SAMSUNG ELECTRONICS IN THAILAND CASE STUDY

Executive Summary

 

This case focuses on the valuing Samsung Electronics, which is a major worldwide manufacturer of consumer electronics, and its ongoing project aimed at capturing 15% of Thailand’s mobile phone market. It will ask students to study a collection of Thailand’s country data, ranging from macroeconomic to cultural, as well as other related materials such as industrial data and the company’s Financials. The selection of the case’s background information was based on several engaging factors involved. First off, Thailand is of a particular interest even among other Southeast Asian emerging markets. As you will see within the case document, Thailand contains several factors that not only magnifies its political/economic risk, but also make its risk profile more difficult to measure. Secondly, Thailand’s mobile phone market is a fairly complicated one when compared with those of its regional neighbors, with an intricate mixture of opportunities and obstacles. The combination of these factors creates a favorable case environment to pursue our main learning objectives for the case, which is as follows.

Learning Objectives of the Case:

 

 

1. Retrieval of relevant/significant data-This case will give students some first-hand experience in professional level data screening. They will have to seep through the considerable amount of case documents and exhibits given within the case to retrieve the few relevant data that will be used to assess the project as well as the company. A considerable amount of the information may prove to be redundant, depending on the student’s approach.

 

2. Multi-tiered measurement of risk-The complexity of Thailand’s risk profile, as well as the special conditions associated with the nation’s mobile phone market, will make risk assessment more complex than the standard text-book case scenarios. Students will have to use their own intuition to yield reliable measurements of risk, such as the country’s beta, and be able to justify them if they are to receive full credit for the subsequent valuation models.

 

3. Valuation of a specific project-The case asks students to value not only Samsung Electronics, but its ongoing project in the Thai mobile phone market. Students will have to aggregate their results from the preceding two case objectives to value the company and the project. In doing so, the student will also have to make several key judgments. They will have to select the appropriate model that best utilizes the available relevant info, and is most fit to retrieve the required numbers. Also, students will have to make key assumptions to justify the use of the valuation model, as well as the numbers that will be used to complete the calculation, due to the inherent unknowns present in the case background. (For example, the fact that the project is an ongoing one and not a concluded one with complete results)

 

 

 

Note to the Professor

            Our goal in writing this case is not just to do a valuation of a firm, but to get across the point that analyzing the business, financial, and country risks involved when dealing with emerging markets is considerably different from what we are accustomed to in valuing U.S. firms.  The differences in culture, business practices, and risks among the various countries of the world significantly change the way a firm does business in each country. While writing this case, we tried to keep in mind the risks involved and only accepted realistic data. For emerging markets, the credibility of data is extremely crucial for trying to evaluate whether or not a project is a wise investment. We hope that after reading our Samsung Electronics case, the reader can get a feel of how one should go about considering an international project from beginning to end.  This kind of analysis is very important to any businessman who wishes to expand abroad.

Project Overview

 

The current and future outlooks concerning the mobile phone market in Thailand provide Samsung Electronics an excellent opportunity to increase revenues and market share.  The Thai youth market is very sophisticated, yet susceptible to the strategy of identity branding. Samsung, as one of the most recognizable brand names in Thailand (Exhibit 1), therefore finds itself in an ideal spot.  The firm viewed Thailand as an integral part of their overall global strategy way back in 1988, when they entered the Thai market by creating a joint venture with Saha Pathana Inter-Holding Co., Ltd.  Thai Samsung (as the joint venture is called) is a crucial part of Samsung’s global vision as Thailand has become a major manufacturing hub for exports to various countries.  With Thailand at the center of their Southeast Asian strategy, Samsung Electronics has enjoyed unprecedented growth in sales and production in the region.  Such performance has led Samsung to forecast 25-30% growth in the region in the year 2003.

 

Samsung Electronics currently ranks third in terms of market share in Thailand, trailing only the two cell phone giants, Nokia and Motorola.  In order to gain market share dominance, many of the competitors in Southeast Asia are involved in competition based on mass production.  Samsung, however, intends to follow a differentiating strategy to increase its market share, offering innovative, luxurious, high-quality products and services.  The trends in the Thai market seem to fit perfectly with Samsung’s differentiating strategy. Having developed multifunctional color screens, enhanced with detailed picture definitions and sharpness, Samsung is the leader TFT-LCD technology.  Other new and modern features are incorporated into the cell phones being offered on the market, including over 40 polyphonic ring tones, built in cameras, and cell phones equipped to handle broadband Internet. With its industry leading technology, Samsung targets the middle to high-end user markets, looking to take advantage of the Thai market characteristics. 

 

As Samsung Electronics scans the economic and market environment, their objective seems to be clear.  By the end of 2003, Samsung Electronics hopes to gain at least an additional 3% market share in Thailand’s mobile phone market.  The challenge that lies ahead is valuing such a move with realistic figures, data, and expectations.  With that said, developing projections for the future performance of a subsidiary within a Korean “chaebol” is an inherently difficult task.  Our group’s initial hope was to calculate both the current value of Samsung Electronics and the NPV of the Thai mobile phone expansion project in which Samsung is planning to invest.  However, given the secretive nature of the financing of Korean subsidiaries within a chaebol, our group decided not to valuate the Samsung Thailand branch.  The numbers are not publicly available.   We know that the fact that the project is a joint venture complicates the breakdown of figures and data.  Despite this obstacle, we still believe that realistic data can be forecasted and obtained and that an accurate NPV valuation is possible.  Since South Korean laws prevent chaebols from owning private banks, unlike the situation for the Japanese keiretsus, the subsidiaries of a chaebol does not have unlimited access to low interest credit.  Because Samsung Thailand cannot use its leverage to pour unlimited amounts of capital into its expansion projects, our calculations will not be distorted.

