Momentive Acquisition 'Trap'... KCC Caught in Debt Spiral

'Cash Cow' Silicon Business Slump Accelerates Debt Increase
Concerns Over Sharp Financial Burden Rise If IPO Delayed or Fails

KCC, the holding company of KCC Group, has fallen into a trap with the acquisition of the global silicone company Momentive. Since acquiring Momentive for a staggering 3.5 trillion KRW in 2019, Momentive has served as the company's core cash cow for several years. However, with significantly increased borrowings due to the merger and acquisition (M&A) and recent deteriorating performance, the financial burden is mounting. If the planned initial public offering (IPO) promised to investors fails, pressure from institutional investors to recover their investments could intensify. With the high-interest rate environment worsening funding conditions, warnings have emerged that next year's financial burden could grow exponentially.

KCC Daejuk Silicone Factory Exterior View

Cash Flow Deterioration Due to Momentive’s Poor Performance... Reliance on Short-Term Borrowings

KCC’s borrowings increased sharply following the acquisition of Momentive in 2019. KCC relied on borrowings for about 2 trillion KRW, more than half of the acquisition price. The year after the acquisition, Momentive was included in the consolidated scope, reflecting acquisition financing borrowings in the consolidated financial statements. KCC’s total borrowings surged from around 2 trillion KRW to 4.4 trillion KRW after acquiring Momentive. However, the cash-generating capability also increased, so the burden was not considered excessive.

In 2021, cash flow improved due to a recovery in the silicone division’s performance. However, profitability worsened due to rising raw material prices, and KCC invested about 380 billion KRW to acquire the remaining shares of Momentive, increasing borrowings to 4.7 trillion KRW. A similar situation unfolded last year, increasing working capital burdens. Additionally, capital expenditures (Capex) rose, and KCC purchased treasury shares worth about 100 billion KRW, pushing borrowings over 5 trillion KRW.

This year, the profitability of the silicone business (Momentive) deteriorated further. With raw material prices rising and the reopening of China, pressure to reduce silicone product prices (selling prices) increased. The silicone division’s operating profit has rapidly declined for four consecutive quarters, turning to losses from the second quarter of this year. The deficit appears to be widening each quarter. In the third quarter of this year, the silicone division recorded an operating loss of 38.3 billion KRW.

As cash flow worsened due to the silicone business slump, KCC has been covering the shortfall with short-term borrowings, increasing short-term debt. By the end of the third quarter this year, total borrowings rose to about 5.48 trillion KRW, with short-term borrowings and current portion of long-term debt?those due for repayment or refinancing within one year?rising to about 2 trillion KRW. The current portion of long-term debt originally refers to long-term borrowings with maturities over one year but that are due within one year.

The trend of increasing short-term borrowings continues into the fourth quarter. Among general companies excluding financial firms, KCC ranks second after SK Group’s holding company SK (2.045 trillion KRW) in terms of corporate paper (CP, including electronic short-term bonds) outstanding balance. The CP balance, a short-term funding instrument with maturities under one year, increased from the 800 billion KRW range a year ago to about 1.5 trillion KRW in November. Notably, CP issuance surged from October, after the third-quarter settlement.

A bond market official commented, "An increase in short-term borrowings with maturities under one year is not a good financial signal," adding, "In a high-interest-rate and credit crunch environment, continuously borrowing with short maturities can lead to sudden liquidity shortages when repayment periods cluster."

Next Year’s Momentive IPO Success Is Crucial... Outlook ‘Negative’

KCC plans to list Momentive on the New York Stock Exchange (NYSE) next year. To this end, it selected Citi Global Markets Securities, Morgan Stanley, and Goldman Sachs as lead underwriters in August. The plan is to use the funds raised from the listing to repay the 1.8 billion USD (about 2 trillion KRW) acquisition financing borrowed for the Momentive acquisition.

However, with the silicone business posting quarterly losses ahead of the listing, the possibility of a negative impact on corporate value has increased. An investment banking (IB) industry insider said, "Until early this year, the listing valuation was expected to reach 5 to 7 trillion KRW, but recent poor performance has made a decline in corporate value inevitable."

If the listing is delayed or canceled, financial pressure on KCC could intensify. When acquiring Momentive in 2019, KCC granted financial investors (FIs) the ‘drag-along’ right, allowing them to demand a joint sale of Momentive shares if the IPO is not successful within five years (by the first half of next year). If KCC refuses, it must pay FIs compound interest of 5% per annum on the investment amount. FIs can exercise the drag-along right starting May next year.

An IB industry insider forecasted, "If KCC fails to list Momentive, repaying the 2 trillion KRW acquisition financing will become difficult, and KCC may face a situation where it must repay the entire investment amount to FIs at once," adding, "This will be a significant burden amid high interest rates and economic downturn." A credit rating agency official expressed concern, saying, "If the listing fails, KCC may respond to FI exit demands by refinancing acquisition loans and utilizing assets such as cash on hand and shares in Samsung C&T, but combined with deteriorating performance of KCC Construction and other KCC Group affiliates, financial burdens will greatly increase."

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