US$1 = ~920 Won

Note 1- FD Sh/out excludes 1.43mm treasury shares and includes 1.45mm non-voting shares.

Note 2- To be conservative on valuation, I am excluding ~150bn of value of Samwhan’s owned HQ building and Samwhan’s 50bn+ of E&P investments (most recently a 27bn investment in Vietnam made in 4Q ’06) as they are difficult to value (although have historically paid attractive returns).

0.8x tangible book value (and book value of land and non-public equity stakes are severely understated as discussed below)

4.9x EV/ 2006 EBIT, 4.8x EV/ 2007 EBIT (obviously Adjusted EV produces NM result)

9.2x 2006 earnings, 8.9x 2007 earnings

2.0% dividend yield

2007 EBIT and earnings are based on what I believe is conservative mgmt guidance and is supported by a ~2.0 trillion Won (2+ year) backlog.  2006 EBIT excludes 4bn of non-recurring expense from a failed attempt by Samwhan to buy Daewoo E&C.

Business

Like most publicly-listed construction companies in Korea, Samwhan is fundamentally a contractor and architectural/engineering services firm.  Labor and equipment is sub-contracted out and thus depreciation and capex are less than 0.5% of revenue (i.e., de minimis) and returns on incremental capital are highly attractive.  Samwhan’s construction contracts (especially for civil contracts) typically have pass-through or cost-plus provisions for increases in labor and raw materials. 

EBIT margins at Samwhan consistently far exceed those of U.S. E&C companies and the lack of significant fixed costs has meant that the company has never been unprofitable in its 50+ years as a public company.

Depending on the year, ~75% of Samwhan’s revenue is typically from civil engineering projects, which has been a generally counter-cyclical sector in the past.  Civil construction projects (hospitals, schools, bridges, tunnels, etc) require prequalification points (PQ) for companies to bid on.  Given Samwhan’s multi-decade track record, it has a strong standing and high level of expertise needed to bid and win these projects. 

In general, civil construction projects carry a 9-11% gross margin and most sell-side firms in Korea (e.g., Morgan Stanley, BNP Paribas, etc) have industry overview pieces and monthly data on the space for more detail.  A simple thing to note is that the government’s budget for civil projects is 8% larger in ’07 than ’06 so new orders should improve this year for Samwhan.  Although you’d never know it from talking to Samwhan (they tend to be very conservative, which I think scares off prospective investors), through May 2007, civil construction orders in Korea were up ~30% year over year.

~10% of revenues are from residential (apartment) construction.  In 2005 and 2006, the Korean government tried out several measures to stem house price escalation and slowdown speculation in the housing market by (counter-intuitively) restricting supply.  As these measures have proven extremely unpopular and unsuccessful, a shift towards relaxing supply is nicely underway. 

In addition, there is a high likelihood of a particularly construction-friendly government coming into power soon.  The presidential elections are in December 2007 and the two leading candidates are largely in favor of substantially expanding housing supply and lowering or stabilizing transaction and property taxes, with the frontrunner being the former CEO of construction largecap Hyundai E&C. 

Most likely, a more rational housing policy should bolster the housing market in the next few years and although residential construction is a small part of Samwhan’s sales, the slowdown in apartment construction in 2006 pushed many diversified E&C companies to bid on civil projects to stay busy, and thus temporarily pushed margins on new projects down.

The remaining ~15% of revenues are typically from commercial construction (sometimes called “architecture”) and overseas projects.

2007 Outlook

Mgmt guidance for 2007:

Revenue: 900+bn (819bn in 2006), GM: 101bn Won (85bn in 2006), EBIT of 58bn (57bn in 2006)

Net Income: 45bn (41bn in 2006)

2007 does not look like a peakish year in terms of revenue or margins (actually ~11% GM would be one the low-end of GM that Samwhan has produced in the past several years).  The company’s backlog of 2.0 trillion Won should provide comfort on the sustainability of earnings in the next few years, and there are many places to diligence the robustness of the Korean construction market. 