 

            Despite the fact that Samsung Electronics has been breaking sales and profit records on a regular basis recently, one misstep in the competitive industry of home electronics could spell trouble for the company.  We wish to evaluate whether or not Samsung’s decision to expand its cell-phone market share in Thailand is prudent from a financial perspective.  If the NPV should be negative or near break-even, we would advise Samsung to halt its expansion until the mobile market environment changes and circumstances become more favorable toward expansion.  The decision to invest is also closely tied to the financial strength of the parent company.  Therefore, we must first valuate Samsung Electronics, discover its worth, and ask ourselves whether it has the necessary capital to invest in Thailand while fulfilling its other debt obligations at the same time.

 

Risks Involved in Samsung Electronics’ Thailand Strategy

 

            Analyzing risk correctly is essential for successful expansion into international markets.  We have divided the risks for Samsung’s Thai mobile phone venture into the following categories: economic, political/business, social, and industry specific.

 

- Economic Risk

           

Being one of the largest economies in Southeast Asia, Thailand grew significantly before the Asian financial crisis hit in 1997 (the attack on the Baht forced Thailand to devalue its currency).  Thailand is well known for having a highly educated, yet inexpensive, work force.  This provides Samsung Electronics with a great opportunity. They have always required highly trained people to build and sell their technology, but in Thailand, they would also be able to economize on labor costs.  Moreover, the currency devaluation, which crippled the economy, did make Thailand’s exports more attractive in the world marketplace, stabilizing its export sector.  However, although Samsung Electronics may realize positives in the price and quality of labor and in the world demand for the Thai product, many investors and analysts still do not have the same confidence in the Thai economy that they had before 1997. They claim that Thailand has not shown huge positive signs that its economy will rebound soon.  In order for Samsung to reach such lofty goals as they have set for themselves in the Thai market, the wealth of the people in the country and their standard of living must trend positively. We view the project performance to be very dependent on GDP per capita growth due to Samsung’s high-end, premium pricing strategy regarding their mobile phones.  In 1998, real output dropped by 9.8% from the year before.  With the IMF bailout, however, the economy grew 4.8% in year 2000.  In 2001, the global downturn effected Thailand negatively, and they grew only 1.8%.  In 2002, there was nice rebound, as the economy grew 4.4%.  This rebound can be explained by the way in which the market views the Thai economy.  The Thai government increased investor confidence through reforming fiscal policy, tightening government spending.  Thus, the rebound in growth can be attributed to the market risk in the global economy.

 

- Political/Business Risk

           

The Thai political environment has stabilized greatly over the past ten years, with no coups during this time.  Over the past three years, Thailand has transformed itself from having had one of the least transparent and legal economies in the world into now having a widely respected economy.  The Asian Financial Crisis had a stirring impact in the way the government viewed business practices.  In order to win trust among investors, the Parliament passed laws to stamp out corruption and to allow public policy to enter into political decisions (16^th Constitution).  However, such changes in business policies cannot become the norm in practice overnight.  Although the 16^th Constitution was passed in 1997, there is still a lot of bribery, and many still hold a “money talks” attitude towards business transactions.  Sadly, bribing seems to be accepted as a part of every day business and is almost expected in business deals.  Mitigation of such risks is not in Samsung’s hands. Instead, it is the duty of the Thai government.  Also, Thailand has very complex legal and regulatory systems when it comes to foreign investment.  There are different sets of rules and laws for different countries, which lead us to suspect that transparency is still in its infant stages.  Although Thailand has taken steps to mitigate these risks, it is still too early to expect Thailand to clear up all of its transparency problems.

 

-Social Risks

           

The social structure in Thailand is characterized by significant disparities between the wealthy and poor.  High-income individuals are inclined to buy luxury items and are buying into marketing and advertising.  These are those individuals whom Samsung must target with its  marketing campaigns.  The poor only make around $20-$40 a month, so there is no way they can afford a Samsung mobile phone.  It is interesting to note that Thailand consumers show very little resemblance in tastes when compared to Western consumers.  Thailand’s main trade partner being Japan, the Thai consumers’ tastes are more related to Japanese tastes.  Thus, Samsung has to be careful in their marketing and advertising and realize what works for them in the United States will not necessarily work in Thailand.

 

 

-Industry Specific

           

The Thai consumer prefers to purchase from brand names with a reputation for having high quality and technological excellence.  Samsung Electronics is currently one of the companies positioned in such ways in the minds of the Thai consumer.  However, there is a huge industry specific risk involved when selling in this market.  With already a great demand in

technology, the intense competition between Nokia, Motorola, and Samsung will only increase this demand.  Thus, Samsung needs constantly to be developing and selling cutting edge technology before its competition.  Since buying decisions are driven by price not by sophistication in technology, this may put a big strain in R&D and marketing costs.  To reach their goal of an increase of 3% in market share, it is essential for them to win or at least keep pace in the technology race.  Samsung seems to ahead as of now, as they are the leader in some mobile phone specifications technology such as TFT screens.

