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I just read the book Samsung Rising by Geoffrey Cain and found it enlightening.

Samsung is a unique company: one of the best brand names to ever come out of East Asia.

This post will give you a brief history of how Samsung made the journey from a post-war trading company to an international technology giant. I will then describe where Samsung is today and where it could be heading in the future.

Samsung began as a trading company

Samsung was founded by Lee Byung-chui (“BC Lee”) in 1938 as a Korean trucking business. It transported goods dried-fish, locally-grown groceries and noodles across Korea.

Samsung is a Korean name formed from the Chinese characters 三星, which means Three Stars. The name must have been partly inspired by Japan’s Mitsubishi’s, which in Japanese is called 三菱, which can be loosely translated into Three Diamonds. Samsung has sought to emulate the large Japanese conglomerates and to overtake them eventually. It would become one of the first family conglomerates in the country - or chaebols as they are known in Korea.

The headquarters of Sanghoes in Daegu in the late 1930s — The headquarters of Samsung trading company

As time went on, BC Lee increasingly focused on securing key licenses and contracts from the government. Because that’s where the big profits were. BC Lee moved from Daegu to Seoul and formed a close relationship with Korea’s post-war dictator Syngman Rhee, who ruled Korea from 1948 to 1961. One of the first government contracts that Samsung was awarded was as a foreign currency recipient. It allowed Samsung to import raw materials such as wool and transform them into finished products like clothing.

It then became a diversified conglomerate. After woollen mills, BC turned to sugar refining. He used the profits to acquire shares in a bank in 1957, an insurance company, a department store and a university. As early as the 1950s, BE Lee was reputed to be the richest man in Korea.

BC Lee prized lifelong loyalty to the company and took a very cautious approach in each new hire. He would sit in on almost every employee interview - about 100,000 interviews in total during his career. His philosophy was:

“Be prudent in hiring someone… but once you’ve hired them, be bold in entrusting them with tasks”

Samsung became obsessed with cultivating lifetime generalists, so-called “Samsung Men”. They would be shuffled around the different departments according to the whims of the HR department.

Over the next few decades, Samsung would develop a near-military style management approach, with orders from the top-down and a reluctance to challenge management. BC Lee was almost a God-like figure and expected absolute devotion to the firm among employees. Commentators described the culture as “quasi-religious”.

General Park Chung-hee after the coup d’état in 1961

When President Park Chung-Hee took over Korea in a military coup in 1961, BC Lee saw an opportunity to get new government contracts. President Park wanted to turn Korea into a modern manufacturing giant to compete with Japan. And so he turned to his new confidantes such as Samsung to reach that goal. As a result, Samsung became a tool to build up a domestic manufacturing industry.

In the following decades, Samsung ventured into consumer electronics. In the early stage, it tried to reverse-engineer competitors’ products, starting with black-and-white television sets.

A Samsung assembly line of black-and-white television sets

Many had doubts about Samsung Semiconductor

In 1974, Samsung’s then-CEO JK Kang received a phone call from a California entrepreneur called Joseph Sudduth. He was a part-owner of Korea Semiconductor, a new joint venture set up by him and a Korean businessman. The JV had fallen on hard times, and Joseph Sudduth wanted to get out. Could Samsung bail him out?

This was the start of Samsung’s foray into the semiconductor business. Internally, Samsung managers warned against the acquisition. They felt that chipsets were expensive to produce and risky. And you were competing with the best of the best: Japanese companies with the full backing of the Japanese government.

During the first decade, Korea Semiconductor was a huge cash drain on Samsung. By then, BC Lee’s third son “Lee Kun-hee” had gotten involved in the business. He was wildly bullish on semiconductors and convinced his father that semiconductors were the future. It would become one of Lee Kun-hee’s greatest contribution to Samsung over the next few decades.

1980s footage of the operations of Samsung Semiconductor

Samsung opened the first semiconductor fabrication plant in 1983. The company built it only six months rather than the industry standard of three years.

But foreign visitors to the plant at the time were not impressed at all. It was placed in the middle of a small-town village, with farmers driving rice cultivators next to what was supposed to be a state-of-the-art semiconductor fab.

