Corporate governance fight over SM Entertainment

By Peter S. Kim

In a rare event that happens every decade or so, a war is being waged around SM Entertainment, one of the most successful entertainment companies in South Korea, which manages several world-famous K-pop groups. This time, the struggle for management control is between Kakao, the internet conglomerate, and HYBE, another K-pop company that has the ridiculously popular group BTS on its roster. The tussle is over the controlling stake of SM held by its founder, Lee Soo-man, and is challenged by a consortium comprised of SM management, Kakao, and activist fund Align Partners.

For many decades, Korea's corporate governance has been considered by many global investors as one of the reasons for the "Korea Discount," a term used to describe stock valuations chronically trading below regional peers. After many false hopes in the past, global investors are understandably skeptical about hopes for Korea's corporate governance movement. But there are signs that this time could be different.

Activist investors have been rising in profile globally over the past decade as investors seek to unlock the underappreciated value of many companies whose management is underperforming for many reasons. In Korea, the complex legal hurdles, lack of transparency, and the inability to actively engage with company management have often hindered foreign investors' efforts for corporate governance reform. Unlike other developed economies, in Korea, the term minority shareholders is a misnomer as collectively, they often hold bigger stakes than founder families but are treated as an afterthought.

This is due to the complex legal structure making it difficult to bring a collective action against companies or their management. Another reason is the cross-shareholdings within chaebol groups, making it difficult for outside shareholders to voice their grievances. The high-profile case revolving around SM Entertainment is a potential game-changer as it is gaining attention from not just foreign investors but the broader local investment community and the general public.

So far, the HYBE-Lee alliance seems to have the upper hand as HYBE is already the largest shareholder of SM Entertainment, with a 15 percent stake from Lee, as announced recently. HYBE now holds the largest stake in SM, followed by the National Pension Service, the nation's dominant owner of the local stock market. In addition to the 15% stake, HYBE has made a public tender offer seeking to secure an additional 25 percent stake. If HYBE succeeds at securing the targeted stake through the tender offer, it could secure over 40 percent stake in SM.

SM's current management struck a strategic partnership with Kakao early this year when it signed a deal to acquire 9 percent of SM. The deal would have made Kakao the second largest shareholder of SM, following SM founder Lee. Prior to the HYBE intervention, SM management had shown its willingness to improve corporate governance, as proposed by Align Partners, which also holds a minor stake in the entertainment company. Meaningfully, many existing shareholders took sides with the activist fund's campaign for improving SM's traditional corporate governance that has allegedly granted favors to founder Lee. The share price of SM has reacted dramatically to the events, with a rise even above the tender offer, reflecting lofty investor expectations.

The latest series of events reminds us of the effectiveness of activism if it is initiated through a constructive platform. In the past, founders were considered the owners of the companies regardless of the stakes held by them. The decision to list their companies and receive public funding comes with great responsibility to shareholders, who have the right to expect shareholder rights based on voting shares and due process as dictated by law.

Historically, the South Korean public has shown its utmost respect to those entrepreneurs who have devoted their lives to starting and growing businesses, which remain one of the main engines of the nation's economic growth. However, some kudos should also go to investors entrusting their hard-earned savings to finance companies' future growth. The tussle over SM Entertainment should be a lesson on the need to hold companies accountable to shareholders.

While many nations continue to even the balance of wealth between the working class and the middle class, balancing the rights between company management and minority shareholders should also be a priority for an economy the size of South Korea. The Korean government recently declared its plan to apply for developed nation status from the current developing nation status. Some of the conditions for the upgrade are to liberalize its currency market and allow easier access to the equity market by foreign investors. Corporate governance is another important step toward achieving global standards as desired by the entire nation.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.