Is Samsung For Real

South Korea’s biggest company is making cool phones. The stock has doubled in a year. The catch: questions about disclosure and family control

Ray Brown, head of electronics for Sears, Roebuck & Co.’s 865 U.S. stores, remembers the moment he stopped being a critic of televisions made by Samsung Electronics Co., South Korea’s largest company. He was attending the Las Vegas Home Electronics Show in January 2001, when his TV buyer Chuck Bacon dragged him over to a crowded Samsung booth that was featuring a large-screen projection model. “That television picture was fabulous,” Brown says. “I thought I knew what Samsung was—its products were sold by every low-end retailer—and I believed the quality was suspect. Now we stock a range of Samsung products. I’m one of its biggest fans.”

Brown’s conversion reflects the change in image and financial health that both Korea Inc. and Samsung Electronics, the country’s most profitable company, have undergone since an economic crisis rocked Asia five years ago. Samsung recovered. Yet questions about disclosure, control by Chairman Lee Kun Hee and a tangle of subsidiaries nag Western investors.

In 1997, South Korea and Samsung were facing their bleakest days since the Korean war almost five decades earlier. As financial turmoil swept north from Thailand, the won tumbled to 1,963 to the U.S. dollar on Dec. 23 from 986 on Nov. 14, thereby doubling companies’ foreign debt and decimating consumer spending. The currency stabilized only after the government of President Kim Young Sam agreed to a $57 billion International Monetary Fund bailout, the largest ever. The following year, gross domestic product contracted 6.7 percent. Daewoo Group—Korea’s second-biggest industrial conglomerate, with interests ranging from autos to securities—never recovered. It owed $80 billion when it collapsed in 1999.

The crisis pushed Samsung to the brink. In 1997, it lost $658 million. Debt doubled to 300 percent of equity, a bur- den so severe that if losses had continued, Samsung would have gone out of business, says Vice Chairman and Chief Executive Yun Jong Yong, 58.

‘Korea has embraced the future at a time when Japan has turned its back on the future,’ says one observer.

Today, Korea’s economy is booming after Kim Young Sam’s successor, President Kim Dae Jung, pushed through measures that prohibit family-controlled conglomerates known as chaebol from propping themselves up by using affiliates to guarantee loans for money-losing companies. The president also ordered banks to lend based on creditworthiness rather than favoritism and opened the financial system to foreign investors. This year, the government expects GDP growth to top 6 percent compared with 0 percent in Japan. Korea’s stock market is holding up better than most: the Korea Composite Stock Price Index, or Kospi, was up 2.1 percent for the year as of Nov. 8 compared with a 13 percent decline in Japan’s Nikkei 225 Index and a 15 percent drop for the Dow Jones Industrial Average. “This is Korea’s moment in history,” says Michael Kim, Seoul-based president for Asia of U.S. private equity firm Carlyle Group. “Japan was the dominant economic power in the region for a couple of decades. Inevitably, China will rise up to take its place. But today and for the next few years, Korea is it.”

Samsung Electronics has blossomed in the new Korea. It’s the world’s No. 1 maker of computer memory chips and flat- screen computer monitors, according to U.S. market research companies Dataquest Inc. and DisplaySearch. It’s second to Sony Corp. in DVD players. This year it jumped to No. 3 in cellular phones, behind Nokia Oyj and Motorola Inc. In the latest quarter, telecommunications accounted for 33 percent of Samsung’s $8.2 billion of sales, electronics like high-definition TVs and handheld computers made up 32 percent and semiconductors contributed 31 percent.

More telling, Samsung is now the world’s 34th-most-valuable brand, ahead of Nike and Gold- man Sachs, according to an August survey by consulting firm Inter- brand Group, a subsidiary of Omnicom Group Inc. And the value of its brand is increasing faster than any other, the survey found. “Korea is cool just now, and Samsung’s products reflect that,” says Tom Hardy, a U.S. commercial designer who helped create International Business Machines Corp.’s Think Pad laptop computer and who now consults for Samsung.

