K-pop agency SM Entertainment reveals position vs HYBE’s ‘hostile takeover’; warns of monopoly

The battle for who is going to take control of K-pop agency SM Entertainment, which manages acts like EXO, NCT, Aespa and Red Velvet, continued with a new salvo.

On Feb. 20, SM Entertainment uploaded a video titled “The reason why SM is against HYBE's hostile takeover” with Chief Financial Officer (CFO) Cheol Hyuk Jang explaining why they are opposed to HYBE’s entry into the company.

SM Entertainment Chief Financial Officer (CFO) Cheol Hyuk Jang explaining why they oppose HYBE's takeover of their company (Screenshot from SMTown video, photos from SM Entertainment, HYBE)

HYBE manages K-pop acts such as BTS, Tomorrow X Together, ENHYPEN, Seventeen, NewJeans and Le Sserafim,

On Feb. 9, HYBE bought 3,523,420 common stocks of SM Entertainment owned by Lee Soo-man Lee, the largest shareholder of SM Entertainment, for 422.8 billion won ($334 million).

This gave HYBE a 14.8 percent stake in SM Entertainment to become the largest shareholder of the company. The expected acquisition date is on March 6.

Since then, the key officials of SM Entertainment and HYBE have aired their positions on the deal.

In the latest video, SM Entertainment’s Cheol Hyuk Jang said HYBE’s takeover over the company would create a monopoly and reduce SM’s corporate value and stock price.

Lee Soo-man founded SM Entertainment but is currently in dispute with its management.

According to Cheol Hyuk Jang, “On February 3, we SM, took the first step toward our new leap forward for our fans, artists, shareholders and employees, by announcing ‘SM 3.0’ focused on the change to the Multi ‘Production Center, Label’ system.”

“As soon as SM’s new vision “SM 3.0” was announced, the largest shareholder sold his stake, and a hostile takeover attempt by a competitor started. This is an attempt that ignores not only the fierce deliberation and efforts of the 600 SM employees who have dreamed of becoming the No.1 entertainment company in the world, but also the values and pride of SM that it has pursued together with the fans and artists,” he said.

He said, “On February 9, HYBE became SM’s largest shareholder by acquiring 14.8% of SM's stake held by executive producer Soo-Man Lee, the company’s former largest shareholder. HYBE has also announced that it would ultimately acquire ~40% stake through a tender offer currently underway.”

“This is clearly a ‘hostile takeover attempt’ that has not been consulted with the current management and board. Through this attempt for hostile takeover, HYBE seems to plan to exercise the management control by dominating the board of directors,” he added.

According to Cheol Hyuk Jang, “We know better than anyone else that under such a governance structure, it is difficult to make decisions that prioritize the value of all SM shareholders, including the remaining 60%.”

He claimed that “this is the same as returning to the wrong past of ‘SM for a certain shareholder’, which we have been trying so hard to break free from.”

“HYBE’s CEO said he will ensure independent management of SM, but I can tell you how empty this promise is and how difficult that promise is to keep. HYBE has not made any requests for due diligence material to SM during the M&A disclosure process. According to HYBE’s disclosure on tender offering and purchase of old shares, over 1 trillion won of capital will be infused into this deal. And HYBE is going to take out a short-term loan to finance this deal,” he said.

He added, “In the case of such large-scale borrowing, it should have been an item for deliberation and voting at HYBE’s BOD ; however, it is a mystery how the BOD resolved an item that involves investment of over 1 Tr Won [about $771 million00 without a due diligence.”

“It is considered a common sense and normal practice in the case of an M&A deal this size to undergo a financial audit or legal due diligence based on the data provided by the target company for merger before any purchasing agreement is signed. In this regard, we think that HYBE’s corporate governance is far from sound or rational. If HYBE takes over SM, it is inevitable that SM will be subject to such weak governance,” he said.

(Screenshot from SMTown video on YouTube)

According to him, “With the optimal album release time limited to 100 times a year, HYBE is already saturated with the artists from its labels. As a result, SM artists will have no choice but to be put on a lower priority. In addition, SM will give up the fan platform business aspired by SM 3.0 and use the HYBE platform. Such a platform will simply increase some licensing revenue but not be properly reflected in the corporate value.”

