Samsung: chipping away at challenges

As with any investment, your capital is at risk.

Samsung Electronics (“Samsung”) is a complicated beast with a number of moving parts combined together as a conglomerate or chaebol. In the interests of simplicity, it is best to break down the company into three broad areas: its Device Solutions division which incorporates its memory and logic semiconductor businesses (25 per cent FY23 revenue); its Device eXperience division which manufactures smartphones, TVs and home appliance (66 per cent FY23 revenue); and Samsung Display which makes display panels for its own and competitors’ smartphones and televisions (12 per cent FY23 revenue). Samsung’s current difficulties mostly lie in its Device Solutions division.

While TSMC is making hay-producing chips for NVIDIA, Samsung is struggling to maintain its position as a credible second source for AI chip designers. While Samsung was competitive with TSMC at the 5 nanometre (“nm”) and 4nm nodes, it has fallen behind at 3nm. At the end of quarter two of 2024, estimates put TSMC’s market share at 62 per cent and Samsung’s at 13 per cent, a distant number two.

However, Samsung made a big process change at 3nm and is still grappling with some of the technical difficulties, but pain taken now should smooth its progress with the next leading node, 2nm, which uses a similar process. While TSMC has served its chip customers well, the likes of Apple, NVIDIA, Broadcom, Qualcomm and AMD would all like Samsung’s foundry business to be competitive.

Samsung’s most important business is making DRAM (predominantly for computers) and NAND (predominantly for smartphones) memory chips. Over a number of years and through various cycles, DRAM has become consolidated to essentially a three player market of Samsung, SK Hynix and Micron. NAND is less concentrated with as many as seven credible players.

In legacy DRAM and NAND, there is little growth at present and increasing competition as China strives for self-sufficiency in the face of US chip restrictions. However, the one area where there has been strong demand is high-end memory chips for servers, but especially for high bandwidth memory (“HBM”) chips used in AI accelerators.

Unfortunately for Samsung, its South Korean competitor SK Hynix has stolen a march on HBM chips (both are held in your portfolio). In particular, SK Hynix is the dominant supplier to NVIDIA, while Samsung is still yet to qualify as a supplier of the highest specification HBM3 chips. However, as with its foundry business, AI customers would very much like a second source to SK Hynix.

In the long run, Samsung does potentially have a unique competitive advantage. Unlike the other semiconductor giants, Samsung could potentially be a one-stop shop for AI accelerators. It could manufacture its customers’ logic chips in its foundry and then package them with Samsung’s own HBM chips - all in-house. This vertical integration has the potential to increase efficiency and lower costs for its customers.

On the Device eXperience side of the business, Samsung continues to hold significant market shares across a number of devices including smartphones, tablets and televisions. Samsung was the first brand to incorporate a degree of AI in its Galaxy S24 smartphone and the first to successfully manufacture phones with foldable screens. Despite these technological advances, Samsung continues to suffer competition from Apple and Chinese brands but has managed to maintain a global market share of 18.3 per cent.

Meanwhile, in televisions, Samsung has been the leading brand for 18 consecutive years with a 30.1 per cent market share. While growth has been pedestrian for many of these devices in recent years, it remains the case that if AI proves to have any utility, then it will drive a large replacement cycle, which should benefit Samsung considerably.

Samsung has historically been an aggressive spender in R&D, investing over US$20bn in each of the last three years. As a result, the company filed over 106,000 patent applications between 2019 and 2022, the most by any company over the period according to a NASDAQ report. Ally this to a culture where executives were mandated to work a six-day week earlier this year and it is clear that Samsung’s historical cultural strengths of innovation and competition remain intact.

However, potentially the biggest lever that Samsung has is to start spending the US$75bn that the company has in cash. In addition, with this amount of cash, the company does not have to limit itself to expanding its capabilities in its existing businesses; capital allocation will be critical. In the short term, Samsung is deploying US$7.2bn in share buybacks, in line with South Korea’s ‘Value-Up’ programme, which should support the share price.

As things stand, we view Samsung’s difficulties as temporary and are willing to be patient. In particular, current valuations of approximately 1.0x Price/Book have historically marked a trough for the company, so much of the bad news is in the price. The EM Team is currently undertaking a review of Samsung and unless some ‘unknown unknowns’ come to light, it is likely that, having been in many of our clients’ portfolios for over a decade, it will remain so for years to come.

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