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The authors are analysts of NH Investment & Securities. They can be reached at jaemin.ahn@nhqv.com and hzl.lee@nhqv.com, respectively. — Ed. 

– On Feb 7, Kakao announced its purchase of 1.23mn newly-issued shares (issuance price of W91,000 per share; total value of W111.9bn) and 1.14mn convertible bonds (W92,300 per share; W105.2bn) of SM Entertainment for the purpose of cross-business cooperation related to entertainment and content. If considering the new shares and convertible bonds, Kakao becomes the second-largest shareholder of SM Ent with a 9.05% stake.

– However, as Lee Soo-man, the largest shareholder (18.46% stake; 16.78% considering dilution), has said that he will apply an injunction to ban the issuance of new shares and convertible bonds, controversy over the firm’s equity structure and management rights will likely continue for the time being. Lee Soo-man’s argument is that while the issuance of new shares and convertible bonds is allowed in cases demonstrating urgent need by management (eg, urgent financing), as SM Ent currently holds net cash of W300bn, no such need is evident.

– This acquisition contrasts with the market expectation of an acquisition of management rights through the purchasing of the largest shareholder’s stake. As SM Ent’s largest shareholder (Lee Soo-man) has lost control in principle, there is the possibility that Kakao will acquire additional shares from Lee Soo-man in the future or collect shares in other ways. However, Kakao has said that it has no plans to acquire shares of Lee Soo-man.

– SM Entertainment: On Feb 3, SM Ent announced that it will move away from its existing system and secure multi-production centers and labels through the four key growth strategies of its SM 3.0 plan. By eliminating bottlenecks (dependence on a single producer) caused by the previous executive producer system and increasing business efficiency, the company aims to grow in both presence (greater frequency of artist activities; record sales +30% y-y) and profitability (4~5% of non-consolidated sales were paid as royalties to Like Planning). If the acquisition concludes with an overall partnership with Kakao, Kakao’s content-related value chain and metaverse capabilities should come to be well-utilized.

– Kakao: Kakao is a platform company that has secured a comprehensive content value chain through Kakao Entertainment, encompassing webtoons, music, entertainment management, and drama/movie production. Currently, it runs a music-related business (Melon) with such labels as Starship Entertainment (Ive, Monsta X, WJSN, etc), Flex-M, and IST Entertainment (Apink, The Boyz, etc). If Kakao embraces SM Ent’s systematic process and IP, its influence in domestic and global markets should strengthen. In addition to artists, the potential for synergies with the webtoon and content businesses of Kakao Entertainment is robust. We expect Kakao and Kakao Entertainment’s influence as a platform through overall content business to level up.

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