Samsung’s shares are red-hot. The stock has risen more than 11-fold in four years to 359,500 won on Nov. 8, from 31,894 won on Sept. 22, 1998. During that time, it’s outper- formed the Kospi index by 800 percent. In the past 12 months, Samsung shares have doubled in dollar terms, giving the company a market value of $46 billion and vaulting it past Sony’s $40 billion market capitalization for the first time.

For many investors, a resurgent Samsung, which accounts for one-fifth of the market capitalization of the Korean bourse, is an obvious buy. “It’s one of the best tech companies in the world and one of the cheapest,” says Sunhee Oh, Hong Kong–based investment director at Standard Life Investments Ltd., which manages $2.5 billion in Asia and this year almost doubled its Samsung Electronics stake to 315,000 shares worth $94 million.

Other investors see good reasons for Samsung’s bargain- basement price: a price-earnings ratio of 8.4 compared with 27 for Tokyo-based Sony. They call it the “Korea discount.” The term describes Western fund managers’ aversion to investing in a country that has traditionally permitted low levels of corporate transparency and favored the chaebol. The conglomerates, armed with cheap cash from compliant banks, put size and market share ahead of profits.

In Samsung’s case, both its structure and ownership are reasons investors should be cautious when buying the stock, says Singapore-based Mark Mobius, managing director of Templeton Asset Management Ltd., which manages $7 billion in emerging-market assets and, with other Templeton units, owns 602,000 Samsung Electronics shares, according to Bloomberg data.

While foreign investors, like U.S. mutual fund company AIM Advisors Inc., own a total of 52 percent of Samsung Electronics, Chairman Lee Kun Hee, 60, controls the company. Lee Kun Hee personally owns 2 percent of Samsung shares. He controls another 12.3 percent through family members and such companies as closely held Samsung Life Insurance Ltd., which holds 6.9 percent of the electronics company, according to Kim Myung Kun of Samsung Electronics’ investor relations team. Lee Kun Hee’s interests are enough to deter challenges from foreign investors, Mobius says. “Family control is not in itself negative, but it results in favoritism and inside deals,” Mobius says.

Samsung’s structure can obscure its results. Samsung Electronics is the biggest company in Samsung Group, which consists of 27 major corporations that sell everything from ships via Samsung Heavy Engineering Co. to financial ser- vices through Samsung Securities Co. There’s even Samsung Everland, a theme park in Yongin, on the outskirts of Seoul. Samsung Electronics itself has 100 subsidiaries, including 50 production and sales units, 20 overseas branches and two consumer finance companies.

The interlocking web of companies makes it difficult for investors to know how Samsung Group’s unlisted units affect Samsung Electronics’ bottom line. “There’s not enough full disclosure, especially through their finance companies,” Mobius says.

In the past, the companies in Samsung Group guaran- teed each other’s loans and bought each other’s shares, sometimes at great cost to shareholders. In the mid-1990s, Lee Kun Hee, a motor sports enthusiast, set up automaker Samsung Motor Inc. The company’s first family sedan rolled out just as the economic crisis hit. By 2000, Samsung Motor was bankrupt. Lee Kun Hee pledged $2 billion of his Sam- sung Life shares to pay creditors. Samsung Electronics, which had invested 483 billion won ($400 million at today’s exchange rate) lost everything.

Samsung can be less open with investors too. Last year, when Lee Kun Hee was diagnosed with lung cancer, Samsung didn’t reveal the illness. In contrast, when News Corp. CEO Rupert Murdoch had prostate cancer in 2000, that company put out a press release. Investor Relations Vice President Chu Woo Sik explains Samsung’s silence by saying word of Lee Kun Hee’s cancer got out anyway. “He’s now completely cured,” says Chu.

Jang Ha Sung, a finance professor at Korea University and a leading shareholder activist, sees danger in the Lee family role. “Control comes at the expense of other minority share- holders,” says Jang, who owns 200 Samsung shares worth $60,000. “The price would definitely go up if there were bet- ter corporate governance.”

