By Asian Venture Capital Journal
Whenever someone downloads a song or streams a music video via MelOn - a hybrid of iTunes and Spotify, and the preeminent digital music delivery platform in Korea - parent company Loen Entertainment gets a 30-40% cut of the proceeds. The remainder is divided up among songwriters, artists, production houses and distributors.
For Affinity Equity Partners, the primary objective on acquiring a majority stake in Loen in September 2013 was to control a larger part of this value chain. Just as vertical integration has become key to the business plans of Netflix, Amazon and Hulu, all of which are now looking to own content rather than serve as third-party distributors, Loen snapped up record labels, production houses and even artist management businesses.
It is now a hybrid of iTunes, Spotify, Universal Music Group and Creative Artists Agency - which is one of the reasons why Kakao Corporation was willing to pay KRW1.87 trillion ($1.55 billion) for a 76.4% interest in the business in March of this year, securing Affinity a KRW1.5 trillion windfall and a return of more than 6x.
"Loen gets a larger share of that 60-70%, but perhaps more important are the strategic benefits of vertical integration that are not easily quantifiable," a representative of the private equity firm explains. "By having the supporting infrastructure in house the company is also able to build a better network in terms of other artists, song writers and producers. It can identify which third-party artists could become hit makers and try to get the distribution rights for those artists."
Non-core divestment
The Loen acquisition came about because the conglomerates that dominate Korea's economy through intricate cross-shareholding webs were under pressure to divest non-core assets. Specifically, the government decreed that great grandson companies - the subsidiary of a subsidiary owned by a conglomerate - had to be fully owned or majority control divested. SK Group had various companies that fell into this category and Affinity made its approach before a decision had been taken on making a tender offer for locally-listed Loen and privatizing it or selling a majority stake.
When SK opted for the latter course of action, the private equity firm moved quickly, buying a 52.6% interest from the conglomerate and a further 8.8% stake from Real Networks. The total equity consideration was $190 million. SK retained a 15% holding.
Much of the due diligence had focused on the music download and streaming side of the business, which then accounted for 90% of revenue, and there were concerted value creation efforts in this area. The website and mobile app underwent a revamp intended to enrich the user experience, and additional elements were introduced such as e-commerce, concert ticket sales and a karaoke function that allows users to sing duets with artists. Big data analytics also made for a more efficient and targeted service.
Meanwhile, bolt-on acquisitions transformed Loen's other capabilities. Purchases included production house Starship Entertainment and artist management business A Cube Entertainment, home to popular girl group A Pink and top male singer Huh Gak, among others. King Kong Entertainment took the company into artist management beyond the music sphere, with actor Kwang-Soo Lee - best known as a cast member in popular Korean variety TV show "Running Man" - now on the books.
Affinity also took steps to improve analyst coverage of Loen, reorganizing the investor relations and public relations functions and taking the company on non-deal road shows to markets such as Hong Kong. By the time of exit, the number of analysts following Loen had risen from one to a dozen, both domestic and foreign.
"The stock market didn't understand the company very well. It was trading as if it were a large and mature mobile operator like SK Telecom, which is now seen almost as utility companies," says the Affinity representative. "It was not seen as an entertainment company with the potential to ride the k-pop wave like YG Entertainment or SM Entertainment, and it wasn't seen in the same way as mobile internet companies such as Kakao or Naver-owned Line. We had to change the market perception."
By the numbers
During the ownership period, Loen's share price rose by 570%. The company generated revenue of KRW357.6 billion in 2015, up 42% on the 2013 total, while net income increased 47% to KRW50.3 billion over the same period. Furthermore, Affinity boosted average annual capital expenditure by 18% and increased headcount by more than 50%, delivering a 41% gain in paying members, a 40% jump in average revenue per user, and EBITDA growth of 63%.
Geographical expansion was another element of the value-add process, with Loen entering into two joint ventures with Chinese partners. Korea's cultural cachet and the interest this has aroused from strategic and financial investors in everything from popular music to TV dramas to cosmetics was of undoubted benefit when it came to exit. Kakao and Daum Communications - which merged in 2014, bringing together the country's top mobile messaging provider and one of its leading web portals - were both seen as potential buyers. So too was Naver, and dialogues were initiated at an early stage.
However, the number of inbound inquiries Affinity received from multiple prospective overseas buyers as well as from domestic groups, to a certain extent forced the issue. "Our base case was to hold the asset for five years," says the Affinity representative. "But we started getting approached by potential buyers - sometimes these discussions are about strategic alliances and progress from there - and we realized our exit could be faster than we had anticipated."