Elliott Associates

The Future Of Samsung Could Rest On A Single Vote Tomorrow

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These are trying times for Samsung Electronics, the largest Korean company by market cap and one of the largest technology companies in the world. The once high-flying smartphone maker has hit several road blocks over the past two years, including greater competition from Chinese Android manufacturers that has led to declining profits for several quarters straight.

If business challenges weren’t enough, the company is also experiencing a critical leadership transition from the group’s patriarch, Lee Kun-hee, to his son, Lee Jae-yong. The elder Lee, who famously guided Samsung’s rise from low-quality consumer goods manufacturer to top device manufacturer starting in the 1990s, had a heart attack last year that has left him incapacitated.

The younger Lee seems destined to take over Samsung, but a crucial shareholder vote tomorrow remains between him and his destiny – and the votes today are too close to call.

At issue is a proposed merger of Cheil Industries and Samsung C&T (Construction and Trading) that is being vigorously opposed by U.S.-based hedge fund Elliott Associates, who is perhaps best known for fighting Argentina over its sovereign debt.

If the merger receives the required two-thirds shareholder approval, ownership will be well on its way to being consolidated by Lee Jae-yong. If it is blocked though, it could massively complicate the future of the most important Android manufacturer in the world.

A Complex Network Of Ownership

Samsung Electronics is just one part of the Samsung Group. In fact, while it is by far the largest and most important company in the family, it is joined by around 80 other companies in industries as diverse as finance, construction, semiconductors, heavy industries, and life insurance.

The Lee family owns small direct stakes in each of these companies, but its real power comes from the cross-ownership structure of these companies. Each company in the Samsung empire owns percentages of other Samsung companies, providing leverage to shareholders like the Lees to influence business strategy and decision-making.

For instance, Cheil Industries, a component of the conglomerate which produces chemicals and electronics materials, owns 19.3% of Samsung Life Insurance, and Life owns 7.2% of Samsung Electronics.

In the strange web of interconnected shareholding that defines Korean chaebol conglomerate structure, the proposed merger of Cheil with C&T is considered by analysts a key linchpin for the Lee family to effectively gain leverage over Samsung Electronics. By combining the two companies, Lee Jae-yong would own key stakes in Samsung Electronics through the newly combined entity’s partial ownership of Samsung Life Insurance, and thus in Samsung Electronics.

Like I said, complicated.

The Unique Opportunity And Challenge Of Korean Law

Of course, if companies are being valued properly, such mergers wouldn’t be worth their time. The price of Cheil Industries should include the ownership stake of Samsung Life Insurance, and by extension, Samsung Electronics. This is not so different from Yahoo and its early large stake in Alibaba.

However, a peculiar securities law has afforded the Lee family with an opportunity to gain additional leverage in the deal. Under Korean law, companies cannot set the prices of their mergers, but instead, must use the trailing price of its stock and a formula to determine the merger value. That law is theoretically designed to protect smaller shareholders, who otherwise would be at the mercy of Korea’s oligarchs to merge their entities together on a whim regardless of underlying value.

In this situation, though, Samsung C&T has been trading well below its fundamental value on the stock market, allowing Cheil to purchase it using the formula at a large discount.

That is what brought the hedge fund Elliott Associates into the fray. They saw an opportunity to block the merger and eventually extract a large profit from a future potentially higher-priced merger. They just need to get 33% of shareholders to vote no, and the deal will be terminated.

Activist investors are nothing new in the United States or even to the tech industry – just witness the recent battles between Carl Ichan and Apple or Carl Icahn and eBay (or, you know, Carl Icahn and everyone).

However, Elliott is the rare hedge fund to enter the South Korean market, where close networks between government, business, and the press ensure that the “system” works for conglomerate-owning families. Already, Elliott has lost two court cases locally, and Korea’s National Pension Fund (which owns a large 11.2% stake in Samsung C&T) has sided with Samsung despite the value it would potetnially lose in the merger.

The Korean securities law opened the door for Lee Jae-yong to gain leverage in the merger, but Korean inheritance laws are also the reason why this whole rigamarole is happening in the first place. While his father Lee Kun-hee owns large stakes throughout the Samsung conglomerate, the younger Lee faces billions of dollars of inheritance taxes when those shares are transferred, likely shrinking his ownership. The only alternative is to gain more leverage through M&A.

The Vote

Where are we now? According to an analysis by the Wall Street Journal, Samsung-affiliates and the Lee family hold about 31% of the votes (all in favor of merging), while Elliott Associates now has about a 7.1% stake in the company (opposing). A handful of other foreign institutions are believed to be opposed, moving the opposition vote count to around 9.5%.

That leaves the power of the vote in the hands of ordinary retail investors, who can swing the vote one way or another. Korea is aptly called the Republic of Samsung, and Koreans hold remarkable levels of pride in the business and its global success.

But the company has also faced hostile reactions from citizens here in recent years, most recently from incidences of leukemia at one of the conglomerate’s semiconductor plants. Another Family, a movie depicting the legal battle over the medical payments, was crowdfunded, although few theaters showed the film locally (Samsung is the owner of one of the two largest theater chains in the country).

For a company which has been almost invincible locally, its fate is now tied up with the common shareholder. From the same WSJ report, the company has provided free watermelons to shareholders in an apparent bid to buy their love. Whether such gestures are a little too late will be seen in just a few hours.

Whatever the vote tomorrow, it is well-past time for Korean conglomerates and regulators to consider ways of improving corporate governance. Shareholding is clearly no longer a family sport, but a democratic model of ownership that needs better protections than currently exist. Samsung is now one of the most important companies in the world, and it deserves better governance than it currently is receiving.

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