samsung the unsung hero - valuewalk...1. samsung electronics (005930 ks equity) price: krw 1,367,000...

SAMSUNG Electronics

A contrarian’s perspective on a top 10 global brand with above average growth potential

and a wide margin of safety.

By: Michael Wood www.evansic.com

Source: Samsung Investor Day Presentation 2013

Contest Qualification

1. Samsung Electronics (005930 KS Equity) Price: KRW 1,367,000

Shares: 150,777,000

FX rate: 0.0009 USD/KRW

Market Cap USD: $185 Billion

2. Samsung Electronics GDR (SMSN LI Equity) Price: USD 672.50

Equiv. GDRs: 276,431,000

Market Cap: USD 185.9 Billion

Prices as of 06/13/14

Prices as of 06/13/14

How to buy Samsung Electronics

• All values from here on out are reported in USD • All prices and market caps are as of 06/13/14 • This report contains forward-looking numbers

that could differ from actual results • Samsung Electronics is not a suitable investment

for all investors and individual circumstances should be taken into consideration

• This report is intended to provide the investor with research relating to Samsung Electronics and is not a solicitation to buy the stock

Disclosure

Cheap price Management: honest & skillful capital allocators Dominant and strengthening competitive advantage (low-cost & high-quality manufacturing) Globally recognized brand that is well taken care of (broad and strong associations) Excellent balance sheet protection

Proven Investment Process

• Market Cap = $ US 186 Billion

• Non-operating assets (net) = $ US 60.4 Billion

• Enterprise Value = $ US 125.6 Billion

• Q1-2014 Book value = $ US 145.5 Billion

• 2014E Net Income = $ US 24.0 Billion

• 2014E Free-cash-flow = $ US 24.0 Billion

EV/FCF2014 = 5.2x (prices as of 06/13/14)

Samsung Quick Stats

1. Samsung’s businesses are not well understood, as the market is assuming Samsung is only a smartphone company

2. Samsung Semiconductor is worth the enterprise value itself (the market price implicitly assumes mobile is worth -$33B)

3. Samsung trades at more than a 50% discount to peers and intrinsic value

4. Samsung is manufacturing 13 products with global #1 market share that have very defensible market positions

5. Several catalysts are in motion to unlock the trapped value, including IPOing non-core businesses, corporate restructuring and massive share buybacks ($60B net cash)

6. Management has an astounding track record of successfully creating shareholder value

Thesis

1. Success of Samsung hinges on the success of the Galaxy S franchise

2. There is no growth left in the smartphone industry (the market is fully saturated)

3. Lenovo will drive Samsung’s mobile operating margins to 3% (while Apple will continue to operate in a vacuum)

4. Samsung is a copy-cat and is only successful because they infringe on others’ patents

5. Samsung is not shareholder friendly and will never return capital to shareholders

This presentation seeks to rectify the myths that cloud the investor’s mindset on Samsung Electronics

Dispelling the Myths

• Apple’s Portfolio:

• iPhone 53%

• iPad 19%

• Mac 13%

• iPod 3%

• iTunes 9%

• Accessories 3%

• Samsung’s Portfolio:

• DRAM 5% • NAND 4% • Logic Chipset 5% • Mobile Display 5% • Large Panel Display 6% • Tablets 4% • Low-end Smartphones 14% • Premium Smartphones 28% • Feature phones 3% • Networking Equipment 2% • Laptop/PC 4% • TV/Screen 13% • Home Appliances 6%

Samsung has a diverse product offering that can withstand the failure of any single product. Even if iPhone wipes out Galaxy S, Apple will still need to buy Samsung’s DRAM and NAND memory chips (in larger quantities).

