Early Christmas present from Samsung

Samsung has for many years been one of the biggest holdings in several of our equity funds. Along with the announced share buybacks, the company's third quarter results were better than market expectations and also contributed to the rise in Samsung's share price.

The discount of the preference shares to the ordinary shares in Samsung also dropped from 21.9 to 18.6 percent. At its peak in 1998, the discount was 82 percent.

This early Christmas present from Samsung Electronics has spilled over to other preferred shares in South Korea where discounts have decreased. For example, the discount decreased from 34 to 26 percent in SKAGEN Kon-Tiki's second largest holding, Hyundai Motor.

We are finally being paid for our activist role as a shareholder in Korean companies, where we have long pressed for greater shareholder friendliness.

Dividend priority

SKAGEN Funds first bought shares in Samsung Electronics during the Asian financial crisis in the late 1990s, mostly discounted preference shares. These are stocks that do not have voting rights, but have priority in payment of dividends. Share liquidity on the stock exchange is, however, lower than for the ordinary shares.

In South Korea, family-controlled holding structures, so called chaebols, are in control of many large listed companies through a web of cross ownership. A generational change has long been underway in Samsung Electronics, controlled by the Lee family. But the Captain of the Samsung conglomerate, and South Korea's richest man, Lee Kun-hee, has for a long time been kept artificially alive in a hospital. His only son, Lee Jae-Yong, is still waiting for the baton to be officially handed over. Expectations of a more shareholder-friendly attitude before the change of management has taken place have been low, so this early Christmas present came as a pleasant surprise.

Glaring examples

In general, Korean shares have been priced at a discount due to a lack of corporate governance. Often with good reason. A recent example of this is Hyundai Motors' purchase of a piece of property in Seoul for about USD 10 billion - estimated to have been twice the market price. One other recent case earlier this year was the merger between the companies Samsung C & T and Cheil Industries that resulted in the Lee family tightening its grip on Samsung Electronics even further.

Buy mostly preference shares

Central to the awaited Samsung buyback program is that the Lee family's shareholding will not be diluted. And what is gratifying for us as owners of preference shares is that relatively more of these will be bought than the ordinary shares.

As Samsung Electronics announced in a press statement: "As long as the discount to the ordinary shares is higher than 10 percent, we prioritise buying back cheaper preference shares."

The combination of share buybacks and payment of dividends will constitute 30-50 percent of the company's cash flow in the period 2015-17. On top of the expansive dividend payout to shareholders, the company will initiate a share repurchase program of 11.3 trillion won, equivalent to USD 10 billion.

Based on the indicated split between ordinary shares and preference shares, the total share buyback program may end up constituting five percent of the ordinary shares and 17 percent of the preference shares.

Following these purchases, the shares will be cancelled. The company size will remain the same, but there will be fewer shares to divide the profits between.

Boosts earnings - reduces risk

The timing of the share buyback program seems considerably more shareholder friendly than previous major repurchases in 2007. At that time the stock was relatively more expensive than it is today.

Given that Samsung Electronics will be buying shares using money out of a bulging and not very profitable cash pile of USD 59 billion (67 trillion won) this will have a direct positive effect on the earnings per share (EPS). This also minimises the risk of Samsung Electronics making expensive acquisitions which are not favourable to shareholders, be it of competing companies or prestigious properties in Seoul.

Still significant upside

After several quarters of reduced earnings and losing market share in mobile, many people had lost faith in Samsung Electronics.

In the discount segment, the company has been attacked by Chinese low-cost players, while at the expensive end of the smartphone market, Apple has taken an increasingly large slice of the pie. At the same time as market share has declined, so has profitability.

It was therefore gratifying to see that the mobile downturn seemed to have stalled in the third quarter, and that the margins - after an inventory clearout - are on the rebound. A new strategy for the mobile division is expected to focus on profitability rather than market share.

The memory division continues to show strong performance and now accounts for 50 percent of company profits. Samsung Electronics' third leg, which is the one most exposed to competition, namely displays and consumer electronics, is also becoming a leg to be reckoned with.

Despite the recent sharp rise in share price, Samsung Electronics is still more than 30 percent off SKAGEN Kon-Tiki's target price of 1,600 won.