Samsung C&T may benefit from activist Palliser Capital's efforts to increase shareholder value.

Company: Samsung C&T (028260.KS)

Samsung C&T Corp is a Korean corporation involved in the trading of industrial goods. The company operates through various segments, including engineering and construction, trading and investment, and fashion and resorts. Samsung C&T Corp's shares do not trade in the U.S.

Stock Market Value: $15.35 billion ($94.71 per share)

Activist: Palliser Capital

Percentage Ownership:  0.62%

Average Cost: n/a

Palliser Capital is a global multi-strategy fund that focuses on opportunities in Asia and Europe. Founded in 2021 by James Smith, who was previously the head of Elliott Investment Management's Hong Kong office, the firm applies a value-oriented investment philosophy to a broad range of opportunities across the capital structure. The senior investment team has significant activist experience, having worked at Elliott. Palliser has experience investing in both Europe and Asia, and their activist investment at Keisei has demonstrated the patience, conviction, and diplomacy of a top activist.

What’s happening

On December 6th, Palliser Capital revealed that it had acquired a 0.62% stake in Samsung C&T (SCT).

Behind the scenes

Palliser believes that Samsung C&T is undervalued by the market due to suboptimal capital allocation, corporate governance issues, and a complex corporate structure. To create $25 billion of shareholder value, Palliser suggests short- and long-term measures. Although it seems impossible to create such value at a $15 billion company, diving into Palliser's thesis reveals that SCT is conservatively underestimating the value that can be created. SCT is a large industrial South Korean conglomerate controlled by the Lee family through multiple, cross-owned affiliates. Its main assets include five publicly traded subsidiaries and an operating business. The post-tax value of SCT's interest in these five publicly traded subsidiaries is $30.9 billion, and the operating business has $30 billion of revenue and $1.55 billion of EBITDA. Using a 5.5 times EBITDA multiple, Palliser values this business at $8.4 billion, resulting in a company valuation of $40.4 billion with net cash of $1.1 billion.

What are the three reasons why this company is trading at a 63% discount? First, its capital allocation policies and practices have left shareholders and others with little confidence that much of this value will accrue to them. Second, Samsung is an iconic and structurally important Korean company that should be investing and growing. Third, Palliser would like to see a more transparent and disciplined capex plan that uses the return on share buybacks as the benchmark and offers a fair return to shareholders. Additionally, SCT has other opportunities to generate cash for capex and shareholder return, such as taking on some debt (the company has $1.1 billion of net cash) to lower its cost of capital and potentially divesting some of the disparate and non-synergistic businesses that make up the operating company.

In South Korea, corporate governance policies do not instill confidence in shareholders that the board is acting in their best interests. Unlike in the U.S., where boards have a duty to shareholders, Korean boards are obligated to the company. Without a charter amendment, there are other ways the company can increase shareholder confidence. The current board consists of five independent directors and four management directors. While Korean companies of this size are required to have 50% independent directors, the term "independent" may not be defined as it is in the U.S. Therefore, investors may not expect board independence to be as robust as it is in the U.S. Moreover, SCT's independent directors lack experience in C-suite positions, relevant industry experience, proven portfolio management and capital allocation expertise. Refreshing the board with experienced independent directors would be a good first step. Additionally, the board is staggered, with three of the four management directors serving as co-CEOs who answer to the board and make up one-third of its composition. Naming one CEO to whom the other division heads would report would simplify decision-making. Furthermore, more transparent communication with the market and aligning management's interests with share

The complex ownership structure of South Korean "chaebols" has led to a discount in the valuation of these companies. SCT was formed through M&A transactions that prioritized family control over efficiency. These chaebols have negatively impacted the valuation of these companies. Over the past 20 years, South Korean chaebols have been converting to two-layer holding company structures. Samsung is one of the two large companies in South Korea that still maintains the chaebol structure. The chaebol structure permeates the entire organizational structure. Despite this, Palliser estimates a $25 million valuation gap. Converting to a holding company structure would increase the value of all SCT subsidiaries. This would inflate the valuation gap even more relative to where the stock trades today.

The undervaluation of the company is not in question, but the key issue is what can Palliser or anyone else do to close the valuation gap. Palliser is currently bringing these issues to a public debate to put pressure on management to make shareholder-friendly changes. The company is not threatening any confrontational actions. Palliser has a history of working with management to effect change, which is beneficial in South Korea as winning a proxy fight is extremely rare. However, the trend is on Palliser's side as South Korea is becoming more shareholder-friendly every year. Additionally, there is a good reason why the Lee family might support changes that increase shareholder value. Lee Kun-hee, the patriarch and former Samsung chairman, was South Korea's richest person at the time of his death in October 2020. His death triggered the largest inheritance tax bill in South Korean history, exceeding $10 billion. South Korea's inheritance tax rate of 50% is the world's second highest after Japan. His heirs have been given five years to pay the inheritance tax, and they could certainly use higher value stock to margin or more capital returned to share

Palliser is not the only one with its thoughts. The City of London Investment Management Company has made two proposals for the 2024 annual meeting: a dividend of approximately $3.42 per ordinary share and a buyback program of $380 million to run until the end of 2024. In South Korea, shareholder proposals are binding if approved by a majority of shareholders, but they are rarely approved. At the very least, enough votes could put pressure on management to do something. A good start would be to retire the 13% of outstanding shares held as treasury shares, which count towards outstanding shares in South Korea and which management has already promised to retire within five years. Doing this would immediately increase earnings per share by 14.4%.

Ken Squire is both the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.