Align Partners' shareholder activism? Think twice

The three-month saga over the control of the K-pop pioneer SM Entertainment Co. early this year was a painful lesson about activist funds: Don’t be fooled by their sweet talk.

Activist funds, including billionaire Carl Icahn's, came on the scene in South Korea in the early 2000s. They targeted companies with good cash flow but poor governance.

Their demands for governance reform and dividend increases were aimed at making quick profits, rather than the companies’ long-term growth. So they had long been regarded as corporate raiders.

But the emergence of Align Partners Capital Management in 2022 as an SM shareholder instilled new hopes for shareholder activism.

Investors seemed optimistic about the new activist fund, at least until the fund on March 14 lent all its shares in the entertainment powerhouse to investors, betting on a drop in SM's share price.

From the transaction, the Seoul-based fund led by former KKR & Co. banker Lee Changhwan pocketed 770 million won ($590,000) in fee income.

It went even further. In late March, its founder and Chief Executive Lee dumped 10,000 SM shares. He is believed to have reaped more than twice his investment in the entertainment pioneer.

The stock loan transaction and Lee’s secret sale of SM shares came after its share price turned south when HYBE dropped a bid for the entertainment giant on March 12 as competition escalated with mobile giant Kakao Corp.

Just one month earlier, Align encouraged investors to buy SM shares. The fund’s CEO Lee appeared on a TV program on Feb. 14, saying SM’s share price would spike to as high as 300,000 won by 2025. At the time, its share price was 116,000 won.

SM shares are now trading at around 100,000 won, down 60% from their March 8 peak.

“SM was the most sought-after stock by both individual and institutional investors this year,” said a fund manager. “They are boiling with anger (at Align Partners).”

Another fund manager described the investors battered by heavy losses from SM shares as casualties of war. 

“Dead bodies are scattered on every side of the battlefield,” he said.

Align built its reputation as a pioneer of local shareholder activism. It has pushed a number of Korean companies to bump up dividend payments and reform governance, driving their shares to outperform the broader markets.

In 2022, Align led a successful campaign against SM to end its unfair business practices with founder and former Chief Producer Lee Soo-man’s boutique firm. Since then, SM’s share price had skyrocketed 84% as of early March this year.

Moreover, its legal action against SM’s Lee and other board members last January prompted Lee to sell most of his SM Shares to BTS firm HYBE Co. for 422.8 billion won last January.

GOD CHANGHWAN

Align has emphasized its commitment to enhancing target companies’ governance to boost their long-term growth.

It also claimed it acted for minority shareholders’ interests and would bring much-needed reform to South Korea’s financial landscape.

Once nicknamed "God Changhwan" for his successful shareholder activism, he occasionally advised financial authorities about policy.

FEE RATES

Align’s stock lending to short sellers faced a backlash for the high rate of fees it charged. The single-month fee of 770 million won paid to Align translates into an annualized rate of about 30%, which industry watchers said was unprecedented and way too high.

That compares with the average 1% fee paid to individual stock lenders to short sellers.

To calm the controversy, Align said in a statement that the stock loans fall under conventional investment activities of an asset manager.

Additionally, its CEO’s sale of SM shares took place after its shares had priced in HYBE’s withdrawal from a bid for the K-pop leader, it added.

In April, it received back the SM stock it had lent to short sellers.

But industry watchers noted that other activist funds in South Korea rarely entered into securities loan transactions even though they generate fee income -- so that they align with other shareholders’ interests.

“Stock lending to those betting on its price fall is kind of a betrayal of shareholders on their side,” said an investment banker. “They went after a small gain at the expense of losing a bigger one.”

Although there was no legal problem with Align’s SM shares transactions, it carried a reputational risk as an activist fund, which is required to meet high ethical standards.

Market watchers advised that Align should not dismiss the alarm bell rung by other investors as just noise.

“It made a splash in the market as the first successful local activist fund,” said another investment banker. "It should have carefully thought about how its acts would be interpreted by minority shareholders on its side.”

Write to Jun-Ho Cha at chacha@hankyung.com

Yeonhee Kim edited this article.