I have used the company’s ’07 guidance which notably includes the impact of ~15bn of SG&A increase from project origination expenses (basically, costs incurred in planning and pitching of unsuccessful proposals for new private development projects).  Project costs for successful proposals are capitalized, and therefore the additional 15bn expense (which assumes a big pick-up in unsuccessful proposals, when you consider what 15bn will buy in Korea) also indicates that guidance is conservative.

Also, note that 2006 contained a few one-time issues/items (e.g., 4bn Won of expenses associated with their unrealistic bid for 50% of Daewoo E&C, a US$2,000 (yes, two grand) bribery ‘scandal’ that initially caused a major railway project to be lost and which has since been over-turned by the courts in Samwhan’s favor) which should make for easy comparisons in 2007, particularly in 2Q and 3Q.  1Q ’07 EBIT was 20.5bn compared to 17.7bn in 1q ’06, although 2Q ’06 reported EBIT was only 5.4bn partly due to non-recurring issues.  IR indicates 2Q went well and didn’t recall major project origination expenses, so there’s a shot of a solid year-over-year comparison and an improvement in guidance.

After a dip in overseas work (the company had a big project in Yemen which concluded in late 2005), Samwhan invested 27bn in an E&P project in Vietnam in late 2006 and could see a benefit starting in 2008 in the form of dividends (booked as 100% margin revenue).

What Its Worth

Samwhan’s balance sheet contains some tremendously valuable assets.

Net Cash and Working Capital

Samwhan’s current net cash position of ~80bn is likely to be maintained or grow throughout 2007 considering that FCF will either accumulate on the balance sheet or be reinvested in high return projects such as developing Samwhan’s Sogong-Dong property (see below).

Note that Samwhan has ~170bn of receivables, 52bn of inventory and 114bn of A/P.  Should things slow down significantly in the civil construction sector in Korea, and if Samwhan’s backlog declines from its current 2.0tn level, cash could be freed up from working capital.

Land and Buildings

The book value of the company’s land is dated and Samwhan has resisted marking much of it to market to avoid raising its real estate taxes.  The annual report breaks out the company’s properties’ book values.

The largest and most important parcel is in Sogong-Dong which is right in the center of Seoul (adjacent to the Westin hotel and near City Hall).  The land is on the books for 68bn but the company admits it is worth over 2x this, and we have found that it was appraised for ~165bn Won a year ago (property values in Seoul are up 5-10% since then).  Samwhan has debated for years on how to develop Sogong-dong (currently it serves as a parking lot whose revenue slightly exceeds real estate taxes) and has looked at doing a deal with various international hotel operators/developers like the Shangri-La.

Early in 2007, the company confirmed that it was negotiating with the Four Seasons on developing Sogong-dong and a basic framework had been reached.  It is looking to build a combination of a hotel and office tower although is not likely to make a comprehensive announcement until the deal economics have been worked out.  I suspect that the 170+bn Won market value of the property will become a lot more obvious to the world in 2007.  Sell-side analysts seem aware of this asset but appear to be waiting till its true value is spelled out and a development timetable is announced.

Although Samwhan’s corporate HQ and the underlying land is worth at least 150bn, I have ascribed no value for conservatism and as Samwhan occupies 4 of the 17 floors it would need to pay some rent if the building was sold.

SOC Equity Stakes

Seoul Express Highway: 23bn book value

ICN Airport Express Railway: 50bn book value

SOC stands for State Owned Capital and SOC projects are large-scale infrastructure projects (highways, bridges, etc) that are performed by consortiums of E&C companies.  Basically, companies buy a stake in the equity of these projects at book value when they win the project and are able to sell it near or after completion.  The Korean government guarantees a minimum level of revenue or return on these projects for 20+ years, and thus the equity is quite valuable and worth a multiple of book, especially for older SOC projects where government-guaranteed returns were over 9%.  Publicly-traded companies such as the Kookmin Bank, Macquarie Infrastructure Fund and Hana Bank have been aggressively buying up Korean SOC equity stakes and levering them up.