Myth 1 Debunked: Sales by Product (2013)

1. Non-core Assets (net) are worth $US 60.4 Billion

2. Samsung Semiconductor is worth $US 125 Billion

3. Samsung Display is worth $US 29.7 Billion

4. Samsung Home Appliance is worth $ US 11.2 Billion

5. Samsung IT & Mobile is worth $ US 208 Billion

Total Equity Value $ US 433B

Upside to current price: 134%

Cheap Price: Samsung SOTP Value

• Cash and Cash Equivalents: $17.0 billion • ST Financial Instruments: $38.6 billion • ST Available-for-sale FA: $1.9 billion • LT Available-for-sale FA: a $7.3 billion • Investment in Associates: b $6.1 billion • ST Borrowings: -$6.8 billion • Debentures: -$1.2 billion • LT Borrowings: -$2.5 billion

Non-Operating Assets (Net) $US 60.4 billion

As of Q1 2014

1. Non-core Assets (net) – $60.4B

(In millions of US Dollar) Mar-14 Dec-13

Equity securities - Listed $ 3,680 ** $ 3,959

Equity securities - Non-Listed 3,088 704

Debt Securities 558 951

Total $ 7,326 $ 5,615

** Listed Equity Securities:

All values in millions of US DollarsNumber of Shares

Owned

Percentage of

Ownership

Acquisition

Cost

Book Value

March 2014

Samsung Heavy Industries 40,675,641 17.6% $ 195 $ 1,166

Samsung Fine Chemicals 2,164,970 8.4% 41 87

Hotel Shilla 2,004,717 5.1% 13 120

Cheil Worldwide 2,998,725 2.6% 2.6 74

iMarket Korea 647,320 1.8% 0.3 15

SFA 1,822,000 10.2% 34 67

Wonik IPS 7,220,216 9.0% 57 56

ASML 12,595,575 2.8% 653 1,123

CSR - 0.0% - 99

Rambus 4,788,125 4.3% 83 43

Seagate Technology 12,539,490 3.8% 197 669

Wacom 8,398,400 5.0% 56 56

Sharp 35,804,000 3.0% 110 108

Other - 42 49

Total $ 1,484 $ 3,680

1. a. LT Assets Available for Sale

• Samsung SDS to be spun-off in Q4-2014

All values in millions of US Dollars

Investee Acquisition CostBook Value

March 2014

Net Asset

Value

Samsung Card $ 1,384.69 $ 2,092 $ 2,077

Samsung Electro-Mechanics 323.82 841 840

Samsung SDI 309.02 1,067 1,316

Samsung SDS 136.54 803 783

Samsung Techwin 144.26 363 395

Samsung Corning Advanced Glass 193.41 186 186

Other 766 766

Total $ 6,117 $ 6,362

1. b. Investment in Associates

• Samsung Semiconductors is worth 9.5x 2015 operating profit

• This equates to a value of $US 125 Billion

• Consistent with Micron (@7.8x 2015 OP) and SanDisk (@ 10x 2015 OP)

• Samsung Semiconductors is worth the enterprise value of the entire company by itself!!!!

All values are in $US Billion

Samsung Semiconductor 2009 2010 2011 2012 2013 2014E 2015E

Total Revenue 21.4 32.0 33.3 30.7 33.5 41.6 44.9

DRAM 7.5 14.8 12.1 10.6 12.3 16.3 17.5

NAND 5.2 6.7 8.1 7.4 9.1 11.1 12.4

System LSI 3.5 5.9 9.9 11.7 11.4 13.5 14.2

Operating Profit 1.7 8.6 5.8 3.7 6.4 11.4 13.0

Operating Margin 8% 27% 17% 12% 19% 27% 29%

2. Samsung Semiconductor

Source: Bloomberg, Company filings, AllianceBernstein

• #1 global market share in overall memory

• #1 global market share in Mobile DRAM (49%)

• #1 global market share in PC DRAM (33%)

• #1 global market share in NAND (32%)

2. a. Samsung Memory

Source: DRAMeXchange

• Samsung trades at half the valuation of sector

• Samsung Semiconductor will earn $11.4 billion operating profit in 2014, on par with Intel and Qualcomm

• Samsung Semiconductor by itself deserves $125 billion valuation, on par with Intel and Qualcomm’s enterprise values

All values are in millions of US Dollars

Semiconductor Market Cap P/B 5-Year

2014 2015 2016 Q1 2014 ROE

Intel $148,500 $136,577 $53,100 14.8 14.2 12.2 2.6 20.7%

Qualcomm $134,170 $102,117 $27,470 14.6 13.5 10.1 3.5 16.4%

Micron Tech. $33,360 $26,992 $16,300 9.6 8.8 8.5 3.3 12.7%

SK Hynix $32,085 $34,168 $13,238 7.7 6.4 6.8 2.8 10.8%

SanDisk $22,280 $19,560 $6,660 15.3 14.7 13.0 3.4 13.4%

Sector Average 12.4 11.5 10.1 3.1 15%

Samsung Electronics $185,531 $125,110 $232,715 5.2 4.9 4.7 1.4 20.1%

P/E ex. net cashGross

RevenueEnterprise

Value

2. Samsung Semiconductor – Peers

Source: Bloomberg, Company filings

• Consolidation in the DRAM space to 3 competitors has caused DRAM prices to soar and margins to expand