 

            Industry-specific risk is controllable, and Samsung Electronics is in very good position to be a leader in the technological advancement in the mobile phone market.  Thus this risk can be effectively mitigated if Samsung continues to create new technologies in the future as they have done in the past.  The rest of the risks outlined above are uncontrollable, but Samsung Electronics must be wise in how they deal with such risks.  The same risks can be applied to all firms competing in the mobile phone market.  After analyzing these risks, the mobile phone project represents the same amount of risk for Samsung Electronics as it would be for Nokia or Motorola.  Samsung Electronics is already in the market and has done quite well, which leads us to assume that they have managed the political/business, social, and economic risks efficiently, and will continue to do so in the future barring any unforeseen events in laws and regulations or any financial crisis.

 

Samsung Electronics is one of the largest manufacturers of consumer electronic devices in the world and is a subsidiary of Samsung Group, the largest “chaebol” in South Korea.  One of its strategic short-term goals is the expansion of its products into new untapped markets within Southeast Asia beginning this year.  The countries of Cambodia, Bangladesh, and Myanmar are just some of the targets in this new ambitious expansion plan. 

 

Within this specific strategic shift, our group wishes to analyze in particular Samsung’s current project that aims to capture 15% of Thailand’s mobile phone market.  Currently, the company only has a 10.7% market share in mobile phones for Thailand.  This project reflects the difficulty that a foreign multinational firm faces when investing in an emerging market economy that has limited transparency and sizable political/economic risk.  We will focus on the issue of accurately valuing the credibility of the investment through NPV analysis, taking into account such issues as the appropriate rate to discount cash flows, the country’s credit risk, and currency exchange rates. 

 

Country Analysis: Thailand

 

With a population of over 70,000,000 people, Thailand is one of the largest economies in Southeast Asia.  It posted extremely expressive economic growth rates of around 9% (from 1985-1995) annually before the bubble economy burst in 1997.  It is known for being a low-cost manufacturing exporter with a highly educated workforce.  Right now, Thailand is slowly rebounding from the crisis through its strong service sector and machinery export industry.  Its largest export market is Japan and until that country shows signs of economic recovery, the Thai economy will not be able to live up to its promise in the near future.

 

Economic Conditions

 

Thailand had been one of the fastest growing economies in the world before it experienced an economic crisis in 1997.  Real GDP had increased by an average of 8.8% year over year from 1990 to 1994.  In 1995 and 1996, real GDP grew 8.8% and 5.5% respectively.  The double-digit average annual growth of manufacturing (10.7%) led this surge in output from 1990 to 1996.

 

Thailand’s economy slowed beginning in July of 1997.  Real output fell 5% in the last half of the year alone, and 9.4% over 1998. With the help of a $17.2 billion relief package from the IMF, the Thai economy expanded in 1999 by 3.3% and by 4.8% in 2000.  The Thai government restored investor confidence by reforming the financial system and tightening fiscal spending.  Global slowdown again hurt Thailand in 2001 as its growth slowed to 1.8%.  The 4.4% increase for 2002 shows that most of the uncertainty around the Thai economy can be attributed to market risk of the world economy.  This can be expected for any economy which has exports contributing to 1/3 of GDP. 

 

At the end of 2002, Fitch revised its outlook on the Thai sovereign rating from stable to positive.  With the revision, investors can expect an upgrade from its current BBB- within a year or two.  At that time, government debt would not require as high a country risk premium.   

 

Inflation had been between 5% and 8% before 1999.  Since 1999, inflation has remained below 2%.  Real interest rates have remained between 10% and 15%.  Perhaps most importantly for economic development, the supply of jobs has finally grown enough to satisfy the former labor abundance.  With unemployment now below 2%, education and training should improve and allow for higher value-added labor to be performed in Thailand.

 

Social Situation

 

Thailand, unfortunately, is characterized by extreme disparities in wealth.  Most of the middle and upper classes reside in Bangkok.  They have relatively high disposable incomes and are very susceptible to foreign marketing and luxury consumer goods.  On the other hand, Peasants represent the majority of the population.  Thai consumer taste exhibits very little Western influence due to the fact that it has never been colonized by a foreign power in its modern history.

 

The great majority of Thais are Buddhist (95%) but there is a significant Muslim population as well.  There is a high level of religious and ethnic tolerance among Thais, in marked contrast to other countries within the region (i.e. Indonesia, Philippines, Malaysia).  The national language is Thai and is spoken by 94% of the population.  English is rarely spoken except among young educated professionals who have studied the language.  Thailand has a very high literacy rate (94%) but has a very under-funded educational system that discourages the growth of secondary language skills except among the elite.

 

Business Practices

 

As in most Asian cultures, Thais prefer to establish personal relationships before entering any business agreements.  Thailand has a very complex legal system and regulatory structure for foreign operations and investment.  Different laws apply to different nationalities.  There are high levels of corruption in the business arena and bribes are viewed as a normal cost of doing business in Thailand.

