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Samsung Is Wired for a Rebound

By Moon Ihlwan

After two straight quarters of profit declines, Samsung Electronics may have the worst behind it. With the global information-technology industry recovering, the South Korean electronic giant's three main businesses -- memory chips, liquid crystal display (LCD) panels, and mobile phones -- are poised to post earnings gains when Samsung releases third-quarter figures on Oct. 17. Yet, Samsung's shares have fallen recently.

The reason? Samsung is a must-have for fund managers from around the globe investing in South Korea. If they reduce exposure to Korea for any reason -- perhaps just because they see better opportunities elsewhere -- they end up selling Samsung regardless of how favorably they view its profit prospects. "As a proxy of the Korean market, Samsung Electronics is bound to fall if the overall market declines," says HSBC Securities' Lee Jeong Ja. The shares aren't traded in the U.S., but investors can buy Samsung Electronics GDRs (global depositary receipts), which are traded in London (SSNHY) and Luxembourg (SSNGY).

The stock slid to a recent bottom of $226 in February, then began a steady climb, peaking at $409 on Sept. 9. Since then, however, it has fallen 10.5%, to $336. Since the February low, Samsung had risen 62%, while the composite index on the Seoul exchange had risen 29% during the period.

DELAYED RECOVERY. Yet Samsung, whose $55 billion market cap accounts for a fifth of the bourse's total capitalization, is 57%-owned by foreigners, and they have huge influence over the stock's movement. When foreigners go chasing profits elsewhere, Samsung pays a disproportionately high price.

What's weighing down the Korean market is a likely delay in the country's rebound. "Buoyant oil prices and U.S. pressure to revalue the Korean currency don't augur well for the recovery," says Huh Chan Guk, chief economist at Korea Economic Research Institute think tank. A high won could hurt exports and kill momentum for a revival.

However, in the past the profitability of Samsung's businesses hasn't been seriously affected by currency changes. "In fact, the season of Samsung Electronics is just beginning," says Chung Chang Won, semiconductor analyst at Daewoo Securities. But a tightening of household borrowing after a credit-card debt bubble burst has depressed Korea's domestic consumption and exports, which grew 16.3%, to $120.1 billion, in the first eight months of this year.

HIGHER FORECASTS. The liquidity constraint is expected to ease, and once that occurs, few doubt that Samsung will be the first to benefit. The world's largest memory-chip maker and a top supplier of cell phones, LCD monitors, and flat-screen TVs is the star performer in Korea. Corporate analysts agree that Samsung's results in the second half of this year will be much better than those in the first half. The first-half profit drops will make full-year 2003 profits lower than last year's record $6.1 billion.

However, Chung and many other analysts have revised their forecasts upward for this year and next, when they predict a record profit. Chung expects Samsung's 2004 net profit to reach $7.5 billion, while Koo Bon Jun, electronics analyst at Citigroup Smith Barney, puts it at $6.9 billion.

Profits are expected to get a boost from a pickup in sales of PCs, servers, and digital gadgets, which will lift margins for Samsung's bread-and-butter products. The cash-rich outfit has pumped $19 billion over five years into new chip facilities and has sprinted past Micron Technology (MU), Infineon Technologies (IFX), and Hynix Semiconductor in the field of dynamic random-access memory (DRAM) chips, used in all computers. Now, Samsung's memory-chip sales exceed those of these three competitors combined.

CAN'T GET ENOUGH. Samsung's DRAMs normally command higher prices and fatter margins because the bulk of its memory revenues come from specialty products, including graphics chips for game consoles and high-density memory modules for heavy-duty servers. "We move up to higher-value chips if other companies catch up," says Hwang Chang Gyu, president of Samsung's memory-chip unit. The fastest growth comes from flash memory, which can hold data even when electric power is turned off.

Samsung execs say the giant simply can't keep up with voracious demand for flash memory chips that go into cell phones, MP3 music players, digital cameras, camcorders, and other handheld devices. Samsung controls 55% of the $2 billion market for what's known as NAND flash memory, used mainly in removable cards that store data, music, and image files. With a sprouting portable digital products field, analysts expect the NAND market to hit $7 billion by 2005.

The LCD unit is another bright spot. Like DRAMs, LCD panels are commodities, and prices are expected to fall as production increases. But strong notebook-PC demand and increasing replacement of cathode-ray-tube computer monitors with LCD screens, as well as consumer preferences for flat-screen TVs have kept LCD prices strong since the fourth quarter of 2002. In the second quarter of this year, Samsung's LCD sales totaled $948 million, up 42% from the first quarter, to account for 11% of its $8.6 billion in second-quarter sales.

"REAL BARGAIN." Then comes the cell-phone business, where Samsung proved that a Korean concern can build a brand through a top-down marketing strategy. By focusing only on mid- to high-end phones, it sold 25 million units in the first half of this year, grabbing about a 10% share for the world's No. 3 position, after Nokia (NOK) and Motorola (MOT). "We're confident we'll get stronger," says Chu Woo Sik, Samsung's vice-president. It's introducing well over 100 models globally this year, including those that allow users to download and view up to 40 minutes of video and watch live TV.

Indeed, despite its vulnerability as the dominant public company in Korea, fund managers and analysts argue that Samsung shares are undervalued, given its leadership in some of the hottest IT products. "Compared with its U.S. or European peers, Samsung is a real bargain," says Park Kyung Min, CEO of Hangaram Investment Management, which allocates nearly a quarter of its $350 million Korean equity investment fund for Samsung. "If the company is based in the U.S., its shares would be at least 2 1/2 times more expensive than they are now."

Maybe, but it still has risks. As long as corporate governance remains a concern in South Korea, and North Korea's nuclear threat poses a security challenge, Samsung is likely to continue trading at a discount to its global peers. Even though it's believed to be one of the most transparent emerging-market companies, persistent corporate scandals in South Korea have kept many foreign investors skeptical of Samsung's decision-making process.

Still, if you can stomach those worries, Samsung is cheap. At a price-to-2004-earnings ratio of less than 8, it's trading well below rivals Nokia, with a p-e of 17, or Motorola, with a p-e of 26.5. Says Merrill Lynch corporate analyst Simon Woo: "Valuation will become an important issue." He and others believe an IT recovery and Samsung's improving brand mean the stock has room to go higher. Moon covers Samsung for BusinessWeek from Seoul

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