Don't Discount Korea's Goliaths
If the market performance of Samsung Electronics Co. is anything to go by, the hedge-fund Davids appear to be winning against the Goliaths of South Korea's chaebol.
Samsung shares rose 2.8 percent Monday to close at 1.86 million won, the highest since listing 42 years ago. Since a surprise $10 billion stock buyback in October 2015 that was widely seen as an attempt to placate foreign shareholders, the stock has gained 42 percent.
Some 15 percent of that increase has come in the last three months alone, after funds associated with Paul Singer's Elliott Management moved from a previous assault on the Samsung chaebol's byzantine structure to push for demergers and capital management at its core electronics business.
The share price response makes a lot of intuitive sense, because Samsung is in dire need of a spring clean on the corporate-governance front.
Chairman Lee Kun-hee was convicted in 2008 of tax evasion and selling bonds to his son and corporate heir apparent Jay Y. Lee at artificially low prices. Samsung Electronics' offices were raided in November by investigators looking into alleged influence-peddling by a personal adviser to President Park Geun-hye. Samsung executives have been summoned for questioning by special prosecutors, Bloomberg News reported Monday.
Given all that, bringing South Korea's chaebol into line with Western corporate governance practices can only be a good thing -- right?
There's just one problem with the idea. While Samsung's share price has soared over the past year, in valuation terms its performance has been pretty meh -- up from 9.3 times blended forward 12-month earnings at the start of 2016, to 9.5 times as of Tuesday. Shouldn't a business focused on returning more value to shareholders be, you know, more valued by shareholders?
Set aside for a moment the fact that buybacks, despite their popularity with equity investors, only really deliver a cosmetic improvement to businesses, and one thing jumps out. The surge in Samsung's share price has precious little to do with the changing relationship between management and shareholders, and everything to do with the company's success in improving earnings.
As Gadfly's Tim Culpan argued, Samsung's better-than-expected profit numbers last week are the best explanation for the shares' strong performance -- and those have been driven by its operational excellence in making chips and display panels, rather than anything Paul Singer is concerned about.
That's a lesson for those who tend to fret that the "Korea discount" -- the degree to which local stocks trade at lower valuations than those in other countries -- is some sort of broader risk to the country's economy, rather than a mere irritant to shareholders.
Equity investors certainly rate Korean companies lower than overseas equivalents, but despite all the tabloid-worthy antics of the chaebol bosses and their families there's precious little evidence that the businesses in question are worse-run. Returns on equity for the Kospi 200 run level with the Nikkei 225 despite having barely half its price-earnings ratio, and handsomely outperform those on the FTSE 100.
Chaebol that match Wall Street standards for corporate governance may well deliver more cash back to shareholders in the short term, but that's no guarantee that they will be better run. It's operational expertise, rather than fiddling around with a company's cash and treasury accounts, that determine long-term value.
While the shenanigans of the chaebol aren't a good look, the activities of U.S. companies aren't always a model of probity, either. If you're looking for a Western fund that's never invested in an ethically dubious business to cast the first stone at Korea's Goliaths, you might be in for a long wait.
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