This year, the 5 trillion won deal for liquefied natural gas (LNG) from SK Innovation, which is gaining attention as the 'biggest catch' of the year, appears to be solidifying into a three-way battle. Global private equity fund (PEF) operator Kohlberg Kravis Roberts (KKR), Brookfield Asset Management, and Korea's capital market giant MERITZ Securities are in contention.
The two operators have bet on acquiring redeemable convertible preferred shares (RCPS) issued by SK Innovation's LNG power plants. Since RCPS is not considered a liability, it is a less burdensome option for SK, making the possibility of completing the deal greater, according to industry insiders.
On the other hand, MERITZ Securities is reported to be investing in LNG assets in the form of convertible preferred shares (CPS) and demanding credit enhancement from SK Innovation. Since credit enhancement would effectively be viewed as a liability, there are opinions that it is uncertain whether SK, which seeks to avoid increasing debt, would be able to accept such conditions. MERITZ Securities is also reported to have proposed investing in SK Innovation's subsidiary SK On in the form of a price return swap (PRS).
◇KKR vs Brookfield, choosing RCPS like SK E&S
According to investment banking (IB) industry sources on the 10th, KKR, Brookfield Asset Management, and MERITZ Securities participated in the preliminary bidding for SK Innovation's LNG liquefaction deal.
The liquefaction of SK Innovation's LNG is aimed at raising funds based on five private power plants, including Gwangyang, Paju, Yeoju, Hanam, and Wirye power plants, as well as LNG terminal and other infrastructure assets. SK aims to secure up to 5 trillion won by liquefying these assets.
Multiple industry insiders have reported that KKR and Brookfield have proposed to invest in the form of RCPS. Each power subsidiary would issue RCPS, selling them to a special purpose company (SPC), which the private equity funds would then invest in.
Some analysts point out that if the redemption rights of the RCPS are activated, the investment of 5 trillion won may be recognized as a liability, which could burden SK. SK Innovation originally pursued this LNG liquefaction deal amid growing financial pressure as its total liabilities reached 75 trillion won, making it difficult to accept a proposal that could increase liabilities.
In response, KKR and Brookfield are said to have alleviated the risk of the investment being recognized as a liability by granting redemption rights to the issuing company, namely, the LNG subsidiaries of SK Innovation. Generally, under Korean International Financial Reporting Standards (K-IFRS), if the redemption right lies with the issuer, it is recognized as equity, while if the redemption right lies with the investor, it is considered a liability. If the decision-making authority regarding redemption lies with the issuer, it is reasonable to classify it as equity due to the lack of creditor rights for the investor.
The RCPS is also a method previously used by SK E&S to raise about 3 trillion won, where the redemption rights were held by SK instead of the investor KKR. This allowed SK E&S to include this RCPS in its total equity, thereby reducing its debt ratio.
However, even if the redemption rights of this RCPS are with SK Innovation, it remains uncertain whether credit rating agencies will recognize it as equity. Rating agencies have pointed out that while they recognized RCPS issued by SK E&S as equity for accounting purposes, it was actually closer to liabilities, causing controversy.
◇CPS investment and SK Innovation seeking credit enhancement?… “effectively a liability”
MERITZ Securities' strategy differs from those of KKR and Brookfield. It is reported that they proposed to invest in a CPS form that excludes 'redemption rights' altogether, focusing only on conversion rights. Instead, they demanded a plan to receive credit enhancement from SK Innovation.
An IB industry insider said, 'MERITZ is said to have offered an interest rate in the 6% range, which would only be possible if it were a credit asset rather than a non-credit asset.' In other words, since the CPS is effectively a liability, the internal borrowing rate could be lower, making it possible to offer SK an interest rate in the 6% range.
Industry analysts suggest that this method may actually increase SK's debt burden. An IB industry insider stated, 'MERITZ has not yet completed due diligence on the LNG assets, meaning they have essentially invested based on the creditworthiness of SK Innovation, making it more reasonable to view the CPS as a liability.'
Conversely, if SK's credit enhancement is removed to alleviate the risk of recognizing the CPS as a liability and to strengthen the equity investment nature, it could result in significant losses for MERITZ Securities. The CPS could be a 'double-edged sword.'
Equity investment is generally difficult to retrieve and highly volatile in price, so if it increases significantly, the Financial Supervisory Service's (FSS) Net Capital Ratio (NCR - the ratio of operating net capital to total risk) regulations would result in a very high risk weight. In this case, the NCR of the securities firm could decrease, effectively blocking other high-risk investment activities.
MERITZ Securities is also reported to have proposed a 'SK On package deal' to SK. MERITZ is said to have recently proposed to invest billions of won in SK On through the PRS method. They intend to support funding by using the assets of parent company SK Innovation and holding company SK Inc. as collateral. Currently, SK Inc. holds a 55.9% stake in SK Innovation, while SK Innovation owns 87% of SK On.
An industry insider noted, 'If MERITZ really has the ability to inject billions into SK On, it would receive very high points in SK Innovation's LNG liquefaction deal as well.'