INTRODUCTION

    In 1938 Byung Chull Lee started a food export business in Taegu, Korea. In the 1950s Mr. Lee expanded his business in to areas like sugar manufacturing and insurance. In the 1960s he further expanded in to department stores, paper, newspapers and finally in 1969 electronics.  By this stage Mr. Leefs business interests were all given the name Samsung, which literally means gthree starsh in Korean. Further diversification occurred during the 70s and 80s as Samsung moved in to chemicals, shipbuilding and a number of new technology products like semiconductors.

     Samsung was one of a number of Korean family controlled conglomerates that became known internationally around this time, the other well known ones being Hyundai and LG.  (In Korean these conglomerates are known as chaebol).

   In the early1990s Samsungfs indebtedness expanded rapidly as the company borrowed from the banks rather than dilute family ownership. This expansion included an attempt to enter the automobile industry starting completely from scratch.

   In 1997 the Asian crisis occurred and Samsung was in a difficult position with a net debt to equity ratio of 350%. The Korean government stepped in to save the banks. They also forced the conglomerates to split up and reduce their debts. In this process Samsung Electronics emerged from the conglomerate as a global leader in semiconductors, mobile phones and consumer electronics.

   The semiconductor division is the biggest manufacturer of DRAMs (Dynamic Random Access Memory) in the world. They are also the biggest manufacturer of NAND Flash memory and increasingly they are trying to expand out of these commodity products in to higher value SOC (system on a chip). They are also the worldsf largest producer of LCD (Liquid Crystal Displays) screens and for some reason these are included in semiconductors.

    The telecommunication division is divided in to mobile phone handsets and wireless equipment. Handsets is by far the biggest element and Samsung is the third biggest manufacturer in the world after Nokia and Motorola haven overtaken SonyEricsson last year. In the CDMA handset market they are number one but in the GSM market they are number five.

     The consumer electronics division also includes home appliances that are primarily sold in Korea. Consumer electronics itself consists primarily of TV, audio and camcorder products.

OVERVIEW

Parent Company accounts and Consolidated accounts for Samsung

            P&L

  Parent 2002 (Wbn)

Consolidated 2002 (Wbn)

  Sales

            40,512

            59,569

  Gross Profits

            13,566

            22,616

  Operating Profits

              7,245

             9,246

  Pre-tax Profits

              8,870

             9,569

  Net Profits

              7,052

             7,052

 Korean accounting historically used parent company accounts but in recent years they have been forced to provide more detailed consolidated accounts.

 Parent company accounts are not as bad as Japanese parent company accounts because even though they exclude revenues and costs of subsidiaries they do include profits (losses) of those subsidiaries in the non operating line. This is why we end up in a situation where parent company profits equal consolidated profits in the table above.

  Korean companies are only required to provide consolidated accounts once a year. They are obliged to provide parent company accounts once a quarter and this is why Korean analysts base their models on parent company accounting.

  In the case of Samsung they have a lot of subsidiaries (see Appendix 1) and some of them are quite important like Samsung Card and Samsung Capital. Samsung also have a large number of affiliates and associates given its conglomerate (chaebol) background.

 I will provide as much information as is possible on the total company but to a certain extent I will be forced to look at parent company information. Samsung Card is the biggest problem for Samsung Electronics and I will therefore look at it separately.

Breakdown of sales by division (parent company)         1 Euro = 1370 Korean Won

Division 02 Sales (Wbn)

        %

03e Sales  (Wbn)

         %

Semiconductors

     12,815

        32

      15,370

        36

Telecom

     12,407

        30

      14,043

        33

Consumer Elec.

     15,290

        38

      13,106

        31

 

     40,512

      100

      42,519

      100

   Samsung has been investing aggressively in semiconductors.  It has become the biggest division and it is likely that it will become even bigger. Consumer electronics should become smaller over time.

Operating Profits by division (parent company)

 Division

 Op. Profit  e02

 Op. Margin %

Semiconductors

         3592

          28

Telecommunications

         2982

          24

Consumer Electronics

           671

            4

 

         7245

          18

 Consumer electronics remains a difficult area for all companies and Samsung is no different.

 

Sales by Geography (consolidated basis)

         Country

  2002 Revenues (Wbn)

                  %

South Korea

            24,195

                40.6

Other Asia

            13,613

                22.9

North America

            11,745

                19.7

Europe

              9,852

                16.5

ROW

                 162

                  0.3

 

            59,567

               100.0

 Consolidated revenues include 100% of Samsung Card and Samsung Capital and therefore probably overstate the importance of Korea to the overall company.

COMPETITIVE POSITION

(1)   Semiconductors

  We can break the semiconductor division in to four distinct parts: DRAMs, Flash, System ICs (Integrated Circuits) and LCD.

 

3Q f03 Revenue Wbn

               %

 Op. Profit Margin %

DRAMs

           1,515

               35

               38

Flash

           1,035

               24

               35

System ICs

              440

               10

               12

LCD

           1,380

               31

               26

 

           4,370

             100

               31

(a)     DRAMs:  These are mass produced low end semiconductors that suffer from violent swings in profitability due to the highly capital intensive nature of the business.

