Company: Samsung C&T (028260.KS)
Business: Samsung C&T Corp is a Korea-based company engaged in the trading of industrial goods. The company operates its business through a group of segments. These include engineering and construction, trading and investment, as well as fashion and resorts. Shares of the company do not trade in the U.S.
Stock Market Value: $15.35 billion ($94.71 per share)
Activist: Palliser Capital
Percentage Ownership: 0.62%
Average Cost: n/a
Activist Commentary: Palliser Capital is a global multi-strategy fund with a bias to Asia and Europe. Founded in 2021 by James Smith, who was previously the head of Elliott Investment Management’s Hong Kong office, Palliser applies a value-oriented investment philosophy to a broad range of opportunities across the capital structure where complexity or distress lead to undervaluation that can be monetized through an effort-intensive process or proprietary catalyst. Nearly the entire senior investment team has had significant activist experience working at Elliott. The firm has experience investing in both Europe and Asia and their activist investment at Keisei has shown the patience, conviction and diplomacy of a top activist.
On Dec. 6, Palliser Capital announced that it took a 0.62% position in Samsung C&T (SCT).
Behind the scenes
Palliser thinks that Samsung C&T (“SCT”) is grossly undervalued by the market due to sub-optimal capital allocation, historic corporate governance issues and a complex corporate structure. The investor suggested short- and long-term measures that could be taken to create $25 billion of shareholder value. On its face, creating $25 billion of shareholder value at a $15 billion company seems ridiculous. However, diving into Palliser’s thesis one could realize that the firm is conservatively underestimating the value that can be created here. SCT is a large industrial South Korean conglomerate controlled by the Lee family through multiple, cross-owned affiliates. SCT has a publicly traded market cap of about $15 billion. Its main assets consist of five publicly traded subsidiaries and an operating business. The post-tax value of SCT’s interest in these five publicly traded subsidiaries are: Samsung Electronics ($13.9 billion), Samsung Biologics ($13.4 billion), Samsung SDS ($1.7 billion), Samsung Life ($1.6 billion) and Samsung Engineering ($300 million). That is a total of $30.9 billion of easily ascertainable and realizable value for a roughly $15 billion company. This does not even count the operating business, which has $30 billion of revenue and $1.55 billion of earnings before interest, taxes, depreciation and amortization. Using a 5.5 times EBITDA multiple, Palliser values this business at $8.4 billion. With net cash of $1.1 billion, that is a company valuation of $40.4 billion.
Why is this company trading at a 63% discount? For three reasons. First, its capital allocation policies and practices have left shareholders and others with little confidence that much of this value will accrue to them. SCT has approximately $1.5 billion of annual cash flow, and only approximately 25% of that is returned to shareholders through a dividend and up to 60% is used for capex. Samsung is an iconic and structurally important Korean company that should be investing and growing. Palliser is not debating that. The firm would like to see a more transparent and disciplined capex plan that uses the backdrop of the return on share buybacks as the benchmark and offers a fair return to shareholders. SCT also has other opportunities to generate cash for capex and shareholder return like taking on some debt (the company has $1.1 billion of net cash) to lower its cost of capital and potentially divesting some of the disparate and non-synergistic businesses that make up the operating company.
Second, SCT’s corporate governance policies do not give shareholders confidence that the board is working for them. In South Korea, boards have a duty to the company, not to shareholders. Absent a charter amendment, there are other things the company can do to give shareholders more confidence. The current board is five independent directors and four management directors. While Korean companies of this size are mandated to have 50% independent directors, “independent” is not defined. That means board independence may not be the way investors would expect it to be in the U.S. Moreover, SCT’s independent directors lack any real C-suite experience, relevant industry experience, proven portfolio management and capital allocation expertise. So, refreshing the board with experienced independent directors would be a great start. The board is also staggered. Three of the four management directors are co-CEOs of the company; these individuals answer to the board and account for one-third of its composition. If SCT named one CEO to whom the other division heads would report, it would simplify decision making. Additionally, more transparent communication with the market and aligning management’s interests with shareholders would also go a long way.
Third, the complex cross-affiliated ownership structure, or “chaebols” as they are called in South Korea, causes a deep discount to value. SCT was formed through a series of M&A transactions that were designed more for the purpose of the family keeping control than efficiency. These chaebols have adversely affected the valuation of these companies. For that reason, South Korean chaebols have been converting to two-layer holding company structures over the past 20 years. Samsung is one of two large companies in South Korea that still has the chaebol structure. This chaebol structure discount permeates the entire organizational structure. Even with the chaebol structure, Palliser estimates a $25 million valuation gap. Converting to a holding company structure would increase the value of all the SCT subsidiaries. Relative to where the stock trades today, it would inflate this valuation gap even more.
The undervaluation is not in doubt here. The key question is what can Palliser, or anyone else, do to close that valuation gap? All Palliser is doing right now is bringing these issues to a public debate to put some pressure on management to make shareholder friendly changes. The firm is not threatening any confrontational actions. Palliser has a history of working with management to effect change. That is good here because winning a proxy fight in South Korea is extremely rare. It has been done before, but not by a non-local activist at an iconic company with a family who owns 30% of the common stock. But the trend is on Palliser’s side as South Korea is getting more shareholder friendly every year. And there is also a good reason why the Lee family might support changes that increase shareholder value. Lee family patriarch and former Samsung chairman, Lee Kun-hee, was South Korea’s richest person at the time of his death on Oct. 25, 2020. Lee’s death triggered the largest inheritance tax bill in South Korean history, exceeding $10 billion. South Korea’s inheritance tax rate of 50% is the world’s second highest after Japan. His heirs have been given five years to pay the inheritance tax, and they could certainly use higher value stock to margin or more capital returned to shareholders.
Palliser is not alone in its thinking. Shareholder City of London Investment Management Company has made two proposals for the 2024 annual meeting: a dividend of roughly $3.42 per ordinary share and a buyback program of $380 million to run until the end of 2024. In South Korea, shareholder proposals are binding if approved by a majority of shareholders, but they rarely are approved. At the very least, enough votes could put pressure on management to do something. A good start would be to retire the 13% of outstanding shares held as treasury shares, which count towards outstanding shares in South Korea and which management has already promised to retire within five years. Doing this would immediately increase earnings per share by 14.4%.
Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.