• Since 2013, Micron is up 410%, SK Hynix +83% and Samsung -10%

DRAM Recovery leaves SMSN behind

• Does a company that is consistently taking share in the semiconductor industry deserve a 50%+ discount to its peers?

Source: Gartner

Semiconductor Industry by Revenue

• Samsung Display is worth at least 9x 2014 op. profit, given that their main competitor LG Display trades at 13.7x 2014 operating profit

• Samsung Display is worth $29.7 billion


Samsung Display 2009 2010 2011 2012 2013 2014E 2015E

Total Revenue 20.7 25.4 26.3 29.0 27.8 29.5 31.1

Large Panel 9.8 21.6 20.4 19.5 14.7 13.6 14.3

Small & Medium Panel - 2.3 2.4 2.3 0.6 0.5 0.5

AMOLED (aka OLED) - 1.5 3.4 7.2 12.6 15.3 16.3

Operating Profit 1.4 1.7 (0.3) 2.8 2.9 3.3 3.6

Operating Margin 7% 7% -1% 10% 10% 11% 12%

3. Samsung Display


• Samsung is the dominant player in display with 99% market share in AMOLED

• Samsung has already announced Super AMOLED, securing a two-stage technology lead on peers

• Despite the technological edge, Samsung trades at a steep discount to its most comparable peer LG Display

3. Samsung Display – #1 Position

• Samsung Display trades at a 50% discount to its inferior South Korean competitor LG Display

• Samsung Display deserves a premium to LG Display (7% assumed)

• This is the basis of the $29.7 Billion valuation All values are in millions of US Dollars

Display Market Cap P/B 5-Year

2014 2015 2016 Q1 2014 ROE

LG Display $9,591 $12,712 $27,370 16.1 10.2 9.1 1.0 8.6%



RevenueEnterprise

Value

3. Samsung Display – Peers

Source: Bloomberg, Company filings

• Samsung Home Appliance is worth 7x 2013 operating profit

• Whirlpool trades at 7.8x 2014 operating profit

• This is the basis of the $11.2 Billion valuation


Samsung Home Appliance 2009 2010 2011 2012 2013 2014E 2015E

Total Revenue 41.0 48.7 42.3 45.0 45.0 52.7 53.4

Visual Display (TV, Monitors) 26.3 28.9 31.3 30.8 29.0 34.0 33.9

Appliance 7.7 10.0 11.0 11.8 13.7 16.1 17.0

Other 7.0 9.8 - 2.3 2.3 2.6 2.6



4. Samsung Home Appliance


• Samsung has been the fastest growing company in the Home Appliance arena

• Samsung is strategically well positioned to take advantage of the smart-home revolution and the convergence between technology and home appliances


• Samsung has been making refrigerators since the 1960’s

• Consistently ranked the highest performance product by Consumer Reports

• Continues to innovate in the space (Partnership with SodaStream brings carbonated water to the fridge)


• Samsung is expecting 5.1% CAGR out to 2017


4. Samsung Home Appliance – TV

• Samsung has had the best selling TVs for the last 8 years

• Samsung has the #1 brand awareness globally for TVs

• $11.2 Billion valuation for Samsung Home Appliance is a discount to Whirlpool’s valuation

• Samsung ought to have a premium valuation due to the disruptive/innovative products and the outsized growth


Home Appliance Market Cap P/B 5-Year

2014 2015 2016 Q1 2014 ROE

Whirlpool $10,680 $12,280 $19,410 10.9 9.5 10.1 2.3 13.9%

General Electric $270,050 $434,451 $149,580 16.0 15.8 14.9 2.0 10.4%

Sector Average 13.4 12.7 12.5 2.2 12%



RevenueEnterprise

Value

4. Samsung Home Appliance – Peers

Non-core Assets = $60.4 billion

Samsung Semiconductor = $117 billion

Samsung Display = $ 29.7 Billion

Samsung Home Appliance = $11.2 Billion

Net Asset Value = $ 218.3 Billion

Market Cap = $ 185 Billion

Implied value Samsung Mobile = -$ 33.3 Billion

Samsung valuation so far…

• Is the world’s largest manufacturer of cell phones really worth -$33 Billion?