Samwhan recently disclosed that it will follow Hyundai E&C’s lead in selling its stake in the Airport Expressway project (negotiations with a buyer are well underway), and expects they will receive at least 2x the book value i.e., 100bn Won.  It is likely that Samwhan will receive a similar 2x book or better valuation for its other SOC stake (which also has a 20 year government guarantee), and in the interim, collect a ~9% dividend.

Samwhan also has some other small SOC/non-public equity stakes with 7bn of book value that I have ascribed no value to, for conservatism.

Public Securities – 51bn after-tax value

The main holdings are Samwhan Camus (31bn after-tax) and a bunch of telecom stocks. Management acknowledges that there is no business or other reason why Samwhan could not sell these.

Current share price: 34,500

As mentioned before, no value is given in the above table to the company’s 50+bn of E&P investments, although updates on these will come later this year.

Competitors’ Valuation and Sell-side Coverage

Large non-residential construction companies like Daelim E&C, Daewoo E&C, etc. trade at ~10-14x EBIT.  Mid-cap peers like Sambu and Korea Development trade at ~8.0-9.0x EBIT.

There’s plenty of sell-side research on the construction sector, and coverage of players smaller than Samwhan.  Some local analysts are familiar with Samwhan, partly from chaperoning investor visits.  ABN Amro and JP Morgan published ‘company visit notes’ earlier this year (they are bullish, though they aren’t very thorough or accurate, in line with most Korean sell-side research). 

Financial Disclosure

In addition to getting the English financials through KIS/brokers, investors can download Samwhan’s audited financials with notes from its website and request its annual reports from the company.  The company is updating its investor presentation. 

“Extremely Deep Value” in the Preferred

1.5mm of Samwhan’s 11.9mm outstanding shares are preferred shares (ticker: 000365) which are economically pari passu with the common shares but are non-voting and receive 1.1x the dividend/share that voting shares receive.  They are trading at around 16,500/share meaning they are theoretically trading below 1/4 of their fair value.  They are not as liquid but the obscene discount and ~5% yield seems to more than make up for this. 

Ownership and Shareholder Activism

Mgmt owns 18% formally, but I believe insiders control ~30% including ‘family and friends’.  The next CEO is not from the founding Choi family and recently bought ~US$200k (6,143 shares) of stock which is not that common in Korea. 

Although Samwhan’s mgmt are increasingly focused on IR and the CFO is reasonably accessible, they have a history of guiding down (perhaps due to the growing foreign ownership) irrespective of their backlog or the medium-term market outlook.  In the past 12 months, they have stalled on using their buyback program, and I hope other shareholders will pressure them to ‘do the right thing’.  The company has acknowledged our recommendation to provide more information on their website (they subsequently put the audited financials on there and may put their IR presentation on as well) and to repurchase the preferred stock i.e., cancel shares extremely cheaply, and hired bankers to evaluate corporate initiatives like this, but they have shown no indications of buying the preferreds back, to date.

Conclusion

Samwhan is worth at least 2x more and is accumulating shareholder value every quarter from substantial FCF.  Industry conditions are stable and look promising.  As awareness of the company increases, I expect the message will increasingly be given to the company that it is in everyone’s interests for them to buyback stock at these prices and also work with the sell-side to get their story out.

Essentially, because it is trading well below liquidation value and below 8x unlevered earnings, I think an investment in Samwhan (voting or the preferred) should work out decently even without any news on the development of Sogong-Dong land.  A deal with Four Seasons (or another interested partner) to flag and realize the value of this property could provide significant value to shareholders considering that this asset is worth ~50% of the market cap and does not appear to be properly priced in.

Nothing contained in this analysis shall be deemed to constitute investment advice or a recommendation to purchase, sell or otherwise transact in any security.  This analysis contains information from sources the author believes to be reliable, but the author cannot guarantee the accuracy of any such information.  The author undertakes no obligation to update or revise this analysis, whether as a result of new information, future events or otherwise.  The author owns shares of the company, and may buy additional shares or sell shares at any time. 

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