[SK Rebalancing] SK Green Energy Becomes 100 Trillion-Won Giant... Difficulty in Convincing Shareholders

Discussion of Merger Between SK Inno and SK E&S at Board Meeting on 17th
Part of SK On's Effort to Revive Battery Business

Potential Shareholder Opposition Depending on Merger Ratio
Convincing Shareholders Likely to Be the Biggest Challenge

SK Innovation and SK E&S plan to hold board meetings on the 17th to approve their merger. SK Inc. will also hold a board meeting to discuss the merger proposal of the two companies. SK Inc. holds 36.22% and 90% stakes in these companies respectively, so the merger agenda is expected to pass smoothly at the board meetings. On the same day, SK Innovation unveiled the ‘Choshim’ (original intention) advertisement signaling a new beginning. SK Innovation will also discuss plans to merge its subsidiaries SK On, SK Trading International, and SK Entum. This is seen as the conclusion of the group-level rebalancing (business restructuring).

According to SK Group on the day, if the merger between SK Innovation and SK E&S is successful, efforts to revive SK On will be actively promoted. SK E&S is an affiliate operating energy businesses such as liquefied natural gas (LNG), hydrogen, and renewable energy, and is regarded as a ‘cash cow’ within the group due to its strong cash-generating capability.

The merger of the two affiliates is considered an inevitable choice to revive the battery business, according to internal group assessments. Batteries, along with artificial intelligence (AI) and semiconductors, are key businesses for the group. Since its launch in October 2021, SK On has recorded losses for 10 consecutive quarters, but the group’s commitment to investing in the battery business remains strong. Park Sang-kyu, President of SK Innovation, recently stated at a workshop for SK Innovation affiliates’ employees, “The electric vehicle-related business is a predetermined future,” pledging continued investment in the battery business. In the ‘Choshim’ advertisement released on the day of the board meeting, SK Innovation emphasized returning to its original intention by shifting investment focus from the traditional petroleum business to batteries.

Within the industry, more attention is being paid to the merger ratio than to whether the merger proposal will pass. The merger ratio is expected to be calculated by evaluating SK Innovation’s corporate value based on either the reference stock price or book value per share (BPS), while the unlisted SK E&S will be valued using a weighted arithmetic average of BPS and earnings per share value.

SK E&S’s net assets amount to 7.5 trillion KRW, which translates to a per-share asset value of 146,000 KRW and an earnings value of 410,000 KRW. The intrinsic per-share value, weighted 40% on asset value and 60% on earnings value, is approximately 300,000 KRW.

On the other hand, SK Innovation’s current stock price is in the 100,000 KRW range, and its BPS as of the end of last year is 230,000 KRW. If the merger ratio is calculated based on SK Innovation’s BPS, it would be 1 to 1.3, but if based on the reference stock price, it would be 1 to 2.7. Since mergers between affiliates can apply discounts or premiums within 10% of the market price for the merger value, the final ratio is likely to be adjusted within this range (1.3 to 2.7).

The variable is the private equity fund (PEF) operator Kolberg Kravis Roberts (KKR), an investor in SK E&S. KKR holds approximately 3 trillion KRW worth of redeemable convertible preferred shares (RCPS) in SK E&S. These are preferred shares that simultaneously have the ‘redemption right’ to demand repayment of the investment at maturity and the ‘conversion right’ to convert preferred shares into common shares.

If SK Innovation pushes for the merger by increasing its equity value, KKR, dissatisfied with this, could demand redemption. This would impose a 3 trillion KRW cash burden on SK E&S. Although repaying in kind by transferring a subsidiary related to the city gas business, which is a profitable business, is an option, it would reduce the effectiveness of the merger with SK Innovation. This condition inevitably lowers SK Innovation’s equity value.

There is also a strong possibility of backlash from SK Inc. shareholders who have received dividends from SK E&S. This is why there is growing speculation that the merger ratio will be calculated in a way that increases SK E&S’s corporate value. However, this could provoke opposition from existing SK Innovation shareholders due to dilution of their shareholding. If the appraisal price for the stock purchase right is set higher than the stock price, orders to sell shares may increase, potentially causing the merger to fail.

The scene of the SK Innovation extraordinary shareholders' meeting held in 2021 at the SK Seorin Building in Jongno-gu, Seoul. Photo by Hyunmin Kim kimhyun81@

Criticism is also emerging within SK Innovation. In September last year, SK Innovation conducted a paid-in capital increase worth 1.14 trillion KRW. The issue price at that time was 139,600 KRW, and compared to then, the current stock price has dropped by nearly 30%. If the merger is completed, employees who participated in the capital increase may turn their backs on the company.

Even if the merger ratio is decided at the board meeting on the day, it is expected to take considerable time to persuade shareholders and push forward with the merger. Professor Seo Ji-yong of the Department of Business Administration at Sangmyung University said, “Generally, there is a view that the merger ratio between SK Innovation and SK E&S will be formed at 1 to 2, but if the basis for calculation is not clearly explained, dissatisfaction may arise on both sides,” adding, “Persuading shareholders is the biggest challenge.”

SK Group is expected to continue additional rebalancing efforts until the end of the year. Besides securing competitiveness in the battery business, efforts to achieve results in other future growth areas such as AI and bio are also likely to be pursued. Once rebalancing is somewhat completed, workforce adjustments seem inevitable. The CEOs of SK Ecoplant and SK Square have already been replaced, and the Chief Commercial Officer (CCO) of SK On has also been dismissed from the position.