Samsung Electronics – Efficient Market

Priced for a Nokia.

• The case for Samsung Electronics is purely based on recovery in semiconductors because if things stay the way they are, there is little to no upside in the shares.
• Following Samsung’s second horrendous mistake in 8 years, the shares have given up 36% of their value but as the problem now resides in its core Semiconductor division, the market has treated the shares unfairly.
• Samsung was the king of both memory and storage but unfortunately, it made a mess of high-bandwidth memory (HBM) which has allowed Micron and SK Hynix to win a rare victory.
• The size of today’s AI models and the amount of data being used means that the speed of the memory and the transport of information between GPUs is a crucial factor in training AI cost-effectively.
• This is why memory has become so important in AI explaining the explosion of demand for memory that operates at very high speed.
• However, getting this type of memory right is no easy task and Samsung is still struggling with heat and power consumption problems with its silicon meaning that it has yet to qualify as a supplier to Nvidia.
• Hence, Samsung is unable to address 85% of the fastest-growing market in memory and its results in 2024 have underperformed both SK Hynix and Micron as a result.
• Samsung has apologised to investors, shuffled management and most recently has promoted the new head of Samsung Semiconductor (Jun Young-hyun) to Co-CEO.
• This is a signal that it is deadly serious about a turnaround and Mr. Jun now has executive authority over other parts of Samsung to push through a number of changes.
• Some of these changes involve cost reductions to boost profitability and also changes to its corporate culture to ensure that blunders like the one currently being experienced do not reoccur.
• This is the second major blunder in 8 years with the first blunder being with its Note 7 smartphone where the batteries were found to be defective and many of them caught fire forcing Samsung to recall all of the Note 7s that it made.
• At the time, I looked at Samsung and compared it to Nokia, Motorola, BlackBerry and so on and I concluded that the handset business was at dire risk of the death spiral that killed off so many of its rivals.
• However, contrary to my expectations and against great adversity, Samsung fixed the problem, halted the market share slide and returned to being the major Android handset vendor with reasonable profitability despite brutal competition from Chinese rivals.
• I see the current situation with HBM Memory being very similar to what happened in 2016 and given its history, I think that there is a very good chance that Samsung fixes this problem, qualifies for Nvidia and takes a good slug of market share at Nvidia and other AI customers.
• Crucially, none of this is priced into Samsung’s current share price at KRW56,000 per share.
• If I assume that the situation remains unresolved and Samsung fails to win any business in HBM, then Semiconductor margins will remain in the low 20s which is low for a company of this calibre.
• If the problem is fixed and Samsung can regain its crown as the king of memory, then I can see semiconductor margins coming back to the mid-30s.
• I think that this is fair as Samsung Semiconductor has achieved much higher than this in the past and so a lower margin but over the cycle looks like a reasonable estimate to make.
• If semiconductor margins remain in the low to mid 20’s then a DCF calculation with a 10% WACC gives a value of around KRW60,000 per share but mid-30s at the same cost of capital gives KRW88,500, 58% above where it is today.
• Essentially, the market is pricing in no recovery at all meaning that the risk-reward ratio on Samsung Electronics is very favourable.
• The shares are also very cheap based on PER with 2024, 2025, and 2026 at 10.5x, 8.5x and 6.9x respectively.
• However, I suspect that should the recovery fail, then Samsung shares will not be re-rated leaving them as a classic value trap.
• I am inclined to take a position in Samsung via the GDR as I see little downside but have not done so yet.