SK hynix ADR trades 30% above domestic shares, leaving retail investors to weigh their options

SK hynix's American depositary receipts have been trading more than 30 percent above the company's domestic shares since the ADRs listed on NASDAQ, complicating the calculus for investors. Attention is now turning to Monday, when two-way conversion between the domestic shares and the ADRs begins — and whether that mechanism will narrow the price gap and lift the domestic share price.

SK hynix ADRs made their official debut on NASDAQ on July 10 (local time).

An ADR is a certificate that allows US investors to hold stakes in foreign companies, including those listed in South Korea. The SEC defines an ADR as a security representing an ownership interest in shares of a non-US company held by a US depositary bank. Major financial institutions such as JPMorgan and Citibank serve as depositary banks, issuing and managing the certificates on behalf of foreign issuers.

ADRs are classified into three levels depending on capital-raising requirements and disclosure obligations. SK hynix's ADR is a Level 3 structure, which allows the company to raise capital simultaneously with the exchange listing. By contrast, SK Telecom and Korea Electric Power Corporation have Level 2 ADRs, which do not permit capital raising through new share issuance.

SK hynix issued new shares to create a separate pool of securities for US investors. The company issued 17.79 million new shares — equivalent to about 2.5 percent of total shares outstanding — and listed 177.9 million American depositary shares. Each ADS traded in the US market corresponds to 0.1 of a domestic ordinary share, meaning the Korean stock was effectively divided into 10 pieces for the US listing.

Securities analysts at home and abroad expect the ADR listing to serve as a catalyst for a revaluation of SK hynix in global markets. The company is now more likely to be included in the Philadelphia Semiconductor Index and will be assessed alongside US memory chipmaker Micron in the same market. There is also growing expectation that the higher valuation formed in the US market could feed through to the domestic shares.

Contrary to hopes that the ADR listing would trigger a revaluation of the domestic shares, the ADR premium has continued to widen, with the same company's stock trading at a higher price in the US market.

According to Investing.com, SK hynix ADRs closed at $171.94 on Tuesday (local time). Converted at the won-dollar exchange rate on Wednesday (1,482 won per dollar), one ADR share is worth approximately 2.55 million won ($1,730) — about 38.8 percent above the domestic closing price of 1.84 million won on Wednesday.

The ADR premium over the domestic shares has held in the 20 to 30 percent range. According to Mirae Asset Securities, the premium stood at 14.4 percent on the first day of trading, July 10, before surging to 48.8 percent on July 14.

Two main factors explain the elevated premium. The first is strong demand from US investors. Bloomberg reported that the SK hynix ADR book-building process attracted orders more than seven times the offered amount, with total order volume reaching $200 billion. Given that backdrop, it was widely anticipated that the ADR price would trade above the domestic share price in the early days of listing.

The second factor is the restricted conversion structure currently in place. Investors can convert ADRs into domestic shares, but not the other way around. If ADRs were cheaper than domestic shares, an investor could buy ADRs in the US, convert them into domestic shares and sell them for a profit. But the reverse — buying cheaper domestic shares and converting them into ADRs to sell in the US market — is not currently possible.

Consider a hypothetical: a domestic share costs 1 million won and 10 ADRs are worth 1.2 million won in won terms. If two-way conversion were freely available, an investor could buy one domestic share for 1 million won, convert it into 10 ADRs and sell them in the US for 1.2 million won. As such trades multiplied, the additional ADR supply in the US market would push the ADR price down while buying pressure on the domestic shares would push that price up, narrowing the gap between the two.

At present, however, domestic shares cannot be converted into ADRs, so even investors who buy the relatively cheaper domestic shares cannot sell them as ADRs in the US market. As a result, even when demand for ADRs surges, no new supply enters the market, keeping the ADR price above the domestic share price.

The price gap is expected to narrow once two-way conversion between domestic shares and ADRs begins Monday alongside the domestic listing of new shares. The Korea Securities Depository will accept conversion requests from investors and the depositary bank, Citibank, verify issuance limits and conversion ratios, and then process the transactions.

Once two-way conversion is in place, arbitrage becomes possible: when domestic shares trade below ADRs, investors can buy domestic shares, convert them into ADRs and sell them in the US market. That process would channel buying pressure into the domestic shares while increasing ADR supply in the US, gradually closing the price gap.

"If ADRs trade at a premium to the domestic share equivalent in the US, arbitrageurs can deposit domestic shares with the depositary bank, receive ADRs and sell them — a channel through which the ADR price can pull the domestic Kospi share price higher," said Lee Jong-wook, a researcher at Samsung Securities.

