A Possible Value Play Reeling From the Smartphone Wars

by Jason Jenkins

For those not necessarily tuned in to the technology world, Apple's (Nasdaq: AAPL) historic courtroom victory against Samsung (OTC: SSNLF.PK) a few weeks ago may have changed the technology game forever…

The decision by the northern California jury ranks among the largest intellectual-property awards ever recorded. It’s a sign that the industry may now take its cutthroat competition from the shelves and move it to legal venues.

Here is the legal decision in a nutshell:

  • The decision gave Apple $1.05 billion in damages stating that Samsung unlawfully copied six Apple patents.

  • The reported patent infringements dealt with scrolling, zooming mechanisms, and some aspects of the design.

  • The seventh patent Apple was suing over was found not to be infringed upon. This was the issue of Samsung's Galaxy Tab infringing on Apple's iPad design.

Before he died, Steve Jobs stated how he would see Samsung’s patent indiscretions brought to justice. And now, after his death, we see Apple is going to go after anyone it feels has stolen from it.

Far From Over…

In no way was the ruling the final word. You can bet that it will be in the appeals courts for months and years to come, and all this may eventually culminate to the steps of the U.S. Supreme Court.

Samsung declared immediately after the decision that they were in for the long haul. Here is the statement they issued:

"This is not the final word in this case or in battles being waged in courts and tribunals around the world, some of which have already rejected many of Apple's claims. Samsung will continue to innovate and offer choices for the consumer,"

One popular outcome I’ve heard circulating around would see Samsung in the future agreeing to pay Apple a license fee for each Android-based smartphone and tablet sold. And researching many of the pundits, I believe this the most likely action. Let’s take a look at their arguments.

Paying the Piper…

Analysts at Nomura said in a note August 27 that any licensing fees paid to Apple would most likely only be applicable to those devices shipped to the United States. These royalties couldn’t be used in places where the courts have already struck down Apple’s suit – such as South Korea and Britain.

If this were the case, Samsung would give Apple around the neighborhood of $600 million per year if you assume, like many analysts, a per device fee of about $20. This wouldn’t hurt Samsung much, if at all. That number would account for only 3% of their annual profits from smartphones.

Nomura stated, “We view this litigation as more about each party’s self-esteem, rather than a money issue…While it seems negative to Samsung on a first look, the penalty has come out less than half of possible worst-case scenarios.”

Bernstein Research also saw little effect on the bottom-line. One of their worst-case scenarios was for a 3.8% drop in 2013 EPS. This may be just more of a kick to the ego rather than the wallet.

Is Samsung Now A Value Play?

The Monday after the verdict, Samsung shares dropped about 7.4%. They have taken a hit, but here are a few reasons Samsung should keep its position as a market leader.

  • Samsung’s financials look really attractive right now. In 2011, its revenue growth was above 20%. Its trailing price-to-earnings ratio is only 12. The trailing P/E for the rest of the industry is around 15. Plus, Samsung has over $20 billion in cash on hand.

  • After the court victory, the lawyers for Apple went after injunctions against the sales of Samsung Galaxy smartphones and tablets in the United States. However, analysts state that the Galaxy Series “had already lived through their life cycles in Samsung’s fast-paced marketing plan.” In order to stay ahead of the whole legal process, Samsung had already revamped their latest version of the Galaxy S III smartphone.

  • The research firm Strategy Analytics stated that Samsung’s smartphone sales in the second quarter grew 150%, to 50.5 million units. That actually comes out to be a record-setting 35% of the market. In contrast, Apple grew at 28%, to 26 million units. Apple is counting on all the hype its next iPhone is building. However, Samsung is believed to have a new Galaxy S IV to introduce as a counter punch.

  • The Monday after the verdict, Citigroup analysts in a note stated that there would be no lasting impact from the court’s decision on Samsung. It went on to say that any Samsung sell-off of shares should be viewed as a buying opportunity. They followed that by stating:

    “We recommend accumulating on the dips, as Samsung will continue to sustain high-end smartphone leadership with the synergy of in-house leading-edge components… Much of the negative outcome from Apple’s court win had already been priced into the Samsung shares, with the market capitalization shrinking around $10 billion in the two-week lead-up to Friday’s judgment.”

The Easiest Way to Buy Shares

It’s hard for us U.S. investors to buy direct shares of Samsung. You can only buy directly on the South Korean, London, or German exchanges if your broker gives you the ability to do so.

However, as we’ve stated here at Investment U in the past, you can get a substantial piece of the company by buying the iShares MSCI South Korea Index ETF (NYSE: EWY) in which Samsung makes up about 23% of its holdings.

Good Investing,

Jason

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