An analysis said the price gap between SK hynix American depositary receipts (ADRs) and the domestic common shares is more likely to narrow through gains in the common shares rather than a sharp drop in the ADRs going forward. Even if the share-conversion process begins, the ADR premium is more likely to stay at a certain level, as in the TSMC case, rather than disappear in a short period.
Lee Jeong-bin, a researcher at Shinhan Investment & Securities, said in a report on the 23rd that "we judge the current 33% SK hynix ADR premium to be a level where the premium from U.S. market access is compounded by supply-demand distortions in the initial listing stage," adding, "it is hard to conclude that the premium will shrink immediately just because the share conversion starts."
The SK hynix ADR started at about a 3% premium right after listing, but it expanded to as much as 52% in a short time on strong interest from U.S. investors and limited float. Since then, the premium has fallen to about 33.2% now.
The report cited strong access demand from U.S. investors, limited ADR supply, and an imperfect arbitrage structure between the common shares and ADRs as reasons for the early listing premium expansion. While ADR prices were surging, the domestic common shares were relatively weak.
Shinhan Investment & Securities focused on the TSMC case, which listed ADRs earlier than SK hynix. TSMC ADRs have maintained an average premium of about 13% since 1998 and 12.6% on average over the past five years.
Lee said, "the TSMC case shows that even if an ADR conversion regime exists, the premium can persist if actual new supply is operationally constrained or if ADR supply does not respond immediately to changes in demand," adding, "it is a reference case that the premium is not completely removed by conversion potential alone, and it suggests that SK hynix's ADR premium may not disappear immediately."
Investors are focused on the share-conversion process between the common shares and ADRs that begins on the 29th. Starting that day, with the additional listing of the underlying domestic shares, applications for share conversion will become possible.
However, Shinhan Investment & Securities said the premium is unlikely to normalize right away just because the share conversion starts.
Lee said, "whether actual arbitrage occurs depends on the size of new ADR issuance by Citibank," adding, "while there is room for additional issuance under the registration criteria, actual ADR supply is subject to the depository's operating procedures and approval conditions."
Lee added, "July 29 is less a point that confirms premium normalization than the first inflection point to check the actual supply response."
Rather, past cases show that after a high ADR premium, the gap narrowed more often through gains in the domestic common shares than through ADR price adjustments.
Shinhan Investment & Securities said that an analysis of corporations with ADR listings, including TSMC, UMC, ASML, Sony, POSCO Holdings, KT and SK Telecom, found that after the ADR premium entered the top 10% to 20% of its historical distribution, the common shares recorded excess returns versus the market over both 20 and 60 trading days.
In particular, "in the high-premium top 10% and 20% ranges, about half of the premium narrowing occurred through gains in the common shares rather than ADR declines," adding, "in past cases, the gap between the two markets narrowed more often as the common shares followed higher rather than as ADR prices corrected."
TSMC, the representative case, also posted double-digit excess returns versus the market in its common shares over 60 trading days after a high ADR premium formed.
Lee said, "currently, with a high ADR premium formed in the early listing stage, SK hynix's 12-month forward price-earnings ratio (PER) is about 4.7 times, placing it in a historically undervalued range," adding, "since a high ADR premium and historical undervaluation are appearing at the same time, it is worth noting the possibility that prices will transfer to the common shares going forward."