[News Analysis] Could Kakao’s M&A strategy be its own undoing?

It may be time for Kakao to consider vertical growth rather than M&A-led expansion

Kakao founder Kim Beom-soo enters the Financial Supervisory Service building in Seoul on Monday for questioning by the financial watchdog's special judicial police. (Lim Se-jun/The Korea Herald)

The Korean financial regulator’s decision to refer Kakao and its executives to the prosecution could lead to disruptions on the IT giant’s future takeover strategy and global expansion plans, sources said Sunday.

Three Kakao executives, including its chief investment officer Bae Jae-hyun, and two entities, Kakao and Kakao Entertainment, who were involved in market manipulation regarding Kakao’s purchase of K-pop agency SM Entertainment, were sent to the prosecution for possible indictment on Thursday, according to the Financial Supervisory Service.

They are accused of manipulating SM Entertainment's stock price above the tender offer suggested by Hybe Entertainment, which also attempted to acquire SM.

The first aspect of Kakao's operations to be directly hit by this incident is Kakao's merger and acquisition drive, according to sources.

This is because CIO Bae Jae-hyun is responsible for developing Kakao's M&A strategy, identifying investment targets, and making investment decisions.

Kakao has been expanding its business through aggressive M&A in recent years. As of August 2023, Kakao has a total of 144 subsidiaries.

Bae has led several major M&A deals, including the acquisition of Loen Entertainment, which operates the music streaming service Melon, in January 2016, and the acquisition of Tapas Media, a major webtoon platform in North America, and Radish, a large US webnovel company, in 2021.

La Jeong-joo, head of the Pi-Touch Institute, a private think tank, believes the FSS's recent moves show that it has secured significant evidence and that this will impact Kakao's future M&A strategy.

"I think Kakao will internally avoid aggressive investments or mergers and acquisitions in the short term," La said.

He, who sees this manipulation attempt as a side effect of Kakao's excessive M&A expansion strategy, also stressed that "Kakao needs to completely change its direction from a quantitative expansion strategy to a qualitative expansion strategy and focus more on upgrading its messenger platform business."

Current risks could also disrupt the IT giant and SM Entertainment's joint international expansion plans.

Kakao aims to increase the portion of its overseas revenue to 30 percent by 2025, and its expansion plan with SM Entertainment was supposed to play a crucial role.

Kakao Entertainment, a subsidiary of Kakao, has been actively promoting global expansion with popular SM Entertainment artists like NCT and aespa. In August, they established a unit together in North America.

Kakao surpassed 1 trillion won in overseas sales last year, and the share of its total revenue made up by overseas sales (19.7 percent) increased by 9.4 percentage points on-year.

In the worst-case scenario, Kakao could lose its position as controlling shareholder in its internet-only bank affiliate, Kakao Bank.

Kakao is the largest shareholder of Kakao Bank, holding just one common share more than the second-biggest shareholder, Korea Investment & Securities. Both companies have a stake of 27.17 percent in Kakao Bank.

If Kakao and Kakao Entertainment, the entities that purchased SM Entertainment's shares, are found to have violated the Capital Markets Act and face heavier penalties than a fine, Kakao will lose its eligibility to be a major shareholder of a bank.

In this case, the financial authority would order Kakao to sell any shares that exceed a 10 percent stake in the bank. The deadline for selling shares is typically six months from the date of the order.

By Song Seung-hyun(ssh@heraldcorp.com)