The Lees, one of Korea’s richest dynasties, with holdings in Samsung public companies alone worth more than $1.6 bil- lion, aren’t about to relinquish their grip. Last year, CEO Yun named Chairman Lee’s only son, Lee Jay Yong, 34, as a Sam- sung Electronics vice president. Analysts expect the younger Lee, a Harvard Business School Ph.D. who owns 0.8 percent of the company, to take over at some point. He already sits in on board meetings as a spectator, says Franz-Hermann Hirlinger, chief Seoul representative of Germany’s Bayerische Landesbank Girozentrale and one of three foreign independent directors. “It’s now understood the chairman’s son will take control even though he has not proven his ability,” says fund manager Mobius. “This is why Korean shares are discounted.”

Hirlinger says he understands investors’ concern about family control. When he joined Samsung’s board in 1998, he says, he was the only member who opposed rubber-stamping management decisions. “It was the first time they had been confronted with a foreigner asking questions,” he says.

One thing Hirlinger says he questioned was the price Samsung Electronics was going to pay Samsung Corp., an arm of Samsung Group, for a headquarters building. Hirlinger says he was concerned that there had been only one valuation, and so he asked for an independent review. As a result, Samsung Electronics saved $500,000 on the $180 million purchase, according to company figures.

Hirlinger says Samsung’s disclosures are improving. The company reports results by division and has a new investor relations department. The board added non-Koreans Göran Malm, chairman of the Asian unit of Swedish Internet consulting firm Icon Medialab International AB, and Tetsuo Iwasaki, chairman of the Japanese unit of Applied Materials Inc., which supplies Samsung with chipmaking equipment. Samsung now has seven independent directors, half of its 14- person board.

Hirlinger defends the role of the Lee family. “The young Mr. Lee is a bright young man, and he’s becoming more and more involved in the company,” Hirlinger says. “I appreciate that. In his position, he could be out with movie stars.”

Samsung Electronics’ former CEO, Kang Jun Ku, credits the present chairman and his father, founder Lee Byung Chull, with building Samsung from a mom-and-pop shop that sold dried fish and fruit into one of the world’s biggest technology companies. Lee Byung Chull opened the Samsung store in 1938. He pushed into noodle making and then diversified into transportation, real estate, brewing, insurance, department stores and publishing.

In the late 1960s, Samsung—which means Three Stars— was one of the biggest chaebol. Lee Byung Chull decided electronics was the business of the future. He founded Samsung Electronics in 1969 to make black-and-white TVs, electric fans and rice cookers. When Kang joined the company four years later, he found four Quonset huts, a 1,650-square-meter factory and a workforce hardly able to assemble the fans, according to his autobiography, A Career in Korea (Korcom International Inc. of Seoul, 1996). Kang expanded into refrigerators, washing machines and watches. In 1975, the company went public in Korea at 1,000 won a share. The stock rose almost 40 percent in the first month. In 1977, Samsung branched into making the semiconductors it needed for its own products. It expanded the chip business throughout the 1980s.

In 1988, a year after Lee Byung Chull died, Lee Kun Hee, now chairman, marked the 50th anniversary of the Samsung store in what he called the company’s “second founding.” He told employees he wanted to turn Samsung from a manufacturer that was struggling to compete in technology and sales with its Japanese rivals into a world-class company capable of taking on the likes of Sony.

Lee Kun Hee, who’d studied business administration at George Washington University in Washington, D.C., tried to instill pride in Samsung products, according to Choi Seung Jin, a senior manager. One strategy stood out, Choi says: Lee sent new recruits to an unfamiliar city with no money. Once there, they needed to raise cash by selling small Samsung devices such as cassette recorders. “When you approach someone and they see you are selling a Samsung product, they react positively,” says Choi, who completed the course. “When I saw that, I felt very strongly that we must always manufacture the best possible product.”

In 1993, Lee Kun Hee made a pronouncement that would shape Samsung’s technology push: He urged employees to think outside the regimented decision-making process that characterized most Korean companies. “Change everything except your wife and children,” Lee declared in one of the directives he issues to staff via the few senior executives who meet him face-to-face.