"Just as TSMC managed its ADR premium by gradually raising the ADR share from 2.9 percent of total shares outstanding at the time of issuance to 20.5 percent today, SK hynix has ample room for a virtuous cycle of revaluation between its ADRs and domestic shares," said Kim Min-gyu, a researcher at KB Securities. The analysis suggests that expanding ADR supply over time will allow the company to keep the premium in check.

According to the depositary receipt registration statement (Form F-6) SK hynix filed with the SEC, the ADS custody limit is 1.78 billion shares, equivalent to 25 percent of total shares outstanding. After accounting for the 2.5 percent in new shares already issued, the company retains 22.5 percentage points of additional issuance capacity.

Some analysts see a scenario in which SK hynix ADRs sustain a high premium over the long term, as TSMC's have. TSMC is the most prominent example of an ADR that has consistently traded above its domestic shares in the US market. According to Shinhan Investment, TSMC's average ADR premium for 2024 through 2026 is 19.1 percent.

The persistence of that premium reflects structural constraints on conversion between domestic shares and ADRs. TSMC gradually expanded its ADR share after listing to manage the premium, but doing so required approval from its board of directors and Taiwan's Financial Supervisory Commission, as well as SEC registration — a process effectively equivalent to a secondary offering. Those hurdles made it difficult to arbitrage the gap by converting cheaper domestic shares into ADRs for sale in the US, allowing the price divergence to persist for an extended period.

SK hynix faces similar constraints. Converting domestic shares into ADRs requires navigating issuance limits, available conversion volume and verification procedures with the depositary bank.

For example, if the ADR issuance limit corresponds to 100 domestic shares and 90 shares are already deposited as the underlying assets for ADR issuance, only 10 additional shares can be converted into ADRs. If all 100 shares are already deposited and the limit is exhausted, further conversion is only possible once existing ADRs are converted back into domestic shares, freeing up capacity. By contrast, converting ADRs back into domestic shares carries no such issuance-limit constraint.

For domestic retail investors, converting domestic shares into ADRs requires a separate application through a brokerage and additional foreign exchange procedures. Given the conversion fees and processing time involved, arbitrage activity is unlikely to ramp up immediately even after two-way conversion begins. Institutional investors, who manage far larger volumes than retail investors, are expected to drive most of the activity.

Market participants identify the elasticity of two-way conversion as the critical variable going forward. "The easier it is to convert between ADRs and domestic shares, the more fully the valuation expansion effect can transfer to the domestic shares," Kim of KB Securities said. "The smoother the conversion process, the higher the likelihood that ADRs and domestic shares will be revalued together."

UBS also weighed in, saying investors will watch the headroom remaining under the foreign ownership limit for additional conversions of domestic shares into ADRs. "Without that conversion flexibility, the US line is likely to trade at a clear and persistent premium due to limited accessibility," UBS said.

So how should domestic investors respond? According to the Korea Securities Depository, domestic investors net purchased $547.48 million worth of SK hynix ADRs between July 10, when the ADRs listed on NASDAQ, and July 20.

UBS on July 8 recommended that investors sell domestic shares and buy ADRs ahead of the SK hynix ADR listing. A securities industry official cautioned that "the strategy is more of an arbitrage play on short-term price differences than a long-term investment approach," adding that while an ADR premium was likely to form in the early days of listing, "it would be premature to assume that translates into a structural premium that persists over the long term."

In practice, ADRs and domestic shares cannot diverge in opposite directions indefinitely. As the price gap widens, arbitrage activity tends to emerge and pull the two prices back toward convergence. "From the perspective of global investors who have access to both the Korean and US markets, there may be a move to buy the cheaper domestic shares rather than the more expensive ADRs," said Kim Jae-seung, a researcher at Hyundai Motor Securities.

If ADRs rise, domestic shares may follow; conversely, if domestic shares move first, ADRs may reflect that gain. Ultimately, the long-term direction of the share price will be determined by the company's earnings and growth prospects, not by the ADR dynamic itself.

"If the US market premium feeds through to a rebound in the domestic shares, a strategy of increasing exposure to SK hynix makes sense," said Noh Dong-gil, a researcher at Shinhan Investment. "On the other hand, if the US premium persists while the domestic shares stagnate or the price divergence deepens, investors should consider trimming their positions as a risk management measure."

Retail investors also need to account for the costs of investing in ADRs. Beyond foreign exchange fees and currency gains or losses, investing in ADRs can trigger additional costs including the 22 percent capital gains tax on overseas equities.