Samsung employees were relentless. They managed to get technology training from America’s Micron, and while they were there, they tried to memorise every diagram they saw and recreate them back in the hotel room. Then they gave gifts of pottery to Japanese executives at a competing manufacturer called PSC in exchange for the opportunity to buy their equipment. It took a lot of hustle to even get in the door.

In the following five years, from 1983 to 1988, Samsung went from one generation behind the Japanese in DRAM to just 6 months behind.

Lee Kun-hee took over after his father’s death

This photo taken March 22, 1988, shows Samsung Group chief Lee Kun-hee at an event in Seoul. (Yonhap) — Lee Kun-hee in the 1980s

BC Lee died in 1987. After his death, Samsung was reorganised into five separate business groups:

Samsung Group (electronics)
Shinsegae (retail)
CJ Group (food, chemicals, entertainment, logistics)
Hansol Group (paper, telecom)
Joongang Group (media)

His third son BC Lee took over Samsung Group, which would later become the heart and the most successful part of the organisation.

Lee Kun-Hee was reticent, contemplative and somewhat of a loner. A friend said:

“A very interesting man… He was the laziest guy I’ve known.”

People didn’t have a lot of hope for him. His nickname at the time was “the silent one”. He had originally wanted to be a film director or start a movie studio but was dragged into the family business by his father.

He was a 1980s playboy. He would drive his Porsche 911 at 200mph on Samsung’s private racetrack. After a car crash in the 1980s, he was hurt so badly that he had to take opioids to ease the pain and was rumoured to be addicted to painkillers for many years.

He actually wasn’t very much involved in Samsung. He spent most of his time at home, where he lived a life of contemplation. He didn’t even take calls from Samsung executives.

For the first few years as a Chairman, he hardly came to the office. But in 1992, he finally realised that Samsung was in trouble:

“From the summer of 1992 until that winter, I suffered from insomnia… I was feeling desperate, as though Samsung, beyond simply having to give up a business or two, might completely wither away. I never slept more than four hours in those days. Instead of my usual big appetite, which would only be satisfied with three portions of bulgogi [marinated slices of beef or pork], I barely managed to eat a meal a day. That year, I lost more than 10 kilograms [20 pounds].”

His exasperation was not without cause. Samsung’s quality control had deteriorated. Revenues were decreasing. Their products had lost share in the important American market. Western expatriates in Korea called the company “Sam-suck”, and Samsung products were widely ridiculed for their poor quality.

Lee Kun-hee’s executives wouldn’t tell him the truth. He was too far removed from the action to get to the bottom of the problem. So instead, he installed hidden cameras and microphones across Samsung offices and factory floors and was shocked at what he found.

These investigations culminated in a corporate trip to Frankfurt. On this trip, he let it all out. He lashed out at them for days, telling them that they “need to change everything except their wives and children”. He wanted designers to become creative, globally aware and creating profitable products.

Samsung recalls chairman's 'Frankfurt declaration' — “The Frankfurt Declaration”

To reinforce his message that quality control had to be improved, he organised a massive bonfire where he threw in US$50 million worth of sub-quality Samsung products to be burned while publicly shaming his executives.

The trip to Frankfurt later become known internally as the “Frankfurt Declaration” and was one of the key turning points in Samsung becoming a serious contender in the global consumer electronics industry.

Becoming more active in Samsung, Lee Kun-hee would later replay recordings of the chairman’s voice for years in company buildings as a continuing reminder of the mandate of every Samsung employee. Some of the words that he uttered were:

“At Samsung, we must adhere to three credos:
Faulty products are our enemy
Faulty products are the root of all evil
If we produce a faulty product three times, we must take it upon ourselves to resign.”

Lee called the new strategy “Perpetual crisis”. Next, Samsung began distributing a book of proverbs called “Change begins with me: Samsung’s new management”. An executive called it “Chairman Lee’s blue book” - a reference to Chairman Mao’s little red book, hinting that Samsung’s new leadership style was not that different from Chairman Mao's in the 1960s and 1970s.

The Frankfurt Declaration worked. Samsung enjoyed a great deal of success in the following decades. It became the largest producer of memory chips in 1992. Ten years later, it became the largest manufacturer of LCDs. And eventually, it entered the mobile phone business.

The transformation into a modern multinational

Compared to other major Korean companies, Samsung survived the 1997 Asian financial crisis unharmed. The only exception was the auto subsidiary - which went bankrupt and had to be bailed out by Renault. A small misstep for Lee Kun-hee in an otherwise very successful career.

