Artisan Partners’ Bull Case For Samsung

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With stock valuations ranging from fair to high depending on what measure you use, and the risk-on/risk-off trading environment causing stock prices to jump even when fundamentals are unchanged, it’s a difficult time for value investors. David Samra and Dan O’Keefe of Artisan Partners insist that they still ‘want it all’ when looking at a stock (cheap valuation, great management, healthy balance sheet, and a quality business), but there simply aren’t always enough stocks that fit the bill in the current market.

Discounts ‘close to the narrowest they’ve ever been’

“We generally become interested when there’s at least 30% upside from today’s price to our estimate of intrinsic value,” says O’Keefe in an interview with Value Investor Insight. “Because we’re bumping up against our 15% portfolio limitations on cash – we’re having to make some relative judgments on which fairly valued stocks to keep and which to sell. That’s not ideal, but it’s the reality of investing when discounts to intrinsic value are pretty close to the narrowest they’ve ever been.”

But even in this challenging environment, O’Keefe and Samra are able to find mispriced companies that the market is underestimating. Samsung Electronics Co., Ltd. (LON:BC94) (KRX:005930), for instance, is held back by concerns that its smartphone segment has unsustainable high margins or that its current market dominance (alongside Apple) could be supplanted as easily as Motorola Solutions Inc (NYSE:MSI) or Nokia Corporation (ADR) (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) were in recent years. But they argue that both of these concerns are based on false assumptions.

Samsung: Smartphone margins not comparable to PCs

Investors worry about Samsung Electronics Co., Ltd.’s (LON:BC94) (KRX:005930) profit margins because they class smartphones along with personal computers, which have a single digit profit margin, and expect competitive pressure to close the gap sooner than later. But this comparison ignores the fact that computer manufacturers are essentially bundling a complex product: the hardware, software, and operating system are made by a host of different companies that all have to get a cut. Apple Inc. (NASDAQ:AAPL) and Samsung are responsible for more of the components that go into their smart phones and either own the OS or get it nearly for free.

If you include margins on Microsoft Corporation (NASDAQ:MSFT) Windows and Intel Corporation (NASDAQ:INTC) CPUs, the margin for PCs is in the 15% – 20% range, which makes current smartphone margins look much more sustainable. As for the possibility of an upstart breaking into the smartphone business, while he doesn’t rule it out entirely, O’Keefe thinks the market has changed dramatically in just the last few years.

“You have two large players with huge profit pools to invest, meaningful scale, and network effects from the software and app environment,” he says. As the Windows Phone has proven, stealing significant market share from Samsung Electronics Co., Ltd.’s (LON:BC94) (KRX:005930) or Apple Inc. (NASDAQ:AAPL) is challenging even for established tech companies.

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