 

Characteristics of the Thai Consumer Market

 

Thailand probably makes the best case for an argument in favor of market segmentation and specific segment targeting in a foreign country by MNCs.  The level of income among the Thai populace fluctuates wildly between $650/month to $20/month.  Households in Bangkok earn and spend more than double the amount compared to their provincial peers.  Furthermore, the youths of under-20 year olds make up 44% of the total population and represent a great deal of purchasing power.  The Thai youth market is very sophisticated and is susceptible to the strategy of identity branding.  Most youths earn an average of $50 in monthly disposable income.

 

A Reader’s Digest survey has found that Thais have very strong brand loyalty to well known brands.  Thais, similar to other Asian consumers, prefer to purchase brand names coming from countries with a reputation for excellence in a particular product category.

Foreign companies should be aware that despite the high savings rate present in Thai families, there has been rising consumer debt among Thais.  The recent terrorist threats in the region have hurt the important tourist industry and the revenues it generates.

 

Samsung and its mobile phone strategy

 

By year-end 2002, Samsung Electronics Co. had taken in $4.5 billion in revenue from exports to Southeast Asia, enjoying an increase of 50% from year-end 2001.  Samsung’s local production in Southeast Asia posted an increase of 60%, up to $1.9 billion from $1.2 billion in 2001.  The success has catapulted Samsung into the stratosphere of market leaders in the Southeast Asian region and now directly competes with names like Sony, Panasonic, and Nokia.  The success in 2002 has fostered high expectations and Samsung has not shied away from making bold revenue forecasts for 2003, expecting to reach $6.3 billion (30% increase) through exports and $2.4 billion (20% increase) through local production. 

 

Thai Samsung Electronics Co., Ltd. was established in 1988 as a joint venture between Saha Pathana Inter-Holding Co., Ltd. and Samsung Electronics, Co. to manufacture home electronics and other hi-tech products.  Samsung views Thailand as a key developing market in its global strategic vision and has chosen the country as a major manufacturing hub for global exports of various hi-tech products.  Thai Samsung’s main mission is to become what is known as a Digital-e Company, providing innovative digital products with the ability for online processes in order to capture the digital-online and network compatibility revolution.  Samsung is currently third in the Thailand mobile phone market, behind Nokia (32%) and Motorola (15%).  By the end of the year, Samsung intends to gain at least an additional 3%.  This intense competition between the market leaders will lead to a further increase growth and boost demand in technology.  The overall demand for cell phones is expected to increase to about seven million units, and the consumer preferences are expected to evolve as well.  Buyers are getting more and more sophisticated and technology conscience instead of being price wary as they were in the past.  Buying decisions are now mainly based on operating efficiency and technological sophistication.  The trends in the Thailand market seem to fit perfectly with Samsung’s differentiating strategy perfectly.  After having developed multifunctional color screens enhanced with detailed picture definitions and sharpness, Samsung is the leader TFT-LCD technology.  Other new and modern features are incorporated into the cell phones offered on the market, including over 40 polyphonic ring tones, built in cameras, and broadband Internet enabled cell phones.  By targeting middle to high-end user markets with industry leading technology, Samsung aims to take advantage of the Thailand market characteristics. 

 

Samsung is very optimistic about its future in Thailand and expects to see spectacular growth in the near future.  Thai Samsung expects to be the leader in the local Thai market not only in mobile phone and networking, but also in home electrical appliances and office networks by the year 2004.  Three concepts Samsung will focus on are high quality, ease of use, and reasonable prices.  Business Week’s annual InterBrand survey ranked Samsung as the world’s 34^th most valuable brand and it has also become the fastest growing global brand with an increase in brand value to $8.1 billion.  Thus, in a brand name driven market such as Thailand, it is not surprising that the Samsung brand name is highly regarded by Thai consumers (Exhibit 1).   Also, a fact that seems to back up Samsung very optimistic view on Thailand is the reaction by the consumers themselves.  The three most cited reasons why Samsung has a strong reputation among Thai consumers are exactly what Samsung strives to do: innovation, quality, and ease of use. 

 

Financial Statements and Performance

 

Over the past 5 years, Samsung Electronics’ financial performance has been exemplified by a strong balance sheet, income statement and statement of cash flows.  In 2002, unaudited results show that the company has reached all time highs in operating income, net income, revenues and earnings per share.  It is still too early to tell from these past financial performances whether or not Samsung will continue its healthy growth in the long run and surpass Sony as the world market leader in home electronics.

 

Balance Sheet

 

When we look at Samsung Electronics’ balance sheets from 1998-2001, we can see that the company has overcome the Asian currency crisis woes of 1997 and became a healthier company according to all financial item indicators.  Cash items grew by roughly    100% from 1999-2001.  Inventory levels have been somewhat volatile but Samsung was able to reduce inventory by 24% in 2000-01. 

 

The majority of the company’s long-term assets consist of plant, property and equipment (over $11 billion).  This indicates that the company has invested a great deal in physical capital and is poised for future growth & expansion given the right opportunity.  Furthermore, the large percentage of fixed assets is representative of its industry.  Like most electronics firms, Samsung realizes it must invest a great deal in manufacturing and R&D to produce innovative products while taking advantage of economies of scale. 