In the late 19980s, Lee Kun-hee wanted Samsung to expand internationally. It had been selling phones in the protected Korean market at very high margins and never felt a need to expand to the highly competitive American and European markets.

The first step in this transformation was to hire foreign employees and to ship local employees out. Lee sent his beloved niece Miky Lee to the United States. She was in her thirties and had a flair for film and the arts. Her job was to find a marketer who could help build Samsung’s brand and presence in America. She concluded that since Motorola controlled the mobile phone market and Sony televisions, Samsung decided to enter the United States with microwave ovens instead. It worked.

Miky was crucial in Samsung’s internationalisation from the 1990s onwards, notably winning a Samsung product placement contract for the American hit movie The Matrix. She later found even greater success in Samsung sister company CJ Group and was recently in the headlines for producing the South Korean movie Parasite.

Miky Lee is the granddaughter of Samsung’s founder, Lee Byung-chul. Photo: Bloomberg — Lee Kun-hee’s niece Miky Lee

Samsung employed American designers to run a new design centre. The Korean employees under them complained that the Americans didn’t tell them what to do. Samsung had developed a bad habit of copying the designs of others: a phone that looked like Motorola’s, a remote control like Sony’s and a car prototype like Nissan’s. This scattered Samsung’s identity across product lines, confusing customers.

A culture change was needed. From that point forward, Samsung was to create its own distinctive design language.

Lee Kun-hee’s son JY Lee became involved in Samsung in the late 1990s. JY Lee was eager to participate in management but needed a success story with which to prove himself. So he jumped into the Internet sector, starting e-Samsung in May 2000, investing in several Korean start-ups.

It became a massive disaster. E-Samsung literally went bust within a year. The broader Samsung Group ordered nine affiliates to bid up the share price of e-Samsung and relieve Jay of any personal financial damage. After these missteps, JY Lee was scarred and took on a lower profile - one carefully managed by his close company aides.

Challenging Apple

Around the year 2000, Samsung set up an R&D centre in Warsaw. This design centre would help Samsung enter into the mobile phone business. That said, early versions were riddled with weak functionality and quality control issues.

The real break for Samsung didn’t come until much later, however. It was the smartphone that would catapult Samsung to become the largest phone manufacturer in the world.

In 2004, Steve Jobs visited Samsung. He wanted them to supply Apple with NAND chips for the iPod. And two years later, he came over to Korea desperate for Samsung to help them supply a tailor-made chip for a new unknown product called “the iPhone” with a deadline of just five months. An Apple engineer later admitted that the iPhone would never have been released in time unless Samsung had got involved.

The launch of Android in 2008 provided a point of entry for Samsung to become a major phone manufacturer. In 2008 Samsung launched the Solstice line of devices, later renamed to Samsung Galaxy.

Samsung Solstice SGH-A887 specs - PhoneArena — Samsung Solstice, the predecessor of the Samsung Galaxy line of smartphones

Samsung came up with a genius marketing campaign, positioning itself as a challenger brand against Apple - just like during the Coke vs Pepsi war of the 1980s or the PC vs Mac war of the 1990s. Samsung customers were portrayed as Apple’s victims. Many people identified with Samsung as a challenger brand.

Samsung never really did much innovation. Instead, it watched how disruptive products like the iPhone fared on the market. And then, when the path to success was blindingly obvious, Samsung released its own version.

Samsung’s strength was to manufacture superior hardware faster than anybody else - much thanks to a strict top-down management system and a superior supply chain.

Third-generation leader JY Lee

Samsung’s third-generation leader JY Lee

Samsung’s third-generation has now taken over the business. Lee Kun-hee suffered a heart attack in 2014, and since then, his son Lee Jae-yong (“JY Lee”) has more or less been running the business.

JY Lee - or simply “Jay” - is known to be “nice, but [not having] the charisma of his father”. He’s cautious, careful and reticent. His mark on Samsung has so far been modest. He hasn’t promulgated a vision for a bold new future as Apple did under Steve Jobs. Instead, the focus is more on incremental improvements rather than anything revolutionary.

