As SK hynix considers issuing American depositary receipts (ADR) using its treasury shares, criticism is emerging that this is an attempt to circumvent the move to mandate the cancellation of treasury shares.
Although it cited enhancing corporate value as the rationale, observers say the effect of issuing ADR would be limited, and with treasury shares that should be canceled instead released on the U.S. stock market, it amounts to a crafty way to raise capital.
On the 10th, SK hynix effectively acknowledged preparations for an ADR issuance by disclosing that it is "reviewing various options to enhance corporate value, including listing on the U.S. stock market using treasury shares." After the disclosure, the stock jumped more than 3% that day alone.
An ADR is a system in which a U.S. depositary institution holds shares of a foreign company and issues depositary receipts based on them for listing on the U.S. stock market. Because they can be traded in dollars, they have an effect similar to a U.S. listing.
The stated reason SK hynix is considering an ADR listing is to address its undervaluation compared with a competitor. SK hynix's current price-earnings ratio (PER) is about 11 times, roughly one-third of U.S. Micron's 34 times. Its expected price-to-book ratio (PBR) for next year is also lower at 2.1 times versus Micron's 3.2 times, highlighting a wide valuation gap.
Kim Seon-woo, a Meritz Securities researcher, said, "If ADRs are issued, the valuation gap with Micron will narrow quickly," adding, "In addition to investors' long-short strategies, we can also expect inflows from funds tracking the Nasdaq and the Philadelphia Semiconductor Index."
However, in the industry, the prevailing view is that this move is aimed at evading rules on treasury shares. The government's proposed amendment to the Commercial Act would require companies to cancel treasury shares within at least one year, but it has no separate provision regarding ADR issuance.
If the Commercial Act amendment takes effect, there are concerns that treasury shares that should be canceled will circulate in the U.S. market as ADRs, reducing the potential improvement in earnings per share (EPS) that shareholders could expect.
An official in the capital markets industry who requested anonymity said, "Moving treasury shares overseas right before cancellation is close to a workaround," adding, "If the goal is to enhance corporate value, cancellation should generally come first, but turning treasury shares into tradable stock through ADRs inevitably dilutes the shareholder return effect compared with cancellation."
In fact, Taiwan's TSMC, often cited as a success case, issued ADRs using common shares, not treasury shares. After listing on the U.S. stock market in 1997, global investors applied valuations similar to local competitors, adding a premium that fed into gains in its underlying shares. It also expanded ADR issuance from about 2%–3% of initial total shares outstanding to roughly 20%, securing trading volume.
An industry official said, "If you are aiming for the ADR effect, there is no need to use treasury shares that are subject to cancellation."
The size of the treasury shares is also seen as a limitation. The treasury shares SK hynix can use amount to only about 2.4% of total shares outstanding, or about 10 trillion won, making it difficult to secure meaningful trading volume in the U.S. market, critics say. In essence, it could end up as a "showcase ADR."
Lee Nam-woo, head of the Korea Corporate Governance Forum, said, "A 10 trillion won size is effectively classified as a small cap in the U.S. stock market, so it is hard to expect inflows from global funds," adding, "TSMC's ADR alone trades 5 trillion won a day. With SK hynix's current treasury share volume, it is insignificant. Rather, cancel 10 trillion won in treasury shares, then repurchase an additional 20 trillion–30 trillion won and issue ADRs—that would be the way to truly boost value."
The main rationale for ADRs—"improving access for foreign investors"—is also unconvincing. Starting next year, foreigners will be able to trade Korean stocks directly without opening an account at a domestic securities firm under a "unified foreign investor account system." As access barriers for foreigners fall, observers say the effectiveness of issuing ADRs should be reconsidered.
Meanwhile, an official involved in discussions on the "mandatory cancellation of treasury shares" bill said, "We recognize that disposing of treasury shares externally through ADRs instead of canceling them could be disadvantageous to ordinary shareholders," adding, "We are reviewing how to reflect this in the bill."