A spcial report from The Korea Times : Vertical integration will give Samsung Galaxies

Vertical integration will give Samsung Galaxies

Radio City Hall in New York is crowded with visitors during a Samsung Electronics’ event to launch its Galaxy S4 in March. This is the first time that Samsung chose New York as the place to unveil a flagship product. / Courtesy of Samsung Electronics

Fitch Ratings expects smartphones to enhance profits

Alvin Lim, director of corporate ratings at Fitch Ratings

By Kim Yoo-chul / source The Korea Times

Samsung Electronics is expected to solidify its leadership in the global technology industry by capitalizing on better profitability and more cash generation, according to a global credit ratings agency, Monday.

“We expect Samsung to continue to enhance its profit and cash generation in the medium-term mainly led by smartphones. In addition, improving industry conditions for semiconductors and display panels are also positive compared with 2012,” said Alvin Lim, director of corporate ratings at Fitch Ratings, in an interview with The Korea Times, Monday.

The credit rating agency stressed Samsung has demonstrated its undisputed ability to develop market-leading products in a number of categories through sizable investment in research and capital expenditure, helping it widen gaps with its rivals.

The U.S.-based firm identified “connectivity” as the main theme of the global information and technology (IT) industry over the medium term as the industry has strived to provide an eco-system in which general consumes can seamlessly experience content and information through various devices under an integrated platform.

A Samsung researcher checks out its EyeCAN device, a pointing device or mouse-replacement for people that are physically-handicapped. The device is a glasses-mounted solution that precisely tracks eye movements, allowing the user to move the pointer accurately.

The agency headquartered both in New York and London said that the firm’s effort to develop the so-called smart watch is a good example showing that it is taking a lead in connectivity.

“Vertical integration with strong component businesses such as semiconductors and display panels, has allowed efficient and timely development of advanced products, most notably the Galaxy smartphone series,” the director said.

Samsung has yet to prove its “creative” innovation, which means the creation of a new product or a market segment that hasn’t existed before, according to Fitch.

However, Lim admitted Samsung has room to become a “true innovator” considering the company’s strength in its robust cash generation.

“Despite prowess in manufacturing technology, Samsung’s success story has been largely based on excellence in innovating to improve products already on the market. In that regard, Samsung still has room for improvement to be labeled as a true innovator, although if we review all of the global consumer technology successes of the last decade, the overwhelming majority would be developments based on existing products,” the director said.

Fitch praised Samsung’s proven ability to generate more cash and the agency attributed that strength to Samsung’s strong position in the mobile handset segment along with other businesses, which provide diversification.

“Samsung’s success enabled it to generate large amounts of cash _ 2012 cash flow from operations was $35 billion _ which it is using to invest in research projects. This investment should enable Samsung to remain at the leading edge of technology for all of its major business units, which in turn should result in high margins and strong cash flow compared with its regional competitors,” it said.

Over-reliance on Google Android software, heavy reliance on its handset division and the inability to create a whole-new product category based on software were cited as the main weaknesses that Samsung should improve on.

“Samsung does not enjoy the same level of competitiveness when it comes to software technology, or possess the ability to create a new product category, both of which have been core strengths of some of other leading companies such as Apple,” it said.

Samsung Electronics is the world’s top manufacturer of TVs and is also the top supplier in display panels and semiconductors. Lim said it’s worth noting that the company’s handset division accounted for 74 percent of the entire operating profit during the first three months of this year.

Lim said this reliance could become a weakness should Samsung Electronics lose its position in the market. He noted that Apple’s possible launch of low-end iPhones, if it materializes, will erode some of Samsung’s market position in emerging markets. “Samsung’s over-reliance on the Android platform due to the lack of a competitive operating system of its own clearly reflects this relative weakness. This maybe a threat should competitors catch up in hardware technology or should industry hardware competence reach a common level and product differentiation is driven by competition in software offerings,” the agency said.

Lim said the agency, which rates Samsung at A plus with an outlook of “stable,” the highest among Fitch’s Asia-Pacific portfolio of rated technology firms, says it’s highly unlikely that Fitch would upgrade Samsung Electronics in the medium term.

“Despite its strong performance, we believe that Samsung’s significant exposure to macro-economic cycles, volatility risk and reliance on relatively fickle, fast-moving, investment-intensive markets is inconsistent with an AA category rating and therefore we are unlikely to upgrade Samsung in the medium term.”

Lim continued; “Samsung’s A+ rating is clearly supported by its technological leadership, dominant market positions, and some diversification offered by non-handset businesses. But the volatility inherent in its core operations, the cyclicality of its semiconductor and display panel businesses, as well as the rapidly changing fortunes of global handset manufacturers, remains a significant risk that is not commensurate with an AA category rating.”

On a related note, he also confirmed that it won’t rate Samsung’s biggest smartphone rival Apple above A+.

Samsung has been quick to boost spending on large scale marketing campaigns impressed by the raised brand awareness, making it possible to become a marketing-driven firm. But Lim disagreed.

“We do not believe the company will become a marketing-driven firm shifting its strategic focus away from product competitiveness. We agree that the marketing is an integral part of operations to manage global market share but it will not be effective without leading products.”

He added the agency has acknowledged that Samsung’s marketing strategy transformed the brand over the last five years. “The fall of Nokia, Blackberry and the Japanese consumer technology giants illustrates that strong brands can struggle if they fail to develop technology-leading, desirable products.”

The impact of the ongoing legal battle with Apple on Samsung should be “short-lived” as the Cupertino-based outfit is already cutting its orders for components to be used in i-devices from Samsung.

“Fitch hasn’t seen any significant negative impact on Samsung’s financial profile as its internal demand has grown steadily. Apple will continue to source some application processors from Samsung to ensure adequate quality and stable supply. Samsung should be able to allocate more capacity to meet increasing internal demand, which should mitigate the impact of lower sales to Apple,” Lim said.

Mentioning a recent study by InterBrand that ranked Samsung as one of the “global top 10” corporate brand, Lim said Samsung’s brand recognition has significantly improved in the past couple of years in both developed and emerging markets due to a clear marketing message.

“We also believe that its heated battle against Apple for the smartphone leadership position, including the legal disputes, has helped consumers become more aware of Samsung products’ features. Its surge in the global smartphone market share as the largest seller, along with its leading position in other major businesses, demonstrates its strong brand power across regions,” he said.

“Samsung may close the gap with its rivals but technology companies’ brand value can be volatile and very dependent on possessing market-leading products.”

Samsung’s brand value last year was estimated at $33 billion by InterBrand, which is still behind other technology majors. Apple was the top with $77 billion, followed by IBM, Google, Microsoft and Intel at $76 billion, $70 billion, $58 billion and $40 billion.