Samsung have managed to be the most successful manufacturer due to their economies of scale. They are the number one in terms of market share and will maintain this position in the foreseeable future due to spending more than double their nearest competitor on capital equipment in the year 2003.

        Company

e02 Market Share %

  Samsung

          31.7

  Micron

          18.5

  Infineon

          12.9

  Hynix

          12.7

  Nanya

           5.3

  Elpida

           5.1

  Others

         13.8

 

        100.0

 There are many different kinds of DRAM and the current industry standard is called DDR (Double Data Rate). The next generation is DDR400. Samsung has been investing in the newest production equipment to achieve leadership in this next generation product.

 Being the leader allowed Samsung to achieve operating margins of 38% in the third quarter while competitors like Micron and Infineon continued to lose money.

 If the PC market continues to grow Samsung should continue to see good profits from this division. Most analysts predict growth in the high single digits next year.

(b)     Flash: These are mass produced semiconductors that do not lose their stored data when power is switched off. They are therefore very useful in products like mobile phones and digital cameras. There are two different kinds of flash, NOR and NAND. Samsung specialise in NAND. They bought a technology licence from Toshiba, who developed the NAND technology and now Samsung have a 65% market share versus Toshibafs 35% share.

NAND is primarily used in Digital cameras so at the moment demand is increasing rapidly.

 Samsung achieved 35% operating margins in the third quarter and even though ST Micro, Infineon and AMD have recently bought licences from Toshiba in order to start producing NAND, Samsung should see further improvement in the next few quarters.

  Toshiba have also announced that they are expanding NAND capacity but  Samsung is ahead of them.

(c)     System IC: These are more sophisticated semiconductors that combine different functions on the one piece of silicon. In this area Samsung is competing against Infineon, ST Micro, Philips, NEC etc. At the moment this is a small part of their business but they intend to expand it rapidly. I presume a certain amount of these System ICs will be used internally in Samsung mobile phones and consumer electronics products, thus replacing chips supplied by competitors.

(d)     LCD:  These are the flat panels that are used in notebook computers, as monitors for desktop computers and the new growth area of TVs.

               

               Samsung are running neck and neck with LG Philips to be the number one producer in the  world. Again this is a reasonably low end product where economies of scale are essential. Samsung are investing in new generation production facilities to retain their leadership position.

             In the third quarter they achieved operating margins of 26% showing once again the benefits of being in a leadership position. Prices have continued to increase as the following chart shows:

People like larger panel sizes for their notebooks and TVS but as you increase the panel size you reduce the output so it is not clear that all the capacity being built will lead to an oversupply situation.

(2)   Telecommunications

     Samsung are now the third biggest handset producer in volume terms and very close to being the second biggest in terms of value. They have seen their market share increase significantly in recent years and will probably exceed 10% in 2003.

     Handsets are about 90% of revenue in the telecom division. They do have a small equipment business but it is irrelevant.

  Samsung have a higher market share in CDMA handsets (20%) because the Korean market operates on that standard. They have been growing their market share in GSM handsets and should be well positioned to compete in 3G handsets.

  Samsung have achieved operating margins of 25% which is close to those of Nokia and well ahead of Motorola, Siemens and SonyEricsson. UBS believe that these high margins are due to their high end strategy. Specifically they identify the following:

(3)   Consumer Electronics

   This division is now less than one third of total sales and like all the major electronics firms it has been struggling to achieve profitability. In the future this division will become less important but the strength of the Samsung brand should at least allow them to make a return above the cost of capital.     Interbrand has identified Samsung as the fastest growing brand in the world in 2003. They went from being the 34th best brand in the world in 2002 to 25th in 2003.

    Samsung also hope that the move to flat panel TVs will help them due to their strength in flat panel production.

(4)   Samsung Card

       Samsung own 57% of Samsung Card and the profits / losses of this subsidiary appear in the equity in earnings line on the parent company accounts (which is part of non operating profits / losses) and are fully reflected in the consolidated accounts with the minority interest line reflecting the 57% ownership.

       Samsung Card like all Korean credit card companies has been hit by a major bad debts problem. We saw this in Kookmin Bank and it has been in the news a lot recently due to problems at LG Card, the biggest card company.

      Samsung Electronics injected capital of W100bn earlier this year and it does appear that Samsung Card have taken action to improve their situation. They have cut their outstanding loans from W28tr in January 2003 to W15.6tr at the end of October. They have taken write offs of over W2.5tr so far this year and currently have about W1.6tr of loans that are delinquent for more than 30 days. This still represents a delinquency ratio of over 10%. This is still high compared to the 4% that USA credit card companies experience but I heard an analyst from Fitch state -at least Samsung slimmed down faster and were nimble.

      This is clearly a problem area but all the analysts have cut their equity in earnings to reflect these problems. This type of issue partially explains the relative cheapness of Samsung electronics.

      Some of Samsung Cardsf strong cash flow may be used to support Samsung Card but at this stage this news is already in the share price.

COST STRUCTURE

   In telecommunications and consumer electronics their biggest cost is component related. They own stakes in a number of component companies which will prevent them from being squeezed too badly.

