SK Hynix’s value-up plans gets C rating;
treasury share cancellation is top priority
“SK Square should be the model to follow” “We raise five key issues to the board”
SK Hynix unveiled its “value-up plan” on November 27th. However, the market’s reaction, as evidenced by the subsequent decline in stock price, suggests that the plan is not shareholder-friendly. We assign a C rating to the plan, as it falls short when compared to the ambitious plan of SK Square’s, which holds a 20% stake in SK Hynix. We gave an A rating to the SK Square plan earlier. Given Park Sung-Ha’s dual role as CEO of SK Square and other non-executive director at SK Hynix, it raises questions as to why a more comprehensive plan wasn’t pursued by Park.
The semiconductor business of SK Hynix is indeed capital-intensive and highly cyclical. The company experienced a significant operating loss of W8 trillion last year, highlighting the industry's inherent volatility. A close analysis of the plan indicates that management and the board have carefully considered the cyclical nature. They have acknowledged a 10-year average cost of equity of 14% (required rate of return from shareholder’s perspective), which is slightly lower than the corresponding ROE of 16% during the same period.
We propose the following to the SK Hynix board:
1. The company has not formulated any plan to cancel the 5.4% stake in treasury shares. Cancellation is considered a major step in enhancing shareholder value. While aligning employee compensation with company performance through equity rewards is a crucial and appropriate strategy, the funding of equity rewards should come from FCF every year (rather than existing treasury shares).
2. The market penalizes capital-intensive businesses, while placing a premium on asset-light models. The company's increasingly capital-intensive nature, as evidenced by a projected three-year average of over mid-30% in capex/sales ratio and PP&E already comprising 50% of total assets, suggests potential downward pressure on its valuation. As the valuation de-rating could adversely affect total shareholder returns, the company's explanation of its shareholder return strategy appears inadequate.
3. The company's capital allocation policy is vaguely defined, with no specific guidelines regarding treasury share buyback/cancellation program. The board should publicly disclose a clear framework. The conditional statement of "additional return within 50% of FCF" lacks clarity to shareholders, in our view. A fixed dividend of W1,500 per share, representing a 6% payout ratio based on current year earnings estimates, seems inadequate. Also the fixed dividend indicates a dividend yield below 1%, that appears meaningless for highly volatile semi sector investors.
4. While we applaud the company’s effort to reduce debt, the new shareholder return policy for 2025-2027, which aims for a net cash position and adequate cash reserves, may adversely impact its share price. Samsung Electronics' long-term practice of holding over W100 trillion in cash and its overcapitalized balance sheet has negatively affected its ROE. The board should establish clear principles regarding the optimal levels of cash and shareholders equity to maximize shareholder value.
5. The company's claim of having a "diverse and independent board" is inconsistent with global standards, in our view. The nomination committee should undertake a more rigorous process in selecting qualified candidates. Given that there are already two other non-executive directors, including the CEO of SK Square, the addition of the SK Inc. CEO to the board is questionable. Furthermore, two of the six independent directors have affiliations with a specific major law firm. Besides Kim Zeong-Won, a senior adviser at Kim & Chang, Han Ae-Ra, a professor at Sungkyunkwan University Law School, was previously associated with Kim & Chang prior to taking up her current position in 2018.
As recommended by the Asian Corporate Governance Association (ACGA), we request that the upcoming general shareholders' meeting in March 2025 be hosted by Chairman of the board Ha Yung-Ku, not CEO Kwak Noh-Jung, and that all six independent directors be in attendance to directly engage with shareholders.
December 2, 2024
Korean Corporate Governance Forum Chairman,
Namuh Rhee
SK Hynix’s value-up plans gets C rating;
treasury share cancellation is top priority
“SK Square should be the model to follow” “We raise five key issues to the board”
SK Hynix unveiled its “value-up plan” on November 27th. However, the market’s reaction, as evidenced by the subsequent decline in stock price, suggests that the plan is not shareholder-friendly. We assign a C rating to the plan, as it falls short when compared to the ambitious plan of SK Square’s, which holds a 20% stake in SK Hynix. We gave an A rating to the SK Square plan earlier. Given Park Sung-Ha’s dual role as CEO of SK Square and other non-executive director at SK Hynix, it raises questions as to why a more comprehensive plan wasn’t pursued by Park.
The semiconductor business of SK Hynix is indeed capital-intensive and highly cyclical. The company experienced a significant operating loss of W8 trillion last year, highlighting the industry's inherent volatility. A close analysis of the plan indicates that management and the board have carefully considered the cyclical nature. They have acknowledged a 10-year average cost of equity of 14% (required rate of return from shareholder’s perspective), which is slightly lower than the corresponding ROE of 16% during the same period.
We propose the following to the SK Hynix board:
1. The company has not formulated any plan to cancel the 5.4% stake in treasury shares. Cancellation is considered a major step in enhancing shareholder value. While aligning employee compensation with company performance through equity rewards is a crucial and appropriate strategy, the funding of equity rewards should come from FCF every year (rather than existing treasury shares).
2. The market penalizes capital-intensive businesses, while placing a premium on asset-light models. The company's increasingly capital-intensive nature, as evidenced by a projected three-year average of over mid-30% in capex/sales ratio and PP&E already comprising 50% of total assets, suggests potential downward pressure on its valuation. As the valuation de-rating could adversely affect total shareholder returns, the company's explanation of its shareholder return strategy appears inadequate.
3. The company's capital allocation policy is vaguely defined, with no specific guidelines regarding treasury share buyback/cancellation program. The board should publicly disclose a clear framework. The conditional statement of "additional return within 50% of FCF" lacks clarity to shareholders, in our view. A fixed dividend of W1,500 per share, representing a 6% payout ratio based on current year earnings estimates, seems inadequate. Also the fixed dividend indicates a dividend yield below 1%, that appears meaningless for highly volatile semi sector investors.
4. While we applaud the company’s effort to reduce debt, the new shareholder return policy for 2025-2027, which aims for a net cash position and adequate cash reserves, may adversely impact its share price. Samsung Electronics' long-term practice of holding over W100 trillion in cash and its overcapitalized balance sheet has negatively affected its ROE. The board should establish clear principles regarding the optimal levels of cash and shareholders equity to maximize shareholder value.
5. The company's claim of having a "diverse and independent board" is inconsistent with global standards, in our view. The nomination committee should undertake a more rigorous process in selecting qualified candidates. Given that there are already two other non-executive directors, including the CEO of SK Square, the addition of the SK Inc. CEO to the board is questionable. Furthermore, two of the six independent directors have affiliations with a specific major law firm. Besides Kim Zeong-Won, a senior adviser at Kim & Chang, Han Ae-Ra, a professor at Sungkyunkwan University Law School, was previously associated with Kim & Chang prior to taking up her current position in 2018.
As recommended by the Asian Corporate Governance Association (ACGA), we request that the upcoming general shareholders' meeting in March 2025 be hosted by Chairman of the board Ha Yung-Ku, not CEO Kwak Noh-Jung, and that all six independent directors be in attendance to directly engage with shareholders.
December 2, 2024
Korean Corporate Governance Forum Chairman,
Namuh Rhee