“As a result, SM will lose a new growth engine by missing out on the data that can help deepen understanding on the fans. Lastly, new business opportunities that might help SM 3.0 strategy will be highly likely to be allotted to HYBE’s wholly-owned subsidiary. In addition to the examples mentioned, there must be many issues that cannot be addressed by the flawed governance structure where a competitor becomes SM's parent company,” he claimed.

He added, “I am confident that this direction will not be the best for SM Entertainment and its shareholders. Some say that there would be a synergy if SM artists joins HYBE’s Weverse platform. However, as mentioned before, this would simply create additional profits for HYBE without any benefits for SM. Rather, such a move would deprive SM of an opportunity to run its own platform business.”

“HYBE currently has a separate business unit that monetizes IP held by its affiliated labels. This means HYBE, not SM, would take the initiative in operating the SM-owned IP and SM’s future profits would be subordinate to HYBE. HYBE says it will acquire former executive producer Soo-Man Lee’s stakes in SM Brand Marketing as well as his shares in DREAM MAKER. It insists that this aims at improving SM’s governance structure. However, the client of SM Brand Marketing and DREAM MAKER is in effect limited to SM Entertainment,” said Cheol Hyuk Jang.

According to him, “The value of these two companies were created thanks to SM Entertainment, therefore, the SM shareholders should be entitled to the value of the shares. In this regard, it is inevitable to interpret HYBE’s purchase of the two companies’ shares as a move to provide additional premium to Soo-Man Lee, ultimately leading to the financial loss of SM shareholders.”

Weverse and monopoly

“In addition, while the businesses of these companies are in competition with Weverse, there is no explanation on how the businesses of these companies would be carried out after acquiring the shares held by producer Soo-Man Lee. This only increases the chance of the value of these companies being handed over to HYBE, while having no impact on the improvement of SM’s governance structure. HYBE says it will ‘create a strong synergy in various business areas by acquiring SM’ However, HYBE has not specified what synergy it is and has not clarified the significance of the acquisition for SM’s shareholders,” he said.

(Screenshot from SMTown video on YouTube)

He added, “We urge HYBE to clarify what synergy the acquisition would create for SM and to clearly state whether this would be benefiting the shareholders of HYBE or those of SM. SM and HYBE are the top two, major entertainment agencies that are leading the Korean entertainment market scene.”

“If the two companies are integrated, the combined entity would create a monopoly by taking 66% of the total market revenue. Furthermore, as of Q3 2022, the two companies’ combined profits from albums/digital music account for 70% of the market. Regarding concert/performance profit, the two companies took up as much as 89%. As a result of an integration, over 60% of the top-ranking artists by album sales would be under a single company, undermining the diversity of the K-pop market,” he claimed.

The CFO said, “A lot of indicators of market share imply that HYBE’s acquisition of SM will undermine fair competition, which clearly shows that this acquisition is unfair. In the Korean entertainment market, the artists have put in their highest endeavors while the entertainment agencies have engaged in constructive competition. This has enabled K-pop to achieve its current global popularity and fandom.”

Ticket prices

“However, If HYBE takes the majority of the market share by acquiring SM’s managerial rights, K-pop would lose opportunities for a greater advancement forward. Ultimately, K-pop fans will be the ones that will be most affected by the monopoly. SM puts reasonable prices to concert tickets to allow broader scope of fans to enjoy cultural performances,” he said.

He said, “Meanwhile, HYBE has taken advantage of its position in the K-pop market to almost double the concert ticket prices as reported in the news several times recently. HYBE is raising not only its own concert ticket prices but also those of the labels it has acquired, which illustrates the impact monopoly will have on the industry. The consolidation of SM and HYBE will accelerate ticket price increase, adding burden to fans who love and support K-pop and K-pop artists.”

“The concert ticket price hike is just one example. The monopoly created as a result of HYBE’s hostile acquisition of SM will cause more diverse and direct problems, including decreased diversity of artists, music and concerts,” he said.

He added, “I have talked about the negative consequences HYBE’s hostile takeover may have on the shareholders, fans and moreover, the K-pop market as a whole. But in addition to the ‘result,’ I would like to talk about the problems found in the process of the hostile takeover. During HYBE’s SM share purchase process, purchase of the shares held by the largest shareholder and the tender offering were planned simultaneously and were announced on the same day.”

