U.S. Activist to Battle Samsung’s Founding Family

Paul Singer’s Elliott Management vows to fight Lee family’s bid for more control.

Koreans have good reason to take issue with controlling families of the chaebols, or business conglomerates. The “nut rage” temper tantrum at a flight attendant that sent a Korean Air heiress to jail symbolized how Korea’s wealthiest families elevate themselves at the public’s expense. The latest example: a Samsung Group merger, which sparked volatile trading in the group’s stocks.

On May 26, Cheil Industries (ticker: 028260.Korea), the founding Lee family’s de facto holding company, and Samsung C&T (000830.Korea) announced an all-stock merger. Under the proposal, shareholders of Samsung C&T can trade 100 of their shares for 35 Cheil shares. The Samsung subsidiaries project growing pretax profit five-fold to four trillion won ($3.59 billion) in five years. But analysts are skeptical. How much synergy can Cheil, with interests from fashion to biotech, have with Samsung C&T’s natural-resources trading business?

In fact, the merger is all about the Lee family tightening its grip on the group’s crown jewel, Samsung Electronics (005930.Korea). Samsung Chairman Lee Kun-hee, 73, who suffered a heart attack a year ago, is passing power to his 46-year-old son, Lee Jae-yong. The younger Lee lacks his father’s prestige—and the family does not own many shares. The family currently directly owns only 4.7% of Samsung Electronics, and another 8.5% indirectly, mostly via its control of Samsung Life Insurance(032830.Korea). Over 70% of Samsung Electronics is free-float. The merger proposal would boost family control to 17.3% through Samsung C&T’s 4.1% stake in Samsung Electronics.

Cheil is getting Samsung C&T cheap. Prior to the merger, Cheil was trading at an all-time high of 3.5 times forward book, while Samsung C&T was valued at only 0.66 times, below its historical average of 0.8 times. Cheil did not offer Samsung C&T’s shareholders a merger premium.

Last Thursday, Samsung C&T shares jumped 10.3% after U.S. activist investor Paul Singer’s Elliott Management said it bought a 7.1% stake and was ready for a fight. Cheil may have to sweeten the deal: Over two-thirds of C&T’s shares are free-float; the Lee family has only a 13% stake; and the merger needs a two-thirds majority to pass. Investors have until June 11 to accumulate shares and Samsung C&T now trades at 0.91 times book.

SINCE THE DEAL WAS ANNOUNCED, Samsung Electronics has fallen 5.7% while IT services provider Samsung SDS (018260.Korea) has jumped 15.7%, on speculation that a merger between the two is another way to boost family control. Since SDS is just 10% of the size of Samsung Electronics, a merger would not require shareholder approval. But a deal would allow the Lees to almost double their direct stake in Samsung Electronics to 6.7%, though, again, it wouldn’t create much synergy. Trading reversed most of its course Wednesday after Samsung Electronics denied there would be a deal.

But the damage was done. Subtracting its cash, Samsung Electronics’ market cap is smaller than Taiwan Semiconductor Manufacturing (TSM), even though it generated twice as much income last year, notes Maybank’s Warren Lau. Samsung’s preferred shares, which do not have voting rights, now trade at just a 17% discount to its common, the narrowest spread of all time, versus their 25% average in the last couple of years. Clearly, investors don’t think the voting rights are worth much.

Clariant Shares Could Fetch 20% More

Takeover or no takeover, the Swiss chemical maker’s prospects look good.

Swiss Specialty chemical maker Clariant has a good formula for investment success.

Revitalized under current management, it has one of its industry’s most attractive growth profiles. In addition, it has been identified as a possible takeover target, and its shares (ticker: CLN.Switzerland) already have benefited from M&A momentum, despite management’s efforts to damp the speculation. The acquisition of Clariant by another company could hand shareholders a handsome windfall—20% or more. But, even without one, investors could be rewarded over the medium term for their patience.

At Friday’s close in Europe of 19.64 Swiss francs ($20.85), the stock is up 17% in 2015, versus a paltry 2% average gain for Swiss equities over the same period, but pretty much in line with a 20% rise in the Stoxx Europe 600 chemicals subsector. Clariant also has American depositary receipts. Listed under the symbol CLZNY, they were trading at $20.77 at midday Friday.

Clariant fetches about 15 times forecast 2016 earnings, versus roughly 16 for Akzo Nobel (AKZA.Netherlands) and just over 13 for BASF (BAS.Germany). Its shares can climb steadily over the next few years, as the company benefits from a transformation led by CEO Hariolf Kottmann. He has reorganized its divisions, cut costs, shed noncore assets, focused on higher-growth businesses, and improved its product portfolio, raising noncyclical revenues beyond 50%. Revenue is estimated at CHF5.93 billion in 2015 and CHF6.17 billion in 2016.

Analysts are particularly excited about the potential of Clariant’s catalysis and care chemicals units. Catalysis manufactures catalysts for the petrochemicals, plastics, and refining industries. It accounted for only 12% of sales last year, but it is growing steadily and is very profitable; its profit margin before interest, tax, depreciation and amortization is 23.5%. Care chemicals, which produces de-icing fluids for aircraft, and ingredients for detergents and cosmetics, accounted for about a quarter of sales last year and boasts an Ebitda margin above 17%. Clariant’s plastics and coatings unit is its biggest, accounting for 42% of sales, but it is more cyclical than the others and its Ebitda margin is a weaker 14%. The company’s other business, natural resources, supplies products and services to the oil and mining sectors. It accounts for 21% of sales.

In 2014, Clariant’s profit margin was 14.2%, up from 14.1% in 2013, compared with less than 7% in 2009. Its margin target of 16% to 19% by 2015 seems to be within reach if it continues to exploit efficiencies while keeping a lid on costs. Earnings per share are forecast to climb this year to CHF1.14 from CHF0.99 last year. In 2016, EPS are estimated at CHF1.32.

Since 2010, Clariant has struggled to convert Ebitda into free cash flow. That is partly due to its 2011 acquisition of Süd-Chemie, which has a higher need for net working capital, and cash flow tied up in noncore businesses.

Clariant will see an improvement in free cash flow if it can reduce net working capital to a peer group average of about 18% of sales from around 20% now. That could lead to a higher dividend, which has averaged 2.1% over the past five years.

As for a takeover, Kottmann has voiced a preference for independence, but an offer at the right price would be difficult to ignore. Evonik Industries (EVK.Germany) has been identified as a possible bidder, but it might have other targets. But, regardless of what happens, Clariant is headed in the right direction.