Samsung’s headquarters in the Gangnam district of Seoul

What JY Lee has done so far is to reinforce Samsung’s focus on creating world-class hardware. He thinks that hardware is Samsung competitive advantage. He also sold off Samsung’s corporate jets and got rid of its sluggish chemical and weapons industries. All the proceeds have been reinvested into Samsung’s core smartphone business instead. Dividend pay-outs have also been greatly increased since JY Lee came onto the scene in 2014.

Another big reform: His father Lee Kun-hee used to control Samsung through the Future Strategy Office. Old man Lee would ask the office to devise options for moving forward in a particular area. After choosing what he thought was the best option, the Future Strategy Office would execute his vision.

JY Lee’s approach is very different. He travels to company offices around the world and has meals with workers at company canteens. That takes a considerable amount of his personal time. As a result, several key projects have been unnecessarily delayed. So there’s a risk that JY Lee’s approach may weaken Samsung’s historical advantage in moving quickly and decisively when opportunities arise.

The fact is that Samsung is a far different company than its Silicon Valley peers. It doesn’t have Silicon Valley’s rebellious, counterculture origins. Instead, it’s an organisation with an almost military-style management system conducting business as if issuing battle orders. That makes it even more crucial that the top leadership is steering the ship in the right direction.

So far, not much has changed since JY Lee took over. Samsung is still run like a military operation. The organisation is doing well across multiple fronts.

Over the past few years, JY Lee has been implicated in corruption scandals: accused of offering financial support to former President Park Geun-hye in return for business favours. He was also accused of market manipulation concerning the acquisition of Cheil Industries to cement his control of Samsung Electronics. Jay was eventually convicted to 2.5 years in prison. His prison sentence may be shortened thanks to a presidential pardon. But it will be difficult to control a vast organisation from a small prison cell.

The 2015 deal to merge Samsung C&T (Lee family holding company) with Cheil was seen as poor corporate governance by some because:

The price offered for Cheil shareholders was low
C&T sold Treasury stock to a local construction company so that they could get enough votes for the merger to go through, securing JY Lee’s control of Samsung Electronics

Then there’s a broader issue about Korea’s edge in a world where Chinese electronics manufacturing is becoming more competitive. Will Chinese competitors overtake Samsung in consumer electronics, just like Samsung overtook Sony 20 years ago?

From this perspective, you could argue that the story of Samsung is as much about Korea’s competitive edge in manufacturing as it is about Samsung’s own internal strategy.

A sprawling conglomerate

Today, Samsung is a sprawling conglomerate, with more than fifty companies in various industries, including shipbuilding, electronics, fashion, advertising, food courts and a hospital.

Its affiliate companies produce around 1/5 of Korea’s total exports, and Samsung’s revenues now represent roughly 17% of South Korea’s GDP. It has become such an integral part of society that many Koreans today call their own country Republic of Samsung - there is such a huge overlap that it’s hard to tell where the country ends and where Samsung begins.

The family holding company is Samsung C&T, which remains perennially undervalued. Some argue that a higher dividend payout ratio from C&T will be used to help pay for JY Lee’s inheritance tax burden. That could potentially help unlock value in the Samsung C&T holding company.

Below Samsung C&T, you will find the following listed subsidiaries:

Samsung Electronics (005930 KS): smartphones, memory chips, displays, home appliances, TVs, telecom equipment
Samsung SDI (006400 KS): smartphone / EV / ESS batteries
Samsung Card (029780 KS): credit cards
Samsung Life (032830): life insurance
Samsung Fire & Marine (000810 KS): property & casualty insurance
Samsung Heavy Industries (010140 KS): shipbuilding
Samsung SDS (018260 KS): IT consultancy
Samsung Engineering (028050 KS): engineering consultancy
Samsung Securities (016360 KS): investment banking
Samsung Biologics (207940 KS): biopharma contract development and manufacturing
Hotel Shilla (008770 KS): hotels

Samsung Electronics remains the core of the portfolio and is the most valuable part of the family empire. When people talk about “Samsung”, they usually refer to Samsung Electronics. The performance of the stock over the past 50 years has been nothing short of astonishing:

Segment overview

Today, Samsung Electronics makes most of its money from memory chips. Over half of earnings come from semiconductors, the majority of which comprise DRAM and NAND chips. Smartphones are the second largest contributor to profits at 32%. Consumer electronics (TVs, PCs), displays (mostly OLED panels for smartphones) and Harman (audio systems for vehicles) remain small contributors.