 

When we examine how the assets are capitalized, we see a potential for financial insolvency.  The company seems to be financing its substantial long-term assets with mostly “short-term borrowings” (30% of total liabilities).  Current liabilities make up a whopping 74% of total liabilities.  Thus, Samsung is very vulnerable to volatile interest rate movements.  If short-term loan payments increase, the company would be hard-pressed to come up with cash from its illiquid long-term assets.  One could argue, however, that the very nature of the Samsung Group reduces default risk for all of its subsidiaries.  Should Samsung Electronics ever run out of cash, the other members of the “chaebol” will likely step in to provide loans and bail the company out of financial distress. 

 

A quick glance at shareholders’ equity shows that the company’s retained earnings makes up 65% of its total.  This shows that management is dedicated to growth and has reinvested most of the company’s earnings back into the business rather than distribute them out as dividends to shareholders.

 

When we do a simple financial analysis on the balance sheet for the company in 2001, we see that Samsung has a current asset ratio of 1.14 and a debt-to-equity ratio of only .31.

 

This shows that Samsung is a mature and established player in the electronics products industry and it is not overloaded with debt. 

 

Income Statement

 

Nowhere is Samsung Electronics’ rapid growth more evident than in its income statements.  From 1998 to 2001, sales grew by 80% and average annual revenue growth for that period was 22%.   The bulk of Samsung’s income consists of exports (68% of total sales in 2001) and we look for that pattern to continue in the future.  With the exception of the 2001 year, Samsung has achieved positive annual growth in all major income item categories (Sales, Gross Profit, Net Income).  We believe this outlier is explained by the occurrence of the September 11^th Tragedy.  Since the US is a major export market for Samsung, the reduced consumer sentiment and market depression that followed the terrorist attack had a severe negative effect on Samsung’s income.  However, by achieving record income levels in the following year, Samsung showed that it still had strong business fundamentals and was able to sell its products more successfully than ever. 

 

From the investor’s point of view, Samsung shares are a very attractive buy in the marketplace.  EPS and profit margins have shown steady growth barring 2001.  Samsung also had an interest coverage ratio of 9.34 for 2001.  This means that Samsung has 9 times as much income as it needs to make its required interest payments.  This is a very healthy figure and means that Samsung’s investors do not need to worry about the firm’s credit risk in the near future.  Samsung is currently trading at a very strong P/E ratio of 16.89 (in Korea).  This ratio reflects investors’ high expectations for future growth from Samsung.

 

Cash Flows Statement

 

We can see that the company’s cash flow movements have been relatively stable over the past 5 years.  Samsung Electronics has kept a safety cushion of $1.5 billion in cash annually to cover its expenses.  Investing activities such as the acquisition of plant and equipment and payment of long-term debt account for the majority of cash outflows.  Once again, the company’s emphasis is to retain cash for expansion opportunities and loan maturities.  We also see cash outflows due to a steady pattern of losses on equity investments and currency translations.  We may extrapolate that the company should focus on hedging currency risk more efficiently and making smarter equity investing decisions in the future. 

 

Business Practices, Stock Information, and Performance

 

For years Samsung Electronics has been putting market share ahead of profits.  Now, with the implementation of just-in-time strategy, Samsung Electronics has experienced a drastic turnaround, and has helped drive the Samsung Group chaebol from the brink of bankruptcy.  In the constantly changing electronics industry, new innovations drive old technology out and drive new ones in at alarming rates.  An example of the just-in-time system at work is in stockpiled PC monitors.  These stockpiles used to lose about 5% of their sales value every month, but with the new inventory strategy, Samsung Electronics saves millions a year by having only two-month supply of inventory.  A cost cutting strategy has also been implemented in order reduce their overall debt.  Showing defiance to Korean business practices such as lifetime employment, Samsung Electronics cut the number of its employees from 83,000 to 55,000, saving $270 million last year.  Overall, Samsung Electronics consolidated debt has been reduced from 27 trillion won (5.8 times equity) to 16 trillion won, or $10 billion (1.2 times its equity).

 

The company has also taken on positive and lucrative investments over the last couple of years.  In October of 1999, Dell agreed to buy $200 million of Samsung's convertible bonds in return for a steady supply of flat-panel screens.  Although the cell phone market has not been great, Samsung is determined to place their stamp on this industry.  The industry expects to see total shipments of about 410 million handsets worldwide in 2003, up from 395 million in 2002.  However, with their unique pricing strategy and targeting mid to high level income ranges, Samsung Electronics expects revenues from cell phone to increase from 10.9 trillion won in 2002 to 13.7 trillion won in 2003.

 

There is however a fear of lack of transparency from investors outside of Korea.  Some are concerned that Samsung may go back into market share first-profits second way of thinking, and the fact that Samsung rejects to break down its profit by division adds even more worries.  This lack of transparency helps explain why Samsung stock traded at 14.2 times its earnings in 1999.

 

Recent political change may mean that economic success might not come so easily to Samsung as it has come in the past.  With the inauguration last week of Roh Moo-hyun, reformation of the chaebol has become a priority.  Roh is said to be much more liberal than outgoing president, Kim Dae-Jung.  Roh’s term began with a sudden arrest of Chey Tae-won, vice-chairman of SK Group, a huge textile manufacturing chaebol.  This new president aims to bring greater transparency to these organizations and to force the firms to consider the interests of minority shareholders. 

