'Kakao Bank at Risk of Being Lost'... Kakao Caught in the Winner's Curse [Seungseop Song's Financial Light]

The Inside Story of the Incident Involving Kakao, SM, and HYBE
HYBE's Failed Tender Offer for SM Amid High Stock Prices
Stock Price Surge Due to Large Private Equity Purchase Orders
Allegations of Market Manipulation Targeting HYBE's Failure Emerge
Financial Supervisory Service Launches Investigation into Kakao's Possible Involvement
If Corporation Is Penalized, KakaoBank May Lose Major Shareholder Status

Kim Beom-su, former chairman of Kakao, is appearing at the Financial Supervisory Service on the 23rd of last month to be investigated regarding allegations of stock price manipulation related to the acquisition of SM Entertainment. Photo by Kang Jin-hyung aymsdream@

Kakao, once known as the ‘national messenger,’ has been plunged into its biggest crisis since its founding. The group’s key executives are embroiled in allegations of stock price manipulation, and there is also a possibility that Kakao Bank could be lost. All of this happened after acquiring SM Entertainment. Some interpret this as Kakao falling into the ‘winner’s curse.’ Although complex and somewhat lengthy, we will explain in detail the background of the incident involving Kakao, SM, HYBE, and activist funds.

Activist Fund Attacks SM

To understand the full story, we need to go back to 2022. Align, a domestic activist fund, believed there were problems with former producer Lee Soo-man’s management style and SM Entertainment’s governance structure. They judged that SM Entertainment was not generating adequate sales and its stock price was not rising well. Therefore, Align Fund began purchasing SM Entertainment shares to correct these flawed management practices.

Of course, they could not instantly secure control of SM Entertainment. Surpassing the 18.46% stake held by former producer Lee required enormous funds. So, in March 2022, Align sent a ‘shareholder letter’ to SM Entertainment. A shareholder letter is a letter sent by shareholders to the management. In it, they demanded the termination of the producer service contract with Like Planning.

Lee Soo-man, former Chief Producer of SM Entertainment, attended the 'Korea-Mongolia Business Dinner' held on the 14th at the Grand Hyatt Hotel in Seoul, and is heading to his car after delivering the keynote speech.
[Image source=Yonhap News]

Briefly, Like Planning is a company 100% owned by former producer Lee. Since 2015, SM Entertainment has provided up to 6% of its sales revenue to Like Planning. According to Align, former producer Lee was set to receive a 6% royalty on existing released music revenue until 2092. Align’s main point was that former producer Lee was unfairly pocketing over 100 billion KRW of company funds.

Afterward, Align sent another shareholder letter, exercised the right to file a shareholder representative lawsuit, and pressured SM Entertainment to disclose board meeting minutes. They then began securing shares for more active involvement.

However, as mentioned earlier, securing shares requires money. Align Fund needed a financially capable ally. Kakao emerged as their ally. The specific plan was as follows: Align mobilized the SM Entertainment board to issue 1.23 million shares through a ‘third-party allotment paid-in capital increase.’ Simply put, this means shares were issued to specific individuals who paid for them. Kakao also secured 1.14 million shares through convertible bonds, making it the second-largest shareholder with a 9.05% stake.

Kakao and HYBE Clash Over SM Acquisition

However, problems arose. Former producer Lee, facing the risk of losing the company, responded with a ‘white knight’ strategy. A white knight is a defense tactic where management finds a friendly party to transfer their shares to when hostile takeovers occur. The white knight Lee found was HYBE, led by Chairman Bang Si-hyuk. HYBE promptly acquired a 14.8% stake in SM Entertainment for 422.8 billion KRW.

Kakao and HYBE clashed over who would take control of SM Entertainment. HYBE took the initiative with a ‘tender offer’ strategy, publicly announcing their intention to buy shares at a set price to defend management rights. The price is usually set at a premium above the market price; HYBE announced they would buy shares at 120,000 KRW each. Their goal was to acquire 25% (5,951,826 shares) of SM Entertainment’s issued shares, completing a total 39.8% stake.

However, HYBE’s tender offer strategy ultimately failed. They only secured 0.98% of shares through the tender offer, far short of the 25% target. The reason was the stock price. SM Entertainment’s stock price soared well above 120,000 KRW, leaving no shares available to buy.

Kakao and Kakao Entertainment counterattacked. Starting March 24, they launched a tender offer to purchase 8,333,641 SM Entertainment shares at 150,000 KRW per share, splitting the purchase equally between the two companies. Subsequently, HYBE withdrew from acquiring SM Entertainment’s management rights and agreed to transfer its shares to Kakao, disposing of its 15.7% stake. Ultimately, Kakao and Kakao Entertainment acquired a 39.87% stake in SM Entertainment, becoming the largest shareholders. The SM Entertainment acquisition battle seemed to end in Kakao’s victory.

Kakao’s SM Acquisition Becomes a Poisoned Chalice

However, last April, the Financial Supervisory Service (FSS) suddenly launched a forced investigation, suspecting Kakao of stock price manipulation during the SM Entertainment acquisition. HYBE had previously failed in its tender offer as SM Entertainment’s stock price surged. Investigators believe that private equity fund (PEF) operator One Asia Partners and others placed large purchase orders on SM Entertainment shares to inflate the stock price. They are also considering the possibility of collusion, given that Kakao’s Chief Investment Officer Bae Jae-hyun is known to have a close relationship with the president of One Asia Partners.

The investigation began to target higher-ups. Hong Eun-taek, CEO of Kakao; Kim Sung-soo, CEO of Kakao Entertainment; and Ji Chang-bae, chairman of One Asia Partners, were summoned for questioning. Bae Jae-hyun, Kakao’s Chief Investment Officer, was arrested. The FSS special investigation team conducted an intense 16-hour investigation, even summoning former chairman Kim Beom-su.

If Kakao as a corporation is criminally punished, it risks losing its status as the largest shareholder of Kakao Bank. Current law stipulates conditions for holding more than 10% of an internet bank’s shares. It requires that the shareholder must not have been fined or punished with imprisonment without prison labor for violations of financial laws, tax offenses, specific economic crimes, or fair trade laws within the past five years. Currently, Kakao holds a 27.17% stake in Kakao Bank; if it sells its shares, the second-largest shareholder, Korea Investment & Securities (27.17%), would become the largest shareholder.

Kakao maintains that the transactions were legal and denies any stock price manipulation. However, investigators are showing confidence. Recently, Lee Bok-hyun, Governor of the Financial Supervisory Service, stated, “We are actively and comprehensively reviewing whether to impose penalties on the (Kakao) corporation.”

Editor's NoteEconomics and finance are difficult subjects due to complex terminology and backstories. Financial Light delivers easy-to-understand economic and financial stories every week. Even without prior knowledge, these stories flow smoothly to ignite your interest in economics and finance.

This content was produced with the assistance of AI translation services.