Samsung's moment of truth

• Published Jun 17, 2015 4:15 PM KST
• Updated Jun 17, 2015 4:15 PM KST

By John Burton

A fight between billionaires can be a great spectator sport and that’s certainly the case between Paul Singer, the head of the U.S. activist hedge fund Elliott, and Lee Jae-yong, the crown prince of Samsung Group.

Elliot’s bid to derail the $8 billion merger of Samsung C&T and Cheil Industries, Samsung’s de facto holding company, can be viewed in several ways.

Elliot is arguing that the Lee family is taking advantage of outside shareholders by transferring valuable assets from Samsung C&T, the group’s construction arm, to Cheil Industries without appropriate compensation. Elliott is the third largest shareholder in Samsung C&T with a 7.1 per cent stake.

This stance is meant to appeal to the deep-seated skepticism and resentment in Korea about the chaebol that is based on fears about the dominance and immense power wielded by their family owners.

After all, the merger represents a key step in carrying out the third-generation family succession of the Lee family at Samsung. The deal is meant to strengthen the family’s grip on Samsung Electronics, the conglomerate’s crown jewel, since Samsung C&T holds a 4.2 per cent stake in Samsung Electronics. Cheil Industries is 42.2 per cent owned by the Lee family.

Opponents of Elliott’s intervention are portraying it as the disruptive act of a foreign “vulture” fund that threatens to sacrifice Samsung’s long-term goals for short-term investor gains. This argument reflects the traditional hostility in Korea toward foreign private equity and hedge funds, which are seen as greedy.

Samsung supporters argue that the Lee family has done a good job in creating the world’s biggest consumer electronics company and the family’s long-term vision and planning has played a key role in the successful rise of Samsung Electronics.

There are merits to both sides of the debate and that is making the outcome of the deal more uncertain than earlier believed as shareholders prepare to vote on the merger on July 17. Some small Korean stakeholders are siding with Elliott, saying Cheil Industries’ all-stock takeover offer for Samsung C&T is too low.

The uncertainty surrounding the deal has caused the share prices of both Samsung C&T and Cheil Industries to fall recently. The outcome may rest on how the National Pension Fund will vote since it holds about 10 percent of Samsung C&T.

The merger has also been guided by the cynical calculations of both Samsung and Elliott. Cheil Industries made its offer for Samsung C&T when the gap between the share price of the two companies had widened significantly, with the share price of Cheil Industries having more than tripled since its listing last December while that of Samsung C&T had fallen.

The timing of offer was aimed at taking advantage of Korean law that sets the merger ratio of share swaps based on a formula computed according to the preceding month’s closing share prices. The result is that Cheil Industries has a much higher market valuation than Samsung C&T although the latter’s net assets are vastly greater.

In turn, Elliott saw the bid as a splendid opportunity to hold Samsung C&T as a “hostage” in the delicate final stage of the Lee family succession in hopes of getting a higher price for the hedge fund’s shares.

Whatever the outcome of the proposed merger, the deal has highlighted the need for the chaebol family owners to deliver more shareholder value to investors. Samsung could win over supporters, including foreign ones, to stop Elliot by promising to increase future dividend payments by its affiliated companies, particularly Samsung Electronics.

Korea has the lowest dividend payment ratio in Asia, creating the impression that the chaebol are mainly run for the benefit of their owners and not shareholders.

Although the Korean media is portraying Elliott as a foreign villain, it is nevertheless playing a useful role by focusing on the issue of shareholder value in Korea. Such outside pressure by shareholder activists is necessary to making the chaebol more efficient and less insular in their management practices.

Returning capital to shareholders is a effective prod in achieving this goal since the large cash hoards that Samsung and other chaebol now sit on protect them from bad executive decisions and discourage them from carrying out needed reforms.

This is particularly the challenge for Samsung. The group has mainly been governed by a risk-adverse bureaucracy of engineers who have commanded legions of well-disciplined and loyal workers. But that model is becoming obsolete as Samsung confronts a new world where open-mindedness and creativity are the driving force of future technology successes.

The best move that Lee Jae-yong could do to preserve his legacy would be accept the need for rewarding shareholders with higher returns as a means to carry out vital corporate culture changes at Samsung.

John Burton, a former Korea correspondent for the Financial Times, is now a Seoul-based independent journalist and media consultant. He can be reached at john.burton@insightcomms.com

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