“Purchase of the old shares and the tender offering must be considered as the same deal, and it had to go through preliminary examination of the Fair Trade Commission. However, as it did not undergo a preliminary examination, it is problematic. If HYBE secures more than 15% of the shares through purchase of old shares and tender offering on Mar 6th, they need to close the reporting of corporate consolidation by Apr 5th, which is 30 days after the purchase date. This can only be viewed as a pre-calculated plan to secure shares first then have an advantageous position at the SM Shareholder’s Meeting before undergoing the preliminary examination by the Fair Trade Commission.,” the CFO claimed.

“Even if the shares are purchased, the Fair Trade Commission examination will serve as a risk for SM’s future. If the corporate consolidation is rejected due to the reason of monopoly, a large number of SM shares will be released into the market, leading to a plummeting share price. If a conditional approval for corporate consolidation is granted, there is a possibility that HYBE will reduce the size of the SM, the acquired company’s business, to execute corrective measures prescribed by the Fair Trade Commission,” he said.

He claimed, “Even if approval is granted, the delay in the examination process will create a setback for SM in executing its business strategy. Voices of most employees who have built SM together are expressing resistance to HYBE’s hostile takeover. According to an anonymous employee survey, 85% of employees oppose SM being absorbed by HYBE. HYBE’s hostile takeover is an act of ignoring the efforts of the employees who are working day and night, and the employees are voicing that they feel ‘the tradition and history of SM are being denied’ and their ‘pride has collapsed.’”

SM Entertainment employees

“As one of the employees, I am also feeling empty and concerned along with my colleagues, and as CFO, I feel a great sense of responsibility to resolve this situation. We want to be clear again that as in the statement released on February 10th, 25 SM executives, including the CEOs, oppose to HYBE’s hostile takeover for the sake of shareholders, fans, the K-pop industry, and employees. Hostile takeover cases that took place against the opinions of the BOD and the company, found in Korea as well as other countries, ended up destroying the business performance of the company and ultimately damaged shareholder value,” said Cheol Hyuk Jang.

He explained that “even 100% share purchase cases found overseas, showed same results. SM will continue to oppose to hostile takeovers by certain major shareholders/groups whose business interests may adversely affect SM and will do our best to protect shareholder rights by establishing a sound and transparent governance structure.”

“SM’s 2022 performance will be announced soon. We will be explaining the SM 3.0 business strategy, a new IP monetization model following the previously announced ‘Multi Production Center/Multi Label’ strategy, along with performance targets. Along with the SM 3.0 overseas strategy and investment strategy, we will share the business performance and corporate value goals of all SM affiliates,” he said.

The CFO added, “SM will not only reinforce its existing IP business by implementing SM 3.0 but also identify new growth engines to realize revaluation in the market and return the value to the shareholders to create higher corporate value, which will be settled as a virtuous cycle.”

“I am sure many of you shareholders are trying to decide what to do with the tender offer proposal by HYBE. I think it would be beneficial for our shareholders to not respond to the tender offer. Because the changes that will be brought about by SM 3.0 will be of far greater value to the shareholders. The share price of SM has already exceeded the tender offer price designated by HYBE, which is 120K Won and when SM 3.0 is realized, prices will go up even further,” he said.

He added, “We will provide the details of SM 3.0 to you before the closing date of application for the tender offer. Please defer your decision until after you have heard the details. On a separate note, the strategic partnership with Kakao, which the market is keenly interested in will be disclosed in detail in our next announcement. At this point in time when we have just taken the first step toward SM 3.0, our executives and employees are dismayed and disheartened by the largest shareholder’s stake sale and competitor’s hostile takeover attempt. This attempt is ignoring all of SM’s hard work and efforts, as well as the values that SM has pursued together with its artists.”

“We are well aware of Soo-Man Lee’s contribution to SM as founder and executive producer. SM’s BOD has made a decision to become the BOD for all its shareholders while protecting the dignity of Soo-Man Lee and SM’s legacy as well as preparing for the new leap for all our shareholders. That is why Soo-Man Lee’s decision came as a bigger shock. The role of our management team is to work for SM employees and artists, as well as for fans and shareholders. This will not change and should not change under any circumstance. As long as our fans and shareholders believe in us, SM will not stop taking a new leap forward. Please look forward to and pay attention to our next announcement regarding the SM 3.0 strategy which will enhance fan and shareholder value,” he said.