• Are the risks so high that a business generating $25 Billion operating profit is worth less than nothing!?

• Contrarian View: The fear of a mobile implosion has created a wide margin of safety for the contrarian investor, not to mention a potentially lucrative investment opportunity!

5. Samsung IT & Mobile

• Consensus view:

– Samsung Mobile generates all of their profit from Galaxy S franchise

– Lenovo will drive Samsung’s operating margins to 3%

– Apple will be unaffected by this inevitable industry paradigm shift

– Growth in smartphones has stagnated and will likely remain so for the foreseeable future

5. Samsung IT & Mobile

• Samsung IT & Mobile is comprised of: – Premium smartphones

– Low-end smartphones

– Feature phones

– Tablets

– Premium PCs and laptops

– Networking equipment


Samsung IT & Mobile 2009 2010 2011 2012 2013 2014E 2015E

Total Revenue 30.1 35.0 60.7 93.1 125.2 143.2 149.7

Mobile/Tablet 27.8 32.4 48.1 81.8 112.7 127.5 132.3

PC/Laptop - - 10.7 7.7 8.1 10.1 11.4

Networking Equipment 2.3 2.6 1.9 3.7 4.3 5.6 6.0



5. IT & Mobile – What is in the group?


• Bifurcated strategy: Focused on the (1) high-end and (2) low-end

• Success in the low-end will continue to drive manufacturing costs lower and bargaining power with suppliers higher

• Success in the high end will be predicated on high quality products and a strong brand image

5. Samsung Smartphone Strategy

• Two dominant premium smartphone franchises: (1) Galaxy Note (2) Galaxy S

• With the Galaxy Note, Samsung pioneered the ‘Phablet’ space

5. Samsung Premium Smartphones

• Launched in Q2-2014

• Sold 10 million units 10% faster than Samsung Galaxy S4

• This successful launch should help dampen the consensus view that the smartphone business is about to implode

5. Samsung Galaxy S5 Selling Well

• Samsung offers a broad array of low-end phones that each focus on one different main performance feature

• First phone released with Tizen OS – Samsung Z

Samsung Z

Samsung Galaxy Young Samsung Galaxy Grand Samsung Galaxy Active

Samsung Galaxy Ace 3 Samsung Galaxy Star

5. Samsung Low-end Smartphones

• Growth in smartphone units – Ericsson

• 16.5% unit growth CAGR over 5 years

• Pricing would have to fall by 16.5% annually for the next 5 years for sales and earnings to remain flat

Myth 2 Debunked: Smartphone Growth

• Samsung is the dominant supplier of smartphones, with 31.2% market share as of Q1-2014

5. Global Smartphone Market Share

When one includes premium smartphones, low-end smart phones and feature phones, Samsung still stands out as the dominant supplier for mobile devices to the world:

5. Global Cell Phone Market Share

• Samsung has a solid line up of premium tablets

• Samsung recently announced the launch of new tablets with 2K resolution (best on market)

5. Samsung Tablets

• According to IDC Samsung took 5% market share directly from Apple in 2013

• Samsung now has 22.3% market share in tablets

• Samsung is the only tablet to gain an real traction against Apple

5. Samsung Tablets Taking Share from Apple

• Apple’s enterprise value trades at 8.9x 2014 operating profit

• Samsung’s IT & Mobile business is worth at least 8x 2014 (10% discount to Apple)

