One of the most exciting corporate drama in recent memory has unfolded in South Korea’s business world, complete with a founder accused of siphoning money, activist shareholders making waves, intra-family drama, and industry titans battling for pole position. Best of all, it involves SM Entertainment (SME), the production company widely credited with the creation of modern K-pop’s business model.
Lee Soo-man, a former radio DJ who founded the company in 1995, implemented what came to be known as the “trainee system” – a systemized approach of unearthing young talent, polishing them and turning them into global superstars like BoA, Girls’ Generation and aespa. But earlier this year, it appeared that he might lose control of the eponymous company, despite his position as the largest shareholder with an 18.6% stake in the company.
The drama began in early 2022, when the activist hedge fund Align Partners Capital Management, with a war chest of KRW 270 billion, acquired 1.1% of SME. After building its position, Align Partners alleged that Lee caused SME to enter into a dubious insider contract with LIKE Production, an entity controlled entirely by Lee, under which LIKE would receive 3 to 6% of SME’s revenue, or more than one-third of SME’s profits. Align scored an early victory in March 2022, when the hedge fund successfully appointed an auditor on the SME board. Align steadily grew its influence within the company’s governance; in October 2022, SME canceled some of its contracts with LIKE.
The activist campaign accelerated significantly in February this year when SME’s co-CEOs Lee Seong-su and Tak Yeong-jun engaged in a full-blown munity. Further confounding the situation is the fact that co-CEO Lee is a nephew of Lee Soo-man’s wife, fueling industry rumors that the Lees were at loggerheads due to the 70-year-old founder’s refusal to let go of the company’s reins and let his nephew succeed him.
On February 3, Lee and Tak announced the “SM 3.0” plan, in which SME would abandon its single-tier producing system, which was ultimately overseen solely by Lee Soo-man, in favor of establishing “multi-production centers,” or independently produced and managed subsidiaries overseeing a more diverse group of artists – in short, cutting the founder from artistic production.
Then on February 7, SME announced that it would issue a new round of shares, most of which would be purchased by Kakao, one of South Korea’s largest tech companies. Having founded an entertainment division in 2021, Kakao has been on the hunt for a greater presence in Korea’s pop music industry. With an investment of KRW 271 billion ($214 million), Kakao acquired 9.05% of SME, instantly becoming SME’s second largest shareholder and significantly weakening Lee Soo-man’s hold over the company.
Lee fought back fiercely, first by filing a lawsuit challenging the new stock issuance, as it diluted the value of existing shares. Then on February 11, Lee threw down the ace up his sleeve: he sold most of his shares, or 14.8%, to HYBE – the production company behind megastars BTS and Le Sserafim. (Lee retained a 3.66% stake in SME, over which HYBE has an option to purchase at a later date.)
HYBE, the largest K-pop production company by market capitalization valued just under KRW 8 trillion, also announced that it would make a tender offer under which it would seek to acquire an additional 25% stake in SME by buying shares from small shareholders at KRW 120,000 ($94.60) per share, a 21.8% premium. Then, on March 3, Kakao’s initial attempt to take over the company was foiled when the Seoul Central District Court ruled in favor of Lee and enjoined SME’s new stock issuance.
But the battle from SME was not over yet. Despite the aggressive tender offer, HYBE could only gain 0.98% more of SME shares as of March 6, falling significantly short of its goal to garner 25% from small shareholders. Despite losing its 9.05% stake because of the court’s decision, Kakao said it would double down by offering KRW 150k per share in an attempt to build a 35% stake in the SME. Unable to match Kakao’s superior funding, HYBE waved a white flag on March 12: HYBE withdrew from SME’s acquisition, because the SME share price “exceeded the appropriate range” to a point that it negatively affected HYBE’s share price.
The proxy battle over SME was a showcase for the emerging shareholder activism in South Korea. Newcomers to South Korea’s corporate governance are often bewildered by the fact that the ostensible owner of a company, such as Lee Soo-man, could control the company while holding far less than 50% of the company’s shares. This is a remnant of South Korea’s developmental era, during which shareholder rights were little more than an aspirational slogan.
Minority shareholders had little recourse in the law against the company’s founder, who had other informal ways – such as bribing government officials – to exercise influence beyond his formal shareholding. This has been the leading cause of the so-called “Korea Discount,” or a phenomenon in which shares in Korean companies do not reflect the value of the company, as the company’s founder could easily plunder the company to the disadvantage of minority shareholders.
But gradual reforms in favor of shareholder democracy have allowed room for an activist fund such as Align to mount a meaningful challenge. Align’s campaign was clearly beneficial for SME shareholders: in addition to clearing the dubious contracts that drained the company’s profit to Lee’s personal bank account, the activist campaign resulted in dueling and highly lucrative offers for stakes in the company that more than doubled SME’s share price in just two months since mid-January.
The proxy battle also has significant implications for K-pop’s future. If HYBE had won the battle to acquire SME, it would have created a behemoth of the K-pop industry as the top two production companies would have become one. Kakao’s victory, however, also creates a different kind of behemoth: a vertical integration of platform and content.
Both HYBE and SME have their own online platforms, but they exist primarily to serve the artists they produce. Kakao, on the other hand, is primarily a platform company, known best for Kakao Talk, the ubiquitous super-app in Korea through which users can chat, send money, hail cabs and order food delivery. While it is not yet clear how SME will evolve under Kakao’s auspices, it would not be a stretch to say the relationship between artists and platform will be different.
An earlier dispute between Kakao and Spotify is illustrative. Spotify, the world’s largest music streaming app, began its service in South Korea in February 2021. Kakao, however, blocked Spotify from playing music by artists under its label, in an apparent attempt to protect its own streaming app Melon. It took more than a month for Kakao and Spotify to come to terms, as music fans criticized Kakao for holding its artists back from the global audience accessible through Spotify.
At the time, Kakao’s entertainment division did have significant talents such as IU, a superstar singer and actress who holds the domestic record for most streamed music cumulatively. On the whole, however, Kakao’s stable of artists was not quite large enough to dictate the terms of how their music is to be distributed. That will change with the acquisition of SME, which arguably has the strongest overall collection of talent in the K-pop industry. We may be seeing a dawn of a new era in K-pop business, in which artists serve the interest of the platform, rather than the platform serving the interest of the artists.
S. Nathan Park is an attorney based in Washington, DC practicing international litigation. Mr. Park is a non-resident fellow of the Quincy Institute for Responsible Statecraft and frequent contributor for media outlets such as CNN, the Washington Post, Foreign Policy, etc., regarding politics and economy of East Asia. The views expressed here are his own.
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