Samsung's Self-Tender Battle: Prioritizing Shareholder Returns
Despite Samsung Electronics' (005930) recent share repurchase and cancellation of approximately 86.96 million common and preferred shares, calls for further preferred share buybacks are intensifying. The debate has evolved beyond the scale of buybacks, encompassing target shares and funding methods.
The key issues at hand include the financial subsidiaries' equity holding limits, the price disparity between common and preferred shares, and the company's valuation in the U.S. market. These factors have sparked a discussion on the most effective approach to enhancing shareholder value.
British activist investment firm, Palisades Capital, advocated for additional preferred share buybacks and cancellations at the Sohn Investment Conference in San Francisco on April 13th. Palisades, a shareholder with holdings in both Samsung's common and preferred shares, has previously urged LG Chem to enhance shareholder returns. In this instance, Palisades proposed the issuance of American Depositary Receipts (ADRs) as a potential solution.
The issuance of ADRs has become a focal point in the discussion, with critics questioning its effectiveness. Samsung's financial affiliates have already executed a $14.3 billion block deal, the largest in history, raising questions about the need for further capital raising. Late-session selling pressure and margin call liquidations have erased intraday gains, indicating a cautious market sentiment towards the proposed ADR issuance.
As the debate continues, Samsung faces the challenge of balancing shareholder demands with its financial strategy. The company must navigate these complex issues to determine the most suitable path forward, ensuring it maximizes shareholder value while maintaining its financial stability.
The Rise of the Priority Share Burnout Theory: A $14.6 Billion Move
"The focus is on priority shares, which trade at a lower price than common shares," says Palliser. The proposal is to raise capital by issuing ADRs at a premium in the U.S. market and then repurchasing and extinguishing the discounted priority shares domestically. ADRs, certificates allowing foreign companies' shares to be traded on local markets, can also be used for new fundraising depending on the issuance method.
$14.3 Billion Block Deal and the Extinction of 87 Million Shares... The Priority Share Extinction Theory Resurfaces
Samsung Electronics extinguished a total of 86,962,775 treasury shares, including 73,359,314 common shares and 13,603,461 priority shares, on April 2nd. This move, valued at approximately $146 billion based on the share price at the time, was significant.
Despite this large-scale extinction, there are constraints on further reducing common shares due to the company's governance structure. This is because the common share holdings of Samsung Life Insurance and Samsung Fire & Marine Insurance are close to the 10% combined holding limit under the Financial Industry Structure Improvement Act (FISIA).
Samsung's Share Buyback and the Impact on Financial Subsidiaries
Samsung Electronics' decision to retire its common shares will reduce the overall number of outstanding shares, thereby increasing the stake of its two financial affiliates relatively. In fact, Samsung Life Insurance and Samsung Fire & Marine Insurance disposed of 7,335,931 Samsung Electronics shares through a block trade on March 20th. The sale, valued at approximately KRW 1.43 trillion, was a strategic move to prevent their stake from exceeding the legal limit following the planned buyback of treasury shares.
However, the situation differs for preferred shares. Since preferred shares lack voting rights, their retirement will not impact the voting power of the financial affiliates. Given that preferred shares trade at a lower price than common shares, the same amount of capital can be used to retire a larger number of preferred shares, which is one of the reasons why activist funds emphasize the retirement of preferred shares.
According to Life Asset Management, the discount rate of Samsung Electronics' preferred shares compared to its common shares was 26.7% as of the closing price on September 9th. This means that with the same amount of money, one could purchase approximately 1.36 preferred shares for the price of one common share.
Life Asset Management's Proposal
Life Asset Management suggested last month that Samsung Electronics engage in a buyback and subsequent retirement of its preferred shares, emphasizing a focus on these shares. The firm later clarified that it was open to a strategy involving the purchase and retirement of both common and preferred shares.
Samsung Electronics has previously considered the discount rate of preferred shares in its buyback plans. In October 2015, the company announced a $11.3 billion share buyback and retirement program, allocating approximately 35% of the initial purchase to preferred shares.
At that time, Samsung Electronics also indicated that it would increase the proportion of preferred shares purchased if the discount rate exceeded 10%. The rationale was that by concentrating on the cheaper preferred shares, the company could retire a larger number of shares with the same amount of capital.
Overseas Activists and the Demand for ADR Issuance
The British activist fund, Palliser Capital, has taken a more involved approach, suggesting a specific method for funding the preferred share retirement. The firm proposes that Samsung Electronics issue ADRs (American Depositary Receipts) on the U.S. market at a higher price than its domestic shares, using the proceeds to fund the buyback and retirement of discounted preferred shares.
Samsung Electronics has adopted a cautious stance regarding these proposals.
Prioritizing Shareholder Returns: Samsung Electronics' Priority Actions
Samsung Electronics' preferred shares are currently trading at a discount of approximately 26% compared to its common stock, prompting attention from financial experts. James Smith, founder and Chief Investment Officer (CIO) of Paliser, emphasizes the need to address this discount to enhance capital efficiency and unlock inherent value across all share classes.
"Resolving the preferred share discount issue can significantly improve capital efficiency and unlock the inherent value embedded in all types of shares." - James Smith, Paliser Founder and CIO
Samsung Electronics has announced an anticipated shareholder return of approximately KRW 90 trillion to KRW 110 trillion for 2026. In the third quarter of this year, the company will distribute approximately KRW 30 trillion in cash dividends, including regular quarterly dividends, with the remaining return scale and the proportion of dividends, share repurchases, and buybacks to be decided by the board in January next year. Activist funds' calls for additional preferred share buybacks have drawn attention to the allocation of future shareholder return resources.
However, it is important to assess whether the issuance of American Depositary Receipts (ADRs) will indeed lead to an expansion of shareholder value. The process of depositing existing shares for trading in the U.S. market does not generate new capital, and issuing new shares may dilute the holdings of existing shareholders. Additionally, the uncertainty surrounding the issuance price in the U.S. market, which may be higher than the domestic share price, and the consideration of listing and maintenance costs, further complicate the matter.
Samsung's ADR Issuance: A Cautious Approach
Samsung Electronics has taken a prudent stance regarding the potential issuance of American Depositary Receipts (ADRs). During the second-quarter earnings conference call on July 30th, the company stated, "At this time, we are not considering the issuance of ADRs."
The company's stable cash generation and lack of immediate need for new funding sources are key factors in this decision. Samsung is evaluating the potential benefits of expanding its overseas investor base while considering the additional disclosure and operational burdens that come with ADR listings. Additionally, the company aims to ensure that any such move provides tangible benefits to all shareholders, including domestic investors.
Prioritizing Shareholder Interests
The issue of share buybacks and the treatment of preferred shares is a delicate matter, as it involves balancing the interests of various shareholder groups. If the discount on preferred shares narrows, preferred shareholders could see a relatively larger price appreciation. Samsung must consider not only equity for common shareholders but also the allocation of resources for critical investments in semiconductor facilities and research and development.
Historical Context and Current Challenges
Adjusting the proportion of shares repurchased, taking into account the preferred share discount rate, is not a new strategy for Samsung. While this issue has resurfaced after over a decade, the circumstances have evolved. This year, the significant share buyback process has materialized with the sale of financial affiliates' shares, and overseas activist funds are now pushing for ADR issuance. Samsung now faces decisions regarding the necessity of further buybacks to reduce the preferred share discount and how to allocate the costs and burdens associated with such actions.