 

Roh pledged to allow for class action lawsuits, meaning that shareholders can now sue for false representation and fraud.  He expects that the future of the Korean economy will be brighter if it moves away from these family organizations towards more modern business organizations.  He believes that it is important for the economy to continually evolve especially as a service provider and in science and technology.  This shift of thinking in the South Korean macroenvironment is sure to have drastic affects on Samsung Electronics’ corporate strategies.

 

Samsung Electronics stock isn't traded in the United States, but investors can buy Samsung Electronics GDRs (global depositary receipts), which are traded on various Asian and European exchanges.  Samsung Electronics sells on the South Korean Stock Exchange for 279,500 South Korean Won.  The U.S. dollar buys 1,194 South Korean Won.  This means that a share of Samsung Electronics can be purchased out of South Korea for 233.50 U.S. dollars.  Because this is such a high price per share, two Global Depositary Receipts represent one share of the underlying Korean stock.  The GDR representing common shares sells at 117.92 U.S. dollars.  This implies a 1.00% premium above the price of the underlying shares.  One GDR represents one share of preferred stock, and sells at a 1.55% premium for 57 U.S. dollars.

 

Within the last year, the common stock GDR has traded within the range of $109.05 to $163.15.  The premium on these GDRs has been as little as –4% and as high as 4%.  The 52-week high on preferred GDR’s was $84, and the low $53.  The premium for these GDRs has ranged from –15% to 8%.   

 

Samsung Electronics: Credit Rating

South Korean credit rating environment

 

For several years, South Korea has been overlooked as a viable market for bond investors, largely due to hard-currency issuance and excessive risk premium. In 2000, South Korea’s credit rating was BBB+, while Mexico’s was BB+. Despite being apart by only one level, South Korea was 110 basis points over. The attractiveness of the Latin American emerging markets, as well as a general lack of issuance and the need to restructure in Korea, led to a period of relative inactivity in terms of investor confidence in the Korean bond market.

 

Recently, South Korea has started to enjoy a more favorable credit rating. In March of 2002, the Moody’s Investors Service raised South Korea’s rating by two levels, from “Baa2” to “A3.” On June 27^th of that year, S&P followed suit and rose Korea’s rating one level to “A-“ from “BBB+.” The updates were accredited to the country’s diverse economy, progressing private restructuring and increasingly strong external position, according to a report published in “Korea Today.” 

 

Samsung Electronics

 

Samsung Electronics has attained a corporate bond rating of AAA (current as of November 2002). For the most part, its credit rating has conformed to the general improvement seen throughout South Korea. Exhibit 4 lists Samsung’s most recent issuances and their current ratings. Virtually all of them once fluctuated around Baa3, which was two levels under their current level. All of them are still under consideration for further updates, and both local currency and US $ issuances are at a uniform level.

Also, S&P has given the company an A-/Stable/A2 for both local currency and foreign currency. As a result, Samsung Electronics have built a strong credit position in both local and international market.

 

Thailand’s Mobile Phone Market

 

General Overview

 

Currently, Thailand has approximately 15million mobile phone users, which represents a 28 percent mobile penetration rate. Comparatively, Malaysia has 40 percent, Philippines at 17 percent, China with 16 percent, and Indonesia has 5 percent, according to a study conducted by Credit Lyonnais Securities Asia(CLSA). The Thai mobile industry is under supervision by two major state agencies, the Telephone organization of Thailand(TOT) and the Communication Authority of Thailand(CAT), both of which report to the Ministry of Transportation and Communications(MOTC). Mobile service providers are required to be licensed by these agencies to operate in Thailand. Licensing-related expenses include registration fee, monthly fee, and airtime fee applied only to outgoing calls. Two large local licensees, AIS and DTAC, has a user-base of 11.1million, or 65% of the total market share. The rest are made up of other licensees, which include other local ones such as Tawan Mobile Telecom, as well as foreign ones such as Samsung. TOT and CAT themselves operate mobile service network on a limited basis as well.

Recent Outlook

 

Despite a global economic slowdown that has grasped the globe’s economy, there are markets that are little or just not affected, and the Asia-Pacific region’s mobile phone market is one of them. The chart below is the projected handset sales, in millions, for the Asia-pacific region, taken from data published by Global Wireless News.

Thailand displays a stable growth pattern, but Thailand itself does not conform to the pattern followed by the rest of the region. After seeing its market penetration increase rapidly from 3.6% in 1998 to 28% in 2002, most industry experts believe that the Thai mobile market is slowing down. In September of 2002, Boonchai Bencharongkul, chief executive officer of DTAC(One of Thailand’s two largest mobile operators), was quoted as saying that the Thai market is “almost saturated, with sales slowing after hitting the peak in the first 3 quarters of 2002.” He attributes this to various factors, such as recuded revenue per line, less aggressive promotional campaigns, and less competition among local providers. The general trend of the local providers have started to shift toward promoting customer retention rather than expansion from 3^rd quarter of 2002.

Samsung Electronics

 

Teaching Note

 

 

Valuation of Samsung Electronics Co. Ltd.

