"Prevent Capital Erosion"‥Lotte Culture Issues 200 Billion KRW New Hybrid Capital Securities with Lotte Shopping Support

Lotte Cultureworks, a cinema operation company affiliated with Lotte Group, issued 200 billion KRW worth of perpetual bonds (hybrid capital securities) with the support of Lotte Shopping. This move aims to secure liquidity for repaying maturing borrowings and simultaneously reduce its debt ratio, which has soared beyond 3000%. Since the COVID-19 pandemic, Lotte Cultureworks’ performance and financial condition have deteriorated severely, bringing it to the brink of capital erosion.

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According to the investment banking (IB) industry on the 22nd, Lotte Cultureworks recently issued 200 billion KRW worth of perpetual bonds under the management of Meritz Securities. The bonds have a maturity of over 30 years and can be extended indefinitely, but the issuer can exercise a call option to redeem early starting from 2027, three years after issuance. If the call option is not exercised, a penalty interest rate of more than 2% above the original coupon rate (6.06%) must be paid. From the third year onward, the interest payments will increase stepwise in a step-up structure.

Lotte Cultureworks’ financial condition has deteriorated to the point where it is difficult to raise funds on its own credit. Therefore, Lotte Shopping has provided side support for this perpetual bond issuance. Lotte Shopping has agreed to provide the necessary funds if Lotte Cultureworks fails to repay principal and interest properly. This agreement means that Lotte Shopping will bear the debt repayment responsibility on behalf of Lotte Cultureworks in case of emergency.

The reason Lotte Cultureworks issued a large-scale perpetual bond is to reduce its debt ratio, which is approaching 3500%. While perpetual bonds have the characteristics of borrowings in that interest is paid on borrowed funds, they also have equity-like features such as perpetual maturity and the ability to defer interest payments. Reflecting these characteristics, international financial reporting standards (IFRS) recognize perpetual bonds as equity in accounting.

Accordingly, Lotte Cultureworks can increase its capital and thereby reduce its debt ratio on the accounting books. Due to the slump in the cinema business caused by COVID-19, Lotte Cultureworks’ performance worsened and its debt ratio surged. Consolidated equity, which exceeded 500 billion KRW in 2018, decreased to 29 billion KRW by the end of 2022 due to consecutive net losses. Over four years, equity shrank to about one-twentieth of its original size. During the same period, liabilities increased more than sixfold from 161.7 billion KRW to 1.01 trillion KRW.

As liabilities increased and equity decreased, the debt ratio rose from 32% to a staggering 3500% by the end of 2022. If net losses had continued last year, the company could have fallen into capital erosion starting this year. With the 200 billion KRW perpetual bonds reflected as equity in the financials at the end of 2022, the debt ratio would drop to approximately 440%.

However, even if Lotte Cultureworks lowers its debt ratio, significant financial improvement is unlikely. An IB industry insider commented, "Perpetual bonds are equity on the books but are practically equivalent to borrowings with a three-year maturity. Although the debt ratio drops sharply, it is difficult to see this as a real improvement in the financial structure."

Another industry source observed, "If net losses had continued last year, Lotte Cultureworks would have fallen into capital erosion. It appears they issued perpetual bonds to prevent capital erosion for the time being."

A credit rating agency official said, "Hybrid capital securities are recognized as equity in accounting, but in credit evaluations, they are viewed as having strong borrowing characteristics, so part of the issuance amount is considered debt. Without fundamental changes such as capital increases by major shareholders or performance improvements, it will be difficult for Lotte Cultureworks to significantly improve its financial structure."

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