At the time, Samsung was a supplier of semiconductors and an assembler of TVs and household products often sold under other manufacturers’ names. Lee Kun Hee decided Samsung would no longer copy technology. Rather, it would initiate on its own. In 1996, he appointed Yun as president and CEO, declared it the Year of Design Revolution and hired ex-IBM designer Hardy and other Westerners.

The economic crisis forced Lee Kun Hee to streamline Samsung. Until then, employees had expected jobs for life. The company pursued market share ahead of profits and tolerated money-losing divisions, according to Yun. Under government pressure, Lee dissolved much of Samsung Group’s central management.

Yun, a career engineer with no family connections to the Lees, says he and nine other managers locked themselves in a hotel to find ways of reducing the 80,000-strong staff by 30 percent. The managers wrote resignation letters, which Yun says they planned to submit if they failed to make the cuts. “We were facing a very grave situation,” Yun says.

Yun reached his job cut target and began closing or selling unprofitable subsidiaries. Among them was ailing U.S. com- puter maker AST Research Inc. In 1999, Samsung sold a 65 percent stake to Beny Alagem, former chairman of Packard Bell NEC Electronics Corp., for $12.5 million—a fraction of the $377 million it had paid for the company in 1995.

Yun says he empowered executives to make decisions, breaking the norm of directives’ coming from above. He let them buy what they needed when they needed it in an attempt to create just-in-time production and delivery. They abandoned the push to grow bigger and focused on goods with higher profit margins.

Chips, phones and an advertising campaign pitching Sam- sung as a leader in digital products anchored the turnaround effort. Instead of budget-priced models, Samsung embraced the most-advanced technology and began charging more than rivals. In cell phones, Samsung was among the first to mass-produce models with color screens, fast Internet con- nections and built-in digital cameras that let users take pho- tos and e-mail the images to friends. From 2000 to 2002, Samsung raised its market share to 9.5 percent from 4.3 per- cent even as the overall mobile phone market shrank by 10 percent, according to Dataquest. Although market leader Nokia tripled profit in this year’s third quarter to $600 mil- lion, the Finnish company’s 22 percent operating margin was lower than Samsung’s 27 percent.

“Samsung’s strategy of targeting the high end of the mar- ket seems to have worked,” says Koo Bon Jun, an analyst at Morgan Stanley in Seoul.

Samsung took a similar approach in its chip business. By outspending rivals on plants and equipment, it be- came first to mass-produce new models, thereby allowing it to charge higher prices. In 2000, Samsung began making chips based on designs from U.S.-based Rambus Inc. while other manufacturers stuck to a simpler-to-produce technology. The result: Only Samsung models worked with the fastest chips made by Intel Corp., whose processors run 87 percent of the world’s personal computers.

Semiconductor division President Lee Yoon Woo persuaded Sony to use Rambus-designed chips in the PlayStation 2 video game console. By developing advanced products and striking deals, Samsung could sell its chips for an average of $6 apiece when the spot price plunged to less than $2, according to data from DRAMeXchange, a Taiwan-based company that runs a spot market for semiconductors.

To keep its edge in chips, Samsung plans to spend $4 billion this year on equipment, research and development, says Lee Yoon Woo, 56. That’s $3 billion more than Boise, Idaho–based Micron Technology Inc., the world’s second- biggest memory chip maker, with a 19 percent share com- pared with Samsung’s 27 percent. Micron had a net loss of $586.5 million in the fourth quarter and $907 million for the fiscal year, both ended Aug. 29.

Samsung stands out because it’s making profits in memory chips and phones while other companies are struggling, says Robert Conlon, chief investment officer of Investec Asset Management Asia Ltd., which manages $400 million of Asian stocks, including 27,000 Samsung Electronics shares worth $8 million, according to Bloomberg data.