           

To valuate Samsung’s net worth, we decided to use the Weighted Average Cost of Capital Approach (WACC), as the data required in its calculation were more readily available.  According to the Modigliani and Miller Propositions, the value of a leveraged firm is calculated using the following equation:

 

V_L = (EBIT * (1-Taxes))/WACC

 

However, given the fact that Samsung Electronics is a large, growing and publicly traded firm, it is obvious that we must take earnings growth and dividend payouts into account.  Thus the following equation was used:

 

V = (((1-b)(EBIT) * (1-Taxes))/(WACC-g))

 

To calculate the Weighted Average Cost of Capital or discount rate, the following equation was used:

 

WACC = Wb*Rb*(1-Taxes) + Ws*Rs

 

 

The cost of debt, the cost of equity, the tax rate, and the relative weights of the equity and debt are all given in Exhibit 1.  Thus, the formula for Samsung’s WACC is the following:

 

WACC = .35 * .056 * (1-.1209) + .65 * .2151

WACC = .157

 

Samsung’s average annual EBIT growth rate for the last 10 years (1992-2001) is roughly 33.2%.  However, for the equation to hold (growth rate is now larger than the discount rate), we must use a stable earnings growth rate that can theoretically be sustained forever.  Since no firm, in the long term, can grow faster than the economy in which it operates (which might be the global economy), a stable growth rate cannot be greater than the growth rate of the economy.  Thus we use the most recent real GDP growth (2001) of South Korea as our growth rate, which turns out to be 3.26%.  The payout ratio is calculated from the 2001 dividend payout (dividends per share/earnings per share) and is 11%.  Earnings before interest and taxes is simply the operating income for the past year.  Now we solve for the value of Samsung Electronics and come up with:

 

V = (((1-.11)(3,487,911) * (1-.1209))/(.157-.0326))

V = 21,936,801.27 Million Korean Won

 

            Here, our valuation is complete and shows that Samsung Electronics is a powerhouse of a company that is worth about $22 trillion Korean Won.

Valuation of the Thailand Mobile Phone Project

            Cost of Capital – Correctly estimating the cost of capital is vital in valuing the project.  Due to the intrinsic risks involved in investing in a project in an emerging market, we discounted the expected cash flows using a risk-adjusted discount rate.  Normally we would construct the discount rate using the capital asset pricing model, but in this case, we are dealing with an international project within an emerging market.  Thus, we have decided to use the Global Integrated Model in order to create a suitable discount rate to value this project.

 

- The Goldman Integrated Model

 

Conducting the Goldman Integrated Model proved to be challenging and the information difficult to assess.  The equation used to calculate our discount rate was as follows:

 

R = Rf + SYS + β(Risk premium)

 

The base assumption when using the Goldman Integrated Model is that the firm’s operations in an emerging market are as risky as the same type of operations in the United States with an added risk premium for the emerging country’s added risk.  Thus, we must use the U.S. risk-free rate and market risk premium in our calculation.  The U.S risk-free rate is the yield on the 10-year Treasury note, 3.93% (from finance.yahoo.com).  The sovereign yield spread (SYS) was

 

calculated using the 10-year treasury note/bond yields from the United States and Thailand.  The yield on the U.S. Treasury note is 3.93% and the yield on the Thailand bond is 3.4%.  Thus, taking the difference between these two, we get the spread equal to .53%.  This is a very narrow spread, and given this, many fund managers are reluctant to buy Asian bonds.  Many analysts blame such tight spreads on increased usage of default swaps.  Default swaps are insurance type products allowing investors to adjust exposures to the risk of default or other event on a bond or loan.  Actually, Thailand is commonly named as the country whose yield is most out of place from where it should be.  Thailand’s beta is .89.  This is the beta listed for the largest Thai mobile phone company, Advance Info Services, which is owned by the Prime Minister.  We used the historical U.S. market risk premium of 7%

 

U.S risk free rate		3.93%
U.S market risk premium		7%
Thailand Beta		0.89
Bond Yield-Spread		0.53%
Cost of Equity		0.1069
Adjusted R		0.2138

 Using all of this data, we have calculated our discount rate to be:

 

R = .0393 + (.0393 – .034) + .89(.7) = .01069 or 10.7%

 

The rate we got from our calculation was much lower than what we had anticipated.  We attribute this finding to a couple of reasons.  First, the risk premium added through the bond spread reflects only the risk of the government’s default on debt and not any of the risks involved in the actual business taking place in Thailand.  Secondly, due to the default swaps, the true bond yield for Thailand has been manipulated.  Given these two reasons, we feel that this rate is too low and not suitable for our valuation.  While we know that it must be adjusted, we realize that we have no way to pinpoint the exact measure of this adjustment.  So, working on theory alone, we feel we should double this rate to 21.4%.  Once we are done with our NPV valuation using both the 10.7% and the 21.4%, we can assume that the real value of the project will fall in between the two values.  If it still comes out positive, we would then be sure that the project would be very profitable and that Samsung should take the project.  Having discounted the projects expected cash flows at a rate twice as high as the calculated rate, a positive NPV will undoubtedly ensure a very high net worth project.

           

            Project Cashflows - We valued Samsung Electronics’ expansion into the Thailand mobile phone market by growing the expected future cash flows from the cash flow growth rate for the years 2001-2003 (2003 is projected year-end cash flow using Samsung Electronics’ expectations).  Through Thai Samsung, the subsidiary that handles Thailand operations, Samsung Electronics has been able to generate a respectable and growing growth rate.  Here is their cash flow breakdown from year to year according to our calculations:

 

2001: Thai Mobile Phone market consisted of approximately 4 million estimated users and was valued at Bt 20 billion, of which Samsung had a 10% market share.  Using this information, we derived the cash flows to be 20*.1 = Bt 2 billion. 