   In semiconductors their biggest cost is capital equipment. They spent in early 2003 when prices were cheap and lead times low so they should be well positioned as supply is now getting tight.

  Research, advertising and labour costs are all large parts of their cost base but nothing here should hurt them on a relative basis.

PROFITABILITY AND RETURNS

 

             02

            03e

           04e

  Operating Margin (%)

            18

            15

           16

  ROIC (%)

            32

            26

           29

  CFROI

            19

            11

           12

  Transaction CFROI

            19

            11

           12

  Samsung is a profitable company that generates good returns. Those returns have fallen in 2003 due to Samsung Card and weak consumer electronics and I believe that the consensus forecasts for 2004 are too conservative and will be revised upwards due to the strength of the semiconductor and handset markets.

Peer group comparison  ( 2002 numbers)

Company

  Op. Margin (%)

          ROE (%)

         CFROI

Motorola

             2.9

            -19.9

             0.8

Siemens

             2.0

             11.0

             5.9

Sony

             2.5

               5.0

             6.2

Sharp

             5.0

               3.6

             3.5

  None of these conglomerate technology companies look particularly good.

VALUATION

COMPANY

                             P/E

MARKET IMPLIED CFROI (T+5)

HOLT PRICE TO BEST

         %

           03e

         04e

Samsung

13.4

         10.2

         6.7

         33

Motorola

66.9

         32.9

         4.8

           0

Siemens

25.9

         19.7

         5.6

           9

Sony

70.2

         39.4

         1.0

       105

Sharp

32.4

         26.7

         4.9

           1

EV / Sales = 1.6x           EV/ EBITDA = 7.1           Div Yield = 1.3%               P/B = 2.9

   Samsung obviously looks cheap relative to the peer group.

   The only unusual number in the table is the apparent cheapness of Sony on a Holt valuation approach. If anyone wants to know why I am not so sure that Sony is cheap please ask.

BALANCE SHEET

   Samsung has a very strong balance sheet with net cash of over W4tr and this is after capital expenditure of 7tr in 2003.

  If the problems of Samsung Card get worse it could use up some of this net cash but this is not big enough to cause a problem.

  According to their annual report they have an unfunded element to their severance package. At the end of 2002 this was W318bn. Relative to the net cash position of the company this is quite small and therefore is not a concern.

MANAGEMENT

  This is always a problem with Korean companies. Samsung is still controlled by members of the Lee family. The Chairman, Kun-Hee Lee is probably the son of the original founder.

  Like all Korean companies they over leveraged themselves in the years leading up to the Asian crisis but they have now managed to get themselves in to a net cash position because of their market leading products. I am therefore judging them on the basis of their ability to create a world leading company and on the basis that they have increased dividend payments and started a share buyback programme.

LIQUIDITY ETC.

Market Cap.
US$62bn
KOSPI index weight (Korea)
21%
Beta v FTSE Global Tech 
0.64
HVT
32.2

 

CONCLUSION

   Buy a position but keep it relatively small due to lingering management and Samsung Card issues.

GRAPH 1                 SAMSUNG ELEC.          MONTHLY RSI

GRAPH 2             SAMSUNG ELEC.         WEEKLY   RSI

GRAPH 3               SAMSUNG ELEC.            WEEKLY RSI

GRAPH 4            SAMSUNG ELEC.          EARNINGS ESTIMATES

GRAPH 5        SAMSUNG ELEC.      1 YEAR RELATIVE    (v Korea & Global Tech)

GRAPH 6      SAMSUNG ELEC.     3 YEAR RELATIVE     (v Korea & Global Tech)

GRAPH 7             SAMSUNG ELEC.          MAJOR HOLDERS

SAMSUNG ELECTRONICS       (K.Power 4/12/03)

   Samsung Electronics is a technology conglomerate and is a world leader in semiconductors, flat panels, mobile handsets and consumer electronics. It is the worlds biggest maker of memory semiconductors with 30% market share, it is number one in flat panel production and is number three in the handset market. These are not the highest technology products but I believe that even in lower end technology products a market leader can do well.

   I believe that we should buy a position in Samsung Electronics because:

(1)   Brand leader – fastest growing brand in the world in 2002 according to Interbrand.

(2)   They have the scale that is critical in lower end technology products. Being number one in memory semiconductors is important because of the economies of scale they achieve.

(3)   They have a strong balance sheet that allows them to remain the leader in terms of scale. They currently have net cash of over W4tr ($3bn). They were the biggest spender on semiconductor equipment in 2003 and this now looks like brilliant timing.

(4)   Valuation – Holt shows upside of 33%.   P/E of 12x and div. yield of 1.3%

  There are risks but I believe the positives outweigh the negatives. The main risks are:

(1)   Problems at Samsung Card

(2)   Intense competition in each of their target markets.

(3)   Korean corporate governance is weak.

Killeevan Investment Consultants Ltd, trading as KIC, is regulated by the Central Bank as an Investment Intermediary.
VAT No IE 6415351U Registered Number 395351
Directors: Kenneth Power (Managing) B.Comm, MBS, ASIP, Regular Member of the CFA Institute.
Siobhan Power