Nuance & Samsung – Private preference

Nuance looks good for private equity not Samsung.

• Nuance is a provider of speech and language technology that is used by Apple in its Siri digital assistant.
• It has fallen on difficult times and with the recent addition of an activist investor, is feeling pressure to release some value.
• Hence, it appears very likely that the company is entertaining suitors, one of which seems to be Samsung Electronics.

Samsung & Nuance

• Samsung is a company at the top of its game but RFM believes that earnings are going to decline for the next 3 ½ years at least. (see here)
• Samsung has ceded control of the ecosystem to Google leaving it with a commoditising handset business.
• This is likely to result in a decline in handset margins from their current 18.4% to 11.3% in 2017E.
• Outside of the ecosystem RFM believes it is possible to earn a good and sustainable return by being the provider of value added technology.
• Both MediaTek and Qualcomm do well in this regard.
• Nuance falls into this category but being owned by Samsung could cause a substantial collapse in revenues.
• This is because many of Nuance’s customers may view Samsung as a competitor and would not want to be dependent on the technology of a competitor.
• Hence, to get value from Nuance, it would have to add enormous value to its own products in order to make up from the revenue loss caused by customer losses.
• This, combined with the fact that the kind of problems faced by Nuance make it ideal for a private equity deal, leads me to believe that private equity will pay much more for Nuance than Samsung will.

Nuance and private equity

• Nuance has got itself into a difficult position.
• Its financial performance has not been great over the last few quarters although some new products have been introduced that could improve the financial position.
• The two other big issues with this company are that it is quite indebted and management compensation is extremely high given the amount of profit that is generated.
• These factors make Nuance ideal for a privatisation where the company is taken over, cleaned up and then returned to the market at a much higher valuation.
• I suspect that this would be the alternative most pleasing to Carl Icahn who holds a 20% stake in the company.
• In this scenario, I would expect him to hold onto his stake until the private equity shop exits.

Take Home Message

• It is easy to see why Samsung might be interested in this company, but I suspect that a private equity outfit is likely to be prepared to pay more to acquire the shares.
• This combined with the fact that the kind of changes that are required to improve performance are best suited to a private equity transaction, are likely to push any deal in this direction.
• Hence, I think it very unlikely that Samsung will acquire this company.
• Should be wrong, it is likely to further increase my concerns around Samsung and push my valuation of KRW1,200,000 per share even lower.
• I remain very cautious on the outlook for Samsung Electronics.