 

2002: Bt 3 billion

 

2003: Thai Samsung estimates to bring in a total of Bt 18 billion from all sales and operations, 30% of which will come from mobile phones.  Thus we calculated the cash flows as 18*.3 = Bt 5.4 billion.

 

Using this information, we have concluded Samsung Electronics’ has been able to garner a growth rate of roughly 39% in terms of cash flow generation since their entry into the mobile phone market in 2000 (we could not find any substantial or relevant statistics from year 2000 to include into this valuation).

To do our valuation, we have grown the projected 2003 cash flow of Bt 5.4 billion by 39% and will grow the cash flows for the next 5 years at the same rate.  Due to the fact that the Thai market has shifted away from being price conscious to being more demanding of new technologically, we believe Samsung is in a very good position to maintain such a high growth rate in the future.  Being the leader in TFT-LCD technology and color screens along with integrating accessories such as a digital camera and high-speed access in their cell phone, Samsung seems to be in position to grow significantly in the near future.

 

NPV Valuation- After growing the cash flows at 39%, we get the next 5-year cash flows to be Bt 7.5 billion, Bt 10.43 billion, Bt 14.5 billion, Bt 20.16 billion, and Bt 28 billion.  Since Samsung’s core strategy in Southeast Asia in recent years is one of heavy investment in marketing, brand building, R&D, and manufacturing, we decided to calculate their initial investment based on this focus.   According to past press releases, Samsung set aside Bt 500 million for a marketing campaign in 2001.  We used this number to represent their marketing and brand-building efforts for this project.  According to a recent news article, Samsung has also invested US$26 million for R&D and manufacturing expansion in Thailand.  We converted this amount to Bhat using a spot exchange rate of $1 = Bt 43.  The resulting operating investment was Bt 1.118 billion.  The NPV calculation is as follows:

 

Using 10.7%

 

NPV =– 1,618,000,000 + (7,500,000,000/1.107) + (10,430,000,000/1.107^2) + (14,500,000,000/1.107^3) + (20,160,000,000/1.107^4) + (28, 000,000,000/1.107^5) =

Bt 54,624,518,111.52

 

Using 21.4

 

NPV =– 1,618,000,000 + (7,500,000,000/1.214) + (10,430,000,000/1.214^2) + (14,500,000,000/1.214^3) + (20,160,000,000/1.214^4) + (28, 000,000,000/1.214^5) =

Bt 39,641,104,648.04

 

 

Conclusions - As you can by the results, we view the mobile phone project in Thailand as a huge opportunity to generate enormous revenue and be an important part of Samsung

Electronics’ overall world success.  We conclude that the NPV will fall somewhere in between Bt 54 billion and Bt 39 billion but to be on the safe side, we would advise Samsung Electronics’

to work with the minimum value.  The minimum according to our calculations is valued at over Bt 39 billion.  There is no doubt Samsung Electronics should invest heavily in the Thailand mobile phone market and we would advise them to invest much more to increase their market share.  The Thai market itself is growing, and many of Samsung’s competitors are staking their claims in the market.  It would be to Samsung’s ultimate benefit to be aggressive and to become a dominant player in the Thai mobile phone market.  According to the high NPV at which we arrived with our analysis, Samsung Electronics has plenty of room to maneuver and invest.  The extra investments should come in the form of R&D or marketing, or optimally, a combination of both.  With so much money and room to maneuver under their budget, Samsung Electronics finds itself in the perfect situation that will allow them to become both the technological leader and the market share leader in the Thailand mobile phone market of the future.

 

Supplementary Materials

1.                  http://www.bangkokpost.net/56pe2002/thaisamsung/thaisamsung.html

2.                  http://www.businessinthailandmag.com/archive/july_aug01/18.html

3.                  http://www.economist.com

4.                  http://www.businessinthailandmag.com/archive/july_aug01/18.html

5.                  http://www.globalwirelessnews.com

6.                  http://www.cat.or.th/eng

7.                  http://www.shinawatra.com/eng

8.                  News & Analysis: Samsung’s climb to prominence by Cordelia Lee

9.                  Thailand Magazine  “Handset Makers Vie for Bigger Chunk”  July-August 2001

10.              Dun & Bradstreet Country Riskline Report: Thailand.  Feb. 2001

11.              National Democratic Institute for International Affairs: Thailand 

12.              Yonhap “Samsung Electronics Posts US$4.5 BLN Revenue in Southeast Asia” 01/02/03

13.              Asia Market Research: Thailand Capsule.  June 2002

14.              Bangkok Post: 56 Prominent Enterprises.  Thai Samsung Electronics Company Limited.

15.              The Nation.  Thai Samsung: Taking the hi-tech road to profit. Nov. 18, 2002

From LexiNexis

16.              Asia Pulse.  Samsung Electronics Posts US$4.5 BLN Revenue in Southeast Asia. Jan. 20, 2003

17.              Global News Wire: Thai Press Reports.  Samsung Launches New Cell Phones. Jan. 16, 2003.