Executive judicial risks throw Kakao its biggest challenge yet

Kakao’s chief investment officer Bae Jae-hyun [Photo by Yonhap]

South Korean platform giant Kakao Corp. is facing its biggest challenge since its founding as the investigation into key Kakao executives suspected of market manipulation during the company’s acquisition of S.M. Entertainment Co., who were arrested on Thursday, has eventually shifted to Kim Beom-soo, the company’s founder and head of the Kakao Future Initiative Center. To make matters worse, Kakao’s stock price and earnings are on a downward trend as judicial risks mean its major community projects are on hold for now.

The Financial Supervisory Service (FSS) said that “the special judicial police at FSS will investigate and send the case to the prosecutor’s office within 10 days,” after arresting Bae Jae-hyun, Kakao’s chief investment officer, on charges that he allegedly manipulated the market price to block a tender offer from rival Hybe Corp. in the competition to take over the managerial control of SM Entertainment. Bae is currently being held at the Yeongdeungpo Police Station in Seoul.

The FSS also announced that it will continue to investigate a member of Kakao’s CIO investment staff, and the head of Kakao Entertainment Corp.’s investment division, whose arrest warrants were dismissed. “Although their alleged crimes are serious, their arrest warrants were dismissed given our principle to investigate without arrest. But as the results of the investigation and objective facts have been established to a certain extent, their escape or destruction of evidence is unlikely,” the FSS said. “We will continue to follow up with their cases.”

Meanwhile, all eyes are now on Kim both inside and outside of Kakao. Although Kim had been left out of the arrest warrant application earlier, the FSS is known to have notified to him on Thursday that he will be summoned for an investigation next week, indicating that the investigation is expanding to include the company’s higher management, and the FSS special judicial police raided Kim’s Pangyo office in August.

Kakao is scrambling to come up with contingency plans for the judicial risk, which appears to be shifting to the founder, rather than filling Bae’s vacancy. The company said it was reluctant to comment on the matter as the investigation has only begun, saying, “We will present our case through our defense team.”

Kakao’s business is also at risk, with the investigation directly impacting Kakao Entertainment and Kakao Bank Co. Since its acquisition of SM Entertainment in March 2023, Kakao Entertainment had been accelerating its overseas expansion with popular artists from both companies, but the business plan has now been disrupted in its entirety and cast a grim shadow on the company’s plan to increase the share of overseas sales to 30 percent by 2025 after the acquisition of SM Entertainment, where overseas sales account for a majority.

Kakao Bank, in which Kakao is the largest shareholder, is also at risk. If Bae is convicted or Kim is caught up in judicial risks, Kakao could be forced to sell most of its stake in Kakao Bank, according to analysts.

Under the current Act on Special Cases Concerning Establishment and Operation of Internet-Only Banks, industrial capital, or non-financial major players, are not allowed to hold more than a 10 percent stake in an online bank if they are punished with a fine or more for violations of the Punishment of Tax Offenses Act, the Act on the Aggravated Punishment of Specific Economic Crimes, or the Fair Trade Act in the last five years.

Following the report on Bae’s detention on Thursday, Kakao shares hit a new 52-week low. The stock continued to weaken throughout the day in the Kospi market and closed at 45,000 won ($33.11), down 1,300 won, or 3.11 percent, from the previous day, falling as much as 43.2 percent from its high this year.

With third-quarter earnings forecasts for the company being revised downward, coupled with executive judicial risks, analysts project that Kakao’s stock price will have a difficult path to recovery. According to financial data tracker FnGuide Inc., Kakao’s third-quarter operating profit estimate is expected to fall 12.5 percent from a year earlier to 131.6 billion won.