Samsung The Elephant
By Carl Delfeld, Fri Dec 9th
Samsung dominates life in its home country like no other companyin the world. But the slogan "what is good for Samsung is goodfor South Korea" is open for debate.
The South Korean economy is a paradox. It has become the thirdlargest economy in Asia after Japan and China. Its 48 millioncitizens have in one generation enjoyed a sizable jump in theirstandard of living and no country has benefited more than SouthKorea from the rise of China which has become a vital exportmarket. Its sovereign credit rating was recently upgraded due toreduced tensions with North Korea and it enjoys foreign exchangereserves of over $200 billion. The Korean people should be fullof satisfaction for a job well done but instead are rather adiscontented lot.
Its per capita income is about one third that of the OECDaverage. Economic growth is expected in the 3-4% range closer toa mature economy than an Asian tiger. Unemployment is becomingan issue and a stronger currency and relatively high wage levelsare crimping exports which account for 40% of its economy.Exports are up only 7% this year after a 31% jump last year.After a credit card binge, average net consumer borrowing isequal to 100% of disposable income and the bank of Korearecently bumped up its benchmark rate for the first time inthree years.
What is going on here? Somewhat surprisingly, South Korea isexperiencing many of the same outsourcing issues that Americanscomplain about. It was the largest investor in China last yearwith over $6 billion in fixed investments. Its largest steelmaker POSCO announced its intention to invest $12 billion in asteel plant in India where it already runs 24 steel companies.Hyundai manufactures 600,000 autos in China and its affiliateKia makes 150,000 more.
Meanwhile Samsung Electronics has become Asia's largesttechnology company by market cap (larger than Sony), and itslargest maker of memory chips and flat panel screens and mobilephones. Samsung enjoys a credit rating higher than South Korea'ssovereign rating. With 62 affiliates, the Samsung groupdominates life in Korea like no other company in history. Itrepresents 15% of the nation's total economic activity, 25% ofthe capitalization of the KOSPI stock market and the taxes itpays represent almost 10% of total government income!
Samsung, up 25% so far this year, is still attractive at about11 times consensus 2006 earnings estimates and its operatingprofit was up 29% in the third quarter. Despite third quarternet income declining 30%, a strong fourth quarter
is expected.There is a shortage of LCD television panels and its flashmemory chip global market share exceeds 60%. As prices have comedown flash chip sales have gone up 40%.
But the company is not a terrific play on the South Koreaneconomy. Rather it is a global play on its three key markets andthe expected payoff from its extraordinary commitment to R&D.The South Koreans are discontented because the five largestcompanies are growing outside the country more than in it and ata stage of development where it should be more competitivemanufacturing onshore. The challenge is the low costmanufacturing platform with huge economies of scale just nextdoor - the issue is China. Samsung already has already has 29plants and 50,000 workers in China.
Since China is already starting to manufacture stuff likemachine tools that the South Koreans were busily exporting in2003 and 2004, South Korean planners believe it must quicklytransform itself into a finance, communications andtransportation hub - akin to the role of Singapore orSwitzerland. The question then becomes do they have the rightcompanies, the right skills and what is its competitiveadvantage?
Together, Samsung, POSCO, KEPCO (Korea Electric Power) and SKTelecom account for almost 50% of South Korean stock market'smarket capitalization. To use a basketball analogy, the SouthKorean starting five are strong but its bench is a bit thin andits team has lost the home court advantage. The problem is notSamsung but rather that they need about ten more Samsungs.
The top four companies also make up 40% of the South KoreaiShare (EWY) ETF which is up 29% so far this year. Samsung aloneaccounts for 23% of this ETF and buying the iShare gives youmore exposure to the top ten South Korean companies. I amtrimming our position in the South Korea iShare to take someprofits off the table and with the expectation that the strongerwon and higher interest rates will lead to a slowdown inexports. Together with the likely re-emergence of the NorthKorean problem, this may very well undermine investor confidence.
Bottom line: buy Samsung based on valuation and top notch globalreach and R&D but expect tougher going for the South Koreaneconomy as China turns from robust export market to directcompetitor.
About the author:Carl Delfeld is head of the global advisory firm ChartwellPartners and editor of the the "Asia-Pacific Growth" newsletterand is the author of "The New Global Investor." For moreinformation please visit http://www.chartwellasia.com