• Therefore, Samsung IT & Mobile is worth $208B


IT & Mobile Market Cap Net Cash P/B 5-Year

(debt) 2014 2015 2016 Q1 2014 ROE

Apple $550,930 $133,627 $417,303 $181,382 10.6 10.2 10.0 4.6 27.6%

Google $371,340 $53,472 $317,868 $52,280 17.3 14.5 12.3 4.3 18.5%

Lenovo $13,271 -$1,500 $14,771 $33,873 16.9 15.2 10.8 4.7 20.3%

Microsoft $339,710 $81,100 $258,610 $88,380 11.3 10.5 9.9 4.0 36.3%

IT & Mobile Average 14.0 12.6 10.7 4.4 26%

Samsung Electronics $185,531 $60,721 $124,810 $232,715 5.2 4.8 4.7 1.4 20.1%


RevenueEnterprise

Value

5. IT & Mobile – What’s it worth?

• If the consensus is correct and Lenovo is successful in driving down Samsung’s operating margins to 3%, then Samsung will still generate $4.3 billion in operating profit for 2014

• Using a 15x multiple this business is worth $64 billion in a worst case scenario (Lenovo trades at 18x operating profit)

• In this scenario Samsung Electronics’ intrinsic value is $283 Billion

• Upside to Samsung Electronics in this scenario is still 52%

The worst case is more than priced into the stock. Samsung provides a margin of safety for the prudent investor even in a (highly unlikely) worst case scenario.

Myth 3 Debunked: Lenovo drives margins to 3%

• Samsung’s brand ranked #8th in the world according to Interband’s Top 100 Global Brands

• Samsung has a premium product and scale like just like its peers on this list

• Samsung’s brand power will help protect against Lenovo’s aggressive pricing

• This will mitigate the downside scenario that IT & Mobile is only worth $64B

Except: Brand Matters to Customers!

• Samsung pioneered one of the great rebranding efforts of the modern era

• #1 brand awareness for Smartphones around the world

• #1 brand awareness for TVs around the world

• Lenovo is competing against a lower cost operator that is more widely recognized in the global market place – they have a tall order ahead of them to try and knock down Samsung

Samsung is a premium brand

• Samsung advertises more aggressively than Coca-Cola (the most prolific advertiser)

• Samsung advertises 4 times more than Apple

• Despite this focus on the customer, the consensus believes that Apple is far more immune to competitive pressure on its margins

• Even if Lenovo or Apple forces Samsung to compete as a low-end player, they will not need to advertise as aggressively (mitigating the impact on operating margins)

Samsung takes good care of their brand

• Samsung is able to advertise more aggressively than Apple because of their commitment to human capital

• Samsung employs over 325,000 people, more than 4 times what Apple employs

• To commemorate the chairman's 25th anniversary, the employees were paid a $2 billion bonus

Source: Investor Presentation 2013

Samsung takes good care of their people

• Since their venture into the cell phones business in 1992, Samsung has amassed a mobile patent portfolio that consists of 16,000 patents

• Samsung couldn’t possible be a copy-cat if they have amassed nearly 50,000 patents since 1989 (second only to IBM)

• Despite Apple’s patent victories in the US, no major victories have been awarded off home-turf

• The most recent patent ruling found that Apple also infringed on Samsung’s patents

Myth 4 Debunked: Samsung’s Patent Portfolio is Strong

• Samsung was founded by Lee Byung-Chul (top), is currently chaired by Lee Kun Hee (left), and will be succeeded by Lee Jae-Yong (right)

• Samsung is a family owned business with the current chairman controlling 49.7% of voting control

• The Lee family has an impeccable record for allocating capital to growing sectors of technology

• Each generation has left their unique mark on the company

‘Three Stars’ of Samsung

Source: Bloomberg, Company Filings

Proven Track Record


Excellent Capital Allocation – Return on Capx

• While most struggled to keep their heads above water in 2009, Samsung set the goal to reach $400 billion sales by 2020

• So far so good:

Management expects more of the same

• Born: 1910

• Died: 1987 (at age 77)

• Founded Samsung in 1969

• Started as a rice-trading operation

• Transitioned into manufacturing TV sets, electric fans and refrigerators

• Extended the business in the 1950s to include banking, insurance, real estate and tungsten exporting

• Invested in microprocessor manufacturing in 1974 by purchasing Korean Semiconductor Company out of bankruptcy

Lee Byung-Chul’s philosophy for establishing new businesses: “Pounce on them when the market is at rock bottom.”

