitors' spending. However, sales plummeted to 15 trillion KRW in 2020 when COVID-19 began, then slightly increased from the following year but dropped to the 13 trillion KRW level last year. This year, the recovery trend remains slow, with sales slightly exceeding 6 trillion KRW until May. Since last year, the soaring exchange rate has reduced the number of travelers visiting duty-free stores.

As a result, the duty-free industry has been entering emergency management one after another. Earlier, Lotte Duty Free launched an emergency management system last month, including voluntary retirement and a 20% cut in executive salaries. In addition to company-wide workforce restructuring, Lotte Duty Free is slimming down its organization by eliminating the Tower Building store, which accounts for 35% of the Seoul Jamsil World Tower branch.

Hotel Shilla has drawn a line, stating that it has no plans for workforce reduction such as voluntary retirement. A Hotel Shilla official said, "Since the first quarter turned profitable compared to the previous quarter, an internal atmosphere of 'let's try' has been formed," adding, "We have entered an emergency management system focusing on improving the financial structure rather than workforce restructuring such as voluntary retirement."

Has the Duty-Free Market Hit Bottom?... Investment Industry Bets on Hotel Shilla's Corporate Value Increase

Some are paying attention to the fact that Hotel Shilla raised funds interest-free while issuing exchangeable bonds with a premium over the current corporate value. All of Hotel Shilla's exchangeable bonds were underwritten by domestic securities firms. Typically, bond investors expect principal and interest income, but these exchangeable bonds are interest-free and valued higher than the current stock price in terms of future corporate value. This means that underwriters expect Hotel Shilla's stock price to rise in the future and have invested accordingly.

Therefore, when issuing these exchangeable bonds, Hotel Shilla included a call option clause allowing early redemption if the company's closing price exceeds 110% of the exchange price (62,200 KRW) for 10 consecutive trading days from July 5, 2027. Additionally, a put option clause was established allowing underwriters to request early redemption every three months after July 5, 2026, which is two years from the issuance date.

An investment industry official said, "In the case of Hotel Shilla, the company is solid, so it is more of an investment in assets than bond investment," adding, "Exchangeable bonds guarantee at least the principal and can yield additional profits if the stock price rises in the future."

However, as the Chinese economy continues to slow and group tours, the core customer base, have not yet resumed, a short-term rebound in duty-free store performance is expected to be difficult. A duty-free industry official said, "Performance improvement depends on the return of Chinese group tourists, which has not recovered this year either," adding, "The situation is not good enough that most duty-free companies have entered emergency management."