Source: Samsung Electronics Business Report 2020

The issue for Samsung is that memory chip prices are cyclical, leading to violent swings in Samsung Electronics’ profitability from year to year.

Spot DRAM prices are enjoying particular strength at this point, as can be observed from Taiwan’s DRAMeXchange DXI indicator (a composite index of DRAM prices):

At the same time, memory chip capex remains elevated at almost twice the level five years ago. There is also a risk that Chinese efforts to monopolise the NAND and potentially DRAM markets could lead to an extended slump in memory prices.

Another issue is a potential hangover from COVID-19 related consumer electronics spending, with laptop-related search queries already back to pre-pandemic levels. Hyperscaler demand continues to be strong.

Overall I’m not as bullish as some other people are about the memory cycle. There are, however, a few growth drivers that could catapult Samsung Electronics revenues higher for decades to come.

Future growth drivers

Samsung sees growth potential in the following five areas:

Semiconductor foundry: Samsung wants to take market share from TSMC in foundry services, essentially producing advanced chips on contract with third-party clients. Samsung wants to invest US$151 billion by 2030 to close the gap with TSMC, whose market cap is actually higher than Samsung’s. Technology-wise, Samsung is strong and in the process of catching up with TSMC. The problem for Samsung is that clients such as Apple see Samsung as a competitor and are therefore unwilling to share their SoC blueprints with it. On the other hand, customers are likely to want to diversify away from a reliance on Taiwan due to geopolitical concerns. Samsung already makes US$12 billion a year from its foundry operations (5% of total revenues), though the majority of this revenue is to other Samsung affiliated entities such as the smartphone business.

5G network equipment: Samsung already ranks as #2 in 5G patents, right after China’s Huawei. So Samsung’s bet on network equipment does have strong technological support. Following America’s ban on Huawei and ZTE, it’s possible that non-Chinese suppliers such as Ericsson, Nokia and Samsung will take market share in the US market. So far, Samsung’s market share is only 3% - far behind Huawei’s 28%. But that may change over the upcoming decade.

Biomedicine: Samsung Biologics was first set up in 2011 as a joint venture between Samsung and Quintiles Transnational. It essentially works as a contractor to pharma companies to produce bio-medicines. Scale matters in this business, and Samsung is already among the top three biopharma CMO (contract manufacturing organisations) businesses globally. Samsung Electronics owns 31% of the shares.

Artificial intelligence: Samsung wants to become a leader in electronic components for autonomous vehicles and other tasks that require heavy data crunching. This growth initiative does not appear to be a major contributor to revenues yet.

Automotive components: A few years ago, Samsung acquired speaker manufacturer Harman International. Since then, it has introduced a hardware/software platform for cars. Its functions include adaptive cruise control, in-car vehicle information, Internet connectivity. It’s meant to be a one-stop solution, similar to Apple CarPlay and Android Auto.

Conclusion

Today, the Samsung empire is at a cross-road. JY Lee does not appear to be the visionary that Lee Kun-hee was in his heydays. But perhaps he will mature into the role - just like his father did.

I expect Samsung to do well in foundry, network equipment and biopharma. The smartphone business is also performing well, but it’s unclear how Samsung could grow that business further without a new revolutionary new product. The demand for foldable phones seems to be modest so far. Expect mid-single-digit top-line growth across the cycle.

The stock has historically traded at 10x earnings. However, as noted above, JY Lee seems more shareholder-friendly than his father, and the dividend payout ratio has risen markedly. So perhaps a low teens PE multiple will be the new normal. But even then, assuming a mid-cycle net profit margin of 13%, some revenue growth and a 15x P/E multiple only gives an EPS of KRW 5,000 and an intrinsic value of KRW 75,000 per share.

Samsung’s shares are not a bargain compared to historical levels. But they trade at an attractive multiple compared to international peers such as Apple. There are several key growth drivers that will continue to drive growth for the next decade.

The most important questions are about governance. Will the leadership transition from Lee Kun-hee to JY Lee lead to a more innovative and dynamic organisation? Or will some of Samsung’s competitive advantages - speed and agility in decision making - one day wither away? Those questions have yet to be resolved.

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Samsung is in a crucial transition