Founder: Lee Byung-Chul

The company’s philosophy promotes the idea that the individual will grow to be a Samsung man by:

1. Acquiring the capability and the courage for empowerment

2. Growing an internationally oriented mind 3. Making use of team spirit and solidarity 4. Reminding the employee of the sovereignty of his

existence as the leader, making history for his time 5. Thinking in terms of effectiveness, not to be

inhibited by past practices and attitudes 6. Cultivating the pioneering attitude

Ahead of their time: Samsung’s 1980 Sahoon

• Age: 72

• Chairman since: 1987

• Son of Lee Byung-Chul

• Most notable accomplishment is the 64MB DRAM memory chip, transforming the formerly bankrupt company into the worldwide memory leader

• Chairman Lee wanted to build a brand, not just a product

• Today, Samsung has 13 products with #1 global market share all under the Samsung brand

• Diagnosed with lung cancer in 2000

• Suffered a severe stroke in 2014

Current Chairman: Lee Kun-Hee

• The fabric of the circular holding structure is unraveling

• 2013: Gov’t bans cross holding structures, provides tax break for unwinding of circular holding structures

• 2014: Chairman Lee tragically suffers a severe stroke

• 2014: Samsung announced IPO of Samsung SDS, Samsung Everland

Catalyst: Corporate Restructuring

• President Park Geun Hye’s government introduced in 2013 legislation banning family-run chaebol businesses from creating new cross shareholdings, which were blamed by the Intarnational Monetary fund for contributing to the nation’s 1997-1999 financial crisis

• The government is also offering tax breaks to encourage the chaebol to unwind existing structures to form more transparent holding companies

Could Jay Lee use this tax break as an opportunity to transfer his father’s assets in exchange for a conversion of Samsung Electronics into a holding company structure?

Catalyst: Gov’t Bans Cross Shareholdings

• Age: 42

• Son of Lee Kun-Hee

• Graduated from Seoul National

University

• Graduated from Keio University (Japan)

• PhD from Hardvard University

• Fluent in Korean, Japanese and English

• Brokered the licensing deal with Android

that enabled Samsung’s Mobile division

to grow from $35 billion to $135 billion

in 5 years

• Main point of contact for key suppliers

and partners (Google, Apple, Sony, HP)

Catalyst: New Chairman Jay Y Lee

• Announced May 8, 2014

• Expected to IPO in Q4 2014

• Established in 1985 as a data system and technology consulting company

• Provides IT and Networking consulting, customized application integration, IT infrastructure outsourcing

Catalyst: Samsung SDS IPO

• Announced on May 15, 2014

• Expected to happen Q1-2015

• Everland is a holding company with influential ownership in Samsung Life (the largest shareholder of Samsung Electronics)

• This IPO marks the unraveling of Samsung’s circular holding structure

• Proceeds are expected to cover estate taxes for Jay Lee and family

Catalyst: Samsung Everland IPO

Lee Kun Hee began succession planning for Jay Lee

• Preserving capital became the priority in 2008 as the Lee family planned for succession.

Lee Kun Hee suffers severe stroke

Myth 5 Debunked: History of Share Buybacks

• Chairman Lee Kun-Hee currently has 49.7% voting control of Samsung Electronics

• Presumed tax bill is $US 6 billion

• IPO of SDS and Everland are expected to yield $3 billion for the family

• Jay Lee will need to repurchase up to $US 20 billion worth of shares within Samsung Electronics to retain his father’s current voting control

Catalyst: Inevitable Share Buyback


Management recognizes valuation disparity


Samsung is firing on all cylinders

• Samsung Semiconductor is worth enterprise value

• Market is ascribing no value to IT & Mobile, Display and Home Appliances

• #8 Global Brand Value in the world

• #1 Brand awareness in Smartphones and TVs

• 13 Products with #1 market share

• Improving corporate governance

• Realigned interests with Lee family

• Massive share buybacks on the horizon

• Limited downside given $60.4 billion Non-core Assets

Conclusion

14’ Rev: $232B 14’ Rev: $11.9B

14’ FCF: $24B 14’ FCF: $3.1B

EV: $129B EV: $159B

Samsung’s enterprise value is $30 billion cheaper than Facebook yet 8x more profitable!!

Valuation Extremes…

What’s in your portfolio?

By: Michael Wood www.evansic.com

samsung the unsung hero - valuewalk...1. samsung electronics (005930 ks equity) price: krw 1,367,000...

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