Will Samsung's Heir Bring Down Apple?

  • Samsung Group's next CEO will be Lee Jae Yong. He's ambitious, capable, well-respected and could be a formidable obstacle in the path of Apple.
  • However, the Group is spread too thin, even Samsung Electronics is facing key challenges in which the on-going expansion of core business units has resulted in an unfavorable competitive dynamic.
  • This bodes well for Apple, as it's more specialized and is more efficient with various cost categories.
  • Furthermore, the heir to Samsung Group is more likely to manage the business conservatively, despite having some support from key shareholders.
  • Going forward, I anticipate Samsung to not only lose momentum in smartphones but to lose an even bigger portion of the market to Apple.
Will Samsung Heir bring down Apple

Samsung Group's next CEO will soon be taking over. His name? Jay Y. Lee (Lee Jae Yong), and apparently he is very motivated to turn Samsung (OTC:SSNLF) around and generate some meaningful value for shareholders especially after the recent battle with Elliott management over consolidation of Samsung.

Samsung is a company that has grown quickly over the years, but quickly grew out of favor as various issues pertaining to smartphones in both the high-end and low-end of the market has created a dynamic in which shareholders have to factor in weaker sales into their financial models. This creates downward momentum on the stock, as it already trades at a bit of a discount as a result of a family ownership structure.

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Source: Samsung Vs S&P 500 by Amigobulls

The challenge is vexing, given Samsung's position in semiconductors, handsets, televisions, displays, storage devices it is going to be really difficult for the company to not only pivot, but grow the business in a way that can adequately address both competitive threats and long-term value creation.

In a sense Jay Y Lee, will have to put on the Warren Buffett and Bill Gates hat at the same time. This means that the next head of the Samsung household will not only have to be a master capital allocator, but he will also need to have to the skills necessary to run the biggest company in Korea. Being both a wizard at investment and business development is going to be difficult. He will have to take over the reins from Lee Kun-Hee, which will be a very difficult transition for the Samsung Group. This is because he is not a proven leader yet and chances are, his management style will become a little more conservative because he is not always going to get unconditional approval from the board on everything that he decides to do. Needless to say, those are problems to think about once he's elected the CEO and Chairman of Samsung Electronics.

Shareholders have already priced in this reality into the stock, however, I would be very cautious of simply buying into the idea that perhaps Samsung will be able to compete with Apple (NASDAQ:AAPL) on equal footing after the transition to a new CEO.

Also See: Apple Stock Analysis video evaluating the fundamentals of the company.

Tim Cook has established a world-class team to design and manage software, hardware, retail, supply chain, and product development. In fact, Apple has built a really large competitive lead over the years. So, whenever Apple wants to launch a new product people are more interested and is able to leverage its brand equity over and over. Furthermore, the company has an envious track record of simply arriving first and then maintaining their competitive position in any given market. Admittedly, Apple did lose PCs to Microsoft (NASDAQ:MSFT) in the 1990s, but it is the only alternative PC ecosystem and earns the vast majority of the PC OEM profit share based on 2015 figures.

The problem Samsung faces when competing with Apple is mostly driven by their inability to add meaningful value in terms of software. But at the same time, Samsung also provides hardware for many of its competitors. So, the competitive advantage that Samsung does have isn't being applied fully to smartphones, and also resources have to be spread across very competitive market verticals, which indicates that Samsung is investing a lot less into smartphone development and rather they are investing more into foundational IP for flash storage, fabs, and other components.

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As you can tell Samsung is the clear leader in research and development when compared to other tech companies. However, I make this comparison to point out that Samsung's research and development spend has spread out in the areas in which Apple, Intel (INTC), and Micron NASDAQ:MU) occupy. This doesn't even include displays, which Samsung also has to allocate a portion of its R&D investment. Intel at a recent analyst briefing mentioned that they had spent around 60% of their research and development into foundational investments. Basically, the amount that they spend on R&D is anywhere from $6 billion-$8 billion when designing cutting edge fabs this does not include capital expenditures. Then Intel spends the remainder of its money on developing mobile, desktop, and server chips. To think of it another way, Samsung's fab to keep pace with Intel's would have to allocate perhaps $5 billion or more in terms of R&D spend. Then Samsung is also the market leader in flash memory for the time being, however, this position is proving to be very temporary given Intel and Micron's breakthrough development in memory technology. Micron invests nearly $2 billion into flash memory development, and I'm presuming Intel invests the other half (maybe slightly less, but I think you guys get the idea). Samsung then must use the remainder of its resources to compete with Sony, LG, Vizio, and Sharp in displays, which probably costs Samsung a couple more billion dollars in terms of R&D.

When you factor in all of these expenses, and also realize that Samsung likes to integrate its hardware into other devices, it becomes more apparent that Samsung isn't really pursuing a strategy in which they become a dominant high-margin mobile OEM. When looking back at PCs, Samsung also became commoditized as profitability in that business was nearly nonexistent. So, for Samsung to maintain really healthy margins it had to pursue semiconductors, displays, i.e. core PC and mobile components.

Going forward, Samsung is likely to compete in the lower tiers of the handset market in hopes of earning passable margins, while also being a participant in the high-end by updating components, and being more of a follower rather than a pioneer of new mobile technologies. This is because Samsung doesn't have the resources to sacrifice some of its other high margin businesses in favor of the smartphone segment.

Apple is just way more focused when it comes to designing new devices, which is why the headline figures of Samsung's R&D don't actually point out how underfunded some of these teams are in comparison to Apple. Every change that is made to the iPhone is observed under a microscopic lens. When it designs a new product category or is making minor adjustments to the user interface of iOS or Mac OS a lot of money is actually invested into very miniscule change. However, over time iPhone users adopt the technology, which creates more of an insulated ecosystem away from Android and Windows. Of course, Apple has its own share of challenges, but they're not nearly as resource intensive to solve. There are various ways in which Apple can maintain its own efficiencies, which creates a dynamic in which shareholders can at least anticipate a high barrier of entry, healthy margins, and sustained growth.

So, therefore, Jay Y. Lee or Lee Jae Yong, the soon to be head of Samsung Group isn't going to be the guy to bring down Apple. Even if he is to bring exceptional management skills to the company, he is still managing a very diversified portfolio of business segments, and probably doesn't have the skill to delicately balance both the investment aspect and the business development aspect at the same exact time. Already investors are starting to see holes in some of the other areas in which Samsung has been absolutely dominant. So, for Samsung shareholders to anticipate the company to pull ahead of Apple would be naïve at this juncture in time. If anything, Jay Y. Lee will sustain the culture of family-owned enterprise, which is actually common in the Korean and Japanese culture. However, for a company that wants to adopt Western culture while holding onto the roots of the family-run business model to me also comes across as naïve. Over the long run, family-run businesses tend to be very conservatively managed, but we've seen many cases where conservatively managed businesses lost to smaller companies over and over again in the tech sector.

So the structural issues of Samsung, is what will prevent them from being able to compete on equal footing with Apple in smartphones going forward. Perhaps, the company is spread too thin and is competing with opposing forces in which they have no control over. It's one thing to out-execute Intel or Sony in isolation. But imagine trying to out-execute Apple in PCs and mobile, while also developing a proprietary OS that can rival both Microsoft and Google. It's just unlikely to happen, the theory of economic scarcity obviously applies here. 2012 to 2013 were magical years for Samsung, but all too often, competitive forces remind us why the good times don't always last.

Alex Cho Alex Cho   on Amigobulls :

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