[ECM] SK On ∙ Lotte Chemical, Unstable PRS Contract… Concerns Over Increased Losses

[Korea Financial Times, Lee Sungkyu] SK On and Lotte Chemical secured a large amount of funds through a Pricing Return Swap (PRS) transaction. This is interpreted as a result of limited other options in a situation where market financing is difficult. Some interpret this as a result that clearly reveals business uncertainty. There are expectations for a turnaround in the atmosphere, but as of now, there is a greater concern that losses will increase.

According to the investment banking (IB) industry on the 13th, SK On secured a total of 1.5 trillion won in funds, including a paid-in capital increase of 1 trillion won last month and an additional 500 billion won recently.

Specifically, it is a PRS (pricing return swap) method. PRS is a structure in which a company transfers stocks it owns to investors who are counterparties and compensates for losses when the value falls. On the other hand, when asset value increases, investors transfer the increased value of the purchased stocks to the company (preserving the difference).
In simple terms, instead of selling shares, the company raises funds based on them. Investors give up profits but limit losses, and it is a type of derivative contract in which they receive fees or dividends.

Meanwhile, Lotte Chemical also signed a PRS contract worth 662.6 billion won by utilizing a 40% stake in its US corporation (Lotte Chemical Louisiana LLC).

SK On · Lotte Chemical, Reasons for PRS Contracts…Limitations in Funding

PRS contracts are made for various purposes. Among them, while large-scale funds are required, there are many cases where debt financing is difficult.

SK On succeeded in turning a profit in the third quarter of this year, three years after its independent launch from SK Innovation in 2021. However, there is a high possibility of deficit again due to the one-time profit base effect. SK On has raised a total of 3 trillion won in funds from financial investors (FIs) since the spin-off. If SK On fails to reach an appropriate level of corporate value by 2026, its parent company SK Innovation will have to repurchase the stake held by FIs. Alternatively, FIs may exercise a drag-along right to sell SK On shares held by SK Innovation.

SK On can only escape the worst-case scenario if its growth leads to increased value and a successful initial public offering (IPO). In this process, since investment expansion is inevitable, funds are needed.

SK On's credit rating is A+, so if a large amount of funds are raised through debt, the burden of financing costs will increase. The corporate bond credit rating guaranteed by its parent company, SK Innovation, is AA0, but it is not enough to reduce the excessive debt burden. If SK On fails to IPO, etc., SK Innovation could also be hit.

In the current situation, it is most ideal for SK On to raise capital in the form of equity. However, due to the limitations of being an unlisted company, it is difficult to evaluate its fair value. However, from SK On’s perspective, it is believed that SK On's current valuation is undervalued due to its confidence in the growth of electric vehicles.

On the other hand, from the perspective of investors, the PRS contract reflects some doubts about SK On’s long-term financial stability and performance improvement.

Lotte Chemical’s situation is not much different. Lotte Chemical’s credit rating is AA0 and its rating outlook is ‘negative.’ It is clearly showing the recession of the petrochemical industry, as it turned to a deficit in the third quarter of this year.

Avoiding the PRS aftermath... Improving Performance and financial stability are urgently needed

The reason why SK Innovation, the parent company of SK ON, and Lotte Chemical cannot aggressively engage in market procurement is related to the group's credit. Both companies are affiliates that have a significant impact on the credit ratings of their respective groups. They chose PRS as a procurement route with the least accounting burden.

However, the PRS arrangement is not without its share of investor negativity, as noted above. This could have a negative impact on the group as a whole if it is not supported by an industry conditions and improving performance.

An investment bank (IB) official said, "Both SK On and Lotte Chemical are raising funds to improve their financial structure," and "Dramatic restructuring of low-profitability sectors will be inevitable in the process." He added, "PRS is not a bad choice in a situation where capital procurement is difficult, but it could face greater difficulties if performance worsens and financial burden increases."

Lee Sungkyu (lsk0603@fntimes.com)