Samsung’s technology push wasn’t always appreciated, even inside the company. Sohn Young, president and CEO of the Seoul branch of public relations firm Incomm/Brodeur, says Lee Kun Hee had his doubters in the early days. Sohn, who was with Samsung from 1984 to 1993, was one of them. “My senior managers were very worried about Chairman Lee’s technology strategy,” he says. “Nor did I think semiconductors would become a cash cow. Now, of course, it has paid off.”

Samsung’s $450 million advertising campaign pays for one of the world’s most prominent electronic billboards, in New York’s Times Square. The billboard—along with Sam- sung Electronics’ sponsorship of the Olympic Games begin- ning in 1998, South Korea’s June hosting of soccer’s World Cup and the fact that more people in Korea use wireless tech- nology than in any other country—creates a buzz that helps Samsung pitch its products. “Korea has embraced the future at a time when Japan has turned its back on the future,” says Kenneth Courtis, Goldman Sachs Group Inc.’s Tokyo-based vice chairman for Asia. “Samsung Electronics, particularly, has been very clever. It is very aggressively pro- moting its brand.”

As for investor concerns about disclosure, Samsung Elec- tronics executives say, the days of bailing out affiliate com- panies are gone. “In the past, cross guarantees were made between Samsung Group companies,” says investor relations Vice President Chu. “These days, if another Samsung com- pany asked us for support, we would say, ‘Hard luck.’”

Even so, the relationships among Samsung Electronics’ units still dog the company. In June, Moody’s Investors Service said two Samsung Electronics finance subsidiaries— Samsung Credit Card Co. and Samsung Capital Co.—may be- come vulnerable as Koreans buy more on credit and defaults rise. Moody’s upgraded Samsung Electronics’ senior unsecured debt one notch to Baa1 but kept it one level below the rating for South Korea’s sovereign debt and for Korean companies like the much smaller Korea Tobacco & Ginseng Corp.

Now Samsung is turning up the pressure on Sony. Last year, Samsung had a $2.4 billion profit on sales of $26 billion. This year, analysts surveyed by I/B/E/S Interna- tional Inc. expect profit to more than double to $5 billion. In the third quarter alone, net income quadrupled to $1.4 billion on sales of $8.2 billion—four times Sony’s profit of $353 million on sales of $14.4 billion for the quarter ended in September. Sony Ericsson, a handset joint venture of Ericsson AB and Sony, lost $93 million on sales of $873 million in the third quarter. By comparison, Samsung’s phone business made $722 million on sales of $2.7 billion during the same period.

Equally important, Samsung’s $2.96 billion of debt rep- resents 38 percent of equity—one-eighth the level at the height of the Asian crisis. Sony’s $9 billion of debt is 46 percent of equity. Samsung has enough spare cash to embark on a $1.4 billion share buyback. Samsung’s Yun says the com- pany wants to grow further by selling shares on the Nasdaq Stock Market in three or four years.

Sony acknowledges the rivalry. When trailers for the hit film Spider-Man, coproduced by Sony Pictures, first appeared in movie theaters, Samsung discovered that a shot of Times Square had been doctored to remove the famous Samsung billboard. After Samsung protested, the sign was reinstated, says Eric Kim, Samsung’s executive vice president of global marketing.

“We are well aware of their strength in releasing new products in volume, and their catching up is a good stimulus to us,” says Sony spokesman Shigenori Yoshida. “We will dif- ferentiate our products by giving them more originality and a more Sony-like touch.”

Japan still rules in Sears stores, according to electronics head Brown. TVs made by two of Samsung’s Japanese rivals—Sony and Panasonic, a unit of Osaka-based Matsushita Electric Industrial Co.—outsell the Samsung brand. That may change, Brown says. “The companies that had the authority in the old analog world are not necessarily gaining the authority in the digital world,” he says. “It’s as if the consumer has wiped the slate clean. Samsung has done a masterful job in making the most of it.”

Samsung CEO Yun says his company isn’t resting. “The next three or four years are going to be a critical period if Samsung is to become a global company,” he says. To do so, Samsung Electronics may have to become as adept at investor relations as it is at making cool gadgets.

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