Corporate raiders, vulture funds urge breakup of Samsung

By Joel Hruska

If the press coming out of Korea is any indication, Samsung isn’t any happier with 2016 than the rest of us. The Galaxy Note 7 debacle blew up Samsung’s quarterly earnings, its washing machine recall fueled negative consumer perceptions, the company’s Korean offices were raided last week as part of an ongoing corruption investigation, and now a vulture hedge fund with a major focus on distressed companies is calling for the Korean giant to break itself apart in the name of enhancing — you guessed it — “shareholder value.”

Elliott Management Corp proposes that Samsung split itself into two companies, pay a $26 billion dividend to stockholders, pledge to return 75% of free cash flow to investors in the future, and appoint three new independent directors. Samsung has already pledged to return 30-50% of free cash to investors this year and has completed a share buyback worth $11.3 trillion won ($9.648 billion). That’s clearly not sufficient for Elliott, which is run by billionaire Paul Singer. But while Elliott Management’s long-term returns are excellent, its methods for securing those returns have come under considerable fire over the years. Elliott Management is widely viewed as a so-called “vulture” fund — a company that buys up distressed assets of both nations and corporations for pennies on the dollar, then spends years in litigation to recover the full value of the debt it purchased. Singer has pursued cases against some of the world’s poorest countries like the Congo, and forced Argentina into partial default by refusing to accept the terms of a settlement that 93% of the country’s other creditors had previously agreed to.

Activist investors like to claim that they focus on improving yields, killing unprofitable products or business segments, and encouraging companies to focus on their strengths, but long-term investigations of the phenomena show decidedly mixed results. A recent article at The Atlantic noted that there were just 52 activist campaigns over a 20 month period from 2005 – 2006, compared to 1,115 activist campaigns from 2010 – 2014. That’s a jump from an average of 2.6 campaigns per month to 23.22 over just four years. A new report entitled “The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance” explores this phenomena and its impact over the short-and-long terms. They write:

Recently, researchers have focused on the targets of hedge fund activism to see whether the investments by these targets in research and development increased or decreased in the aftermath of a hedge fund engagement. In common, they have found a sharp decline. A 2015 study used a sample of firms targeted in 2009 and found that “surviving” firms (i.e., those not taken over) decreased their investment in R&D (measured as a percentage of sales) by over 50%.

The chart below is taken from the paper, and shows the sharp decline in R&D investment by activist targets compared to average R&D spending in a random sample of companies not targeted by activist campaigns.

The implications for Samsung, in this case, aren’t so different from the implications Qualcomm faced when it was targeted by Jana Partners (Qualcomm ultimately defeated the vultures who sought easier prey elsewhere). Slashing R&D and splitting company assets might make a great payday for rich investors, but it won’t serve Samsung or its customers. In fact, it virtually guarantees Samsung’s own smartphone efforts will be superseded by other companies and Chinese manufacturers, particularly if the Korean company agrees to start returning the vast majority of its free cash directly to investors. Samsung’s existing corporate board may be implicated in government scandals, but slashing the firm’s R&D expenditures and committing to aggressive self-enrichment schemes won’t benefit anyone but the handful of ultra-rich investors at hedge funds like Elliott. Samsung has pledged to respond to the activist investors by the end of the month but has made no further comment.