Why Samsung Can Be an Apple of Investors’ Eyes

 

January 18, 2018 [Technology, Samsung, Apple, Investment Returns]
Josh Rubin


Samsung is no longer a stodgy conglomerate (or chaebol in Korea) that just makes consumer and industrial electronic devices and equipment, along with some home appliances. Its sales of semiconductor chips and panels account for nearly half of total revenues.

Bottom-up, fundamental research is about much more than kicking the tires and noting how shiny or dinged a car, stock, or bond may appear. Many people in the U.S. may think of Samsung as the also-ran phone company that also makes appliances and computers. Yet nowadays, these business lines don’t really drive the Korean conglomerate’s business.

It’s true that back in 2012 and for the next few years, smartphones were more than half of Samsung’s operating profit. This put it in direct competition with Apple’s brand equity and the great iPhone operating system. At the same time Samsung also faced off against low-end, and low-cost, Chinese competitors. These competitive dynamics put Samsung in a bind, and after a rise and then fall, 2016’s operating profit was in line with that of 2012's.

But Samsung’s time in the wilderness drove it to refocus on the areas where it could really differentiate itself against the competition. Its pursuit of market share gains in smartphones was de-emphasized, and the segment now comprises only around 20% of operating profit.

Meanwhile, the conglomerate has solidified its leadership position in the consolidated industry of NAND (nonvolatile random access memory), also called “flash” memory. NAND offers enhanced storage capabilities and reduces power consumption, which enables a lightweight, efficient battery. Moreover, NAND improves convenience by enabling your iPhone, iPad, and computers using NAND to just turn on immediately after being asleep, rather than needing time to boot up again.

Samsung also has a strong position in DRAM (dynamic random access memory), which is the slower but much less expensive type of computer memory, and which does need some time to boot up. While less “special” than NAND, the DRAM industry has consolidated over time and provides attractive levels of profitability for the remaining market participants.

Samsung is also the clear leader in screen technology, including OLED (organic light-emitting diode), which makes high-end smart phone apps pop with vivid colors and allows for unique phone form factors like curved or potentially foldable screens. More than two-fifths of Samsung’s annual revenues are now generated from its semiconductor and display panel division.

The future for these three businesses is OLED bright. Together, they allow Samsung to be much more of an “agnostic” winner. As it competes against the iPhone, each iPhone sold reportedly contains well over $100 in Samsung components, and materially more in the case of the iPhone X, although Samsung declines to break out the data. The bigger point is, whether you buy a Galaxy or iPhone, or even a lower-end phone, Samsung benefits.

Technological progress continues to naturally deepen the need for more memory and processing speed across more end markets, from personal computers to data centers to autonomous vehicles to the broader internet of things, or IoT, as Thornburg details in a new whitepaper on investing in disruptive innovations. As these end markets evolve, Samsung can again profit from the deployment of new technologies regardless of which company innovates fastest or gains the most market share in these fast-moving industries.

Meanwhile, the conglomerate’s corporate governance structure and shareholder alignment are improving. This turn follows tough times from 2014 to 2016, when it was beset by a corruption scandal, not to mention the Galaxy Note 7 problem when batteries caught on fire. As the Korean government implemented corporate governance reforms, Samsung broke up the combined chairman and chief executive role. It introduced three new co-CEOs who can more closely oversee the conglomerate’s business segments and exposure to the growth in AI (artificial intelligence) and IoT applications.

One clear manifestation of Samsung’s more shareholder-friendly program is an increase in capital returns via dividends and share buybacks, and more capital discipline involving higher-return hurdles for capital expenditures.

Apple has been a great investment in recent years, with a total return of more than 60% from 2015 through 2017. But Samsung’s just more than 100% total return in the same period is even better. Those willing to roll up their sleeves and dig into Samsung’s business units, new management structure, and corporate governance should see that it’s not your dad’s chaebol anymore.

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