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Apple vs. Samsung! The free cash flow “Clash of the Titans”!

December 10th, 2013 |  Published in Apple, Digital and Mobile Technology, Samsung

Clash of the Titans 1


10 December 2013 – Over the weekend I started prepping for the Mobile World Congress (MWC), the “Mother of All Mobile Events”, held in Barcelona, Spain, where EAM Capital now has an office. Paris and Barcelona are becoming Europe’s tech hubs (I will have a detailed post on why in early 2014) so it is wise to have a footprint in each. I am in Barcelona now for H-P Discover which is just one of a stream of high-tech events now home-based here. Then back home to Paris tomorrow for Le Web.

MWC runs the last week of February 2014. But this is a mega 5-day event. For the TMT (telecom-media-technology) space it is Hog Heaven. It is the largest gathering of TMT C-level corporates … including a bevy of GCs and Legal Directors. With 75,000+ attendees every year plus 1,600 vendors the planning must come early.

This weekend I started plowing through my Apple-Samsung material for a long-piece I am writing pre-MWC about Apple, Samsung, smartphones, innovation, design, and mobile tech which will go out to my TMT and IP listservs. But I started with a financial analysis, given Apple and Samsung compose 65% of my investment portfolio. Plus I own an equal number of their products. But I am one of those “hold-and-never-sell” guys so years ago I latched onto Apple at $80 a share and Samsung at 485,500 at KRW a share, with automatic reinvestment, and never looked back. So this financial look was more academic.

Note: if one decides to invest in Samsung, I recommend purchasing it on the South Korean market with ticker 005930.KS, instead of the U.S. market, for the simple reason that Samsung trades on the OTC Grey market and over the last three months has had an average volume per day of just 6 shares a day and thus is extremely illiquid.

I did a deep dive into the Wall Street Journal‘s “Seeking Alpha” series that parses/chops/granulates all of the finance numbers, especially the Mycroft Psaras analysis … from whom I stole the “Clash of the Titans” theme … plus the Gartner, H-P and E&Y smartphone industry reports and came up with this:

* Samsung keeps extending the smartphone crown. You see the Twitter bursts almost everyday.

* It widened its lead over Apple in the smartphone market in Q3, with Gartner estimating that Samsung sold 80.36M smartphones vs. 55M a year earlier and Apple 30.33M vs. 24.62M.

* Samsung’s market share held steady at 32.1% while Apple’s dropped to 12.1% from 14.3%.

* By operating system, Google’s Android (I know, there are over 22 versions of Android) accounted for 205M devices, or 81.9% of the market, Apple’s iOS 30.33M, or 12.1%, and Microsoft’s (MSFT) Windows 8.9M, or 3.6%.

* The total number of cellular phones sold rose to 455.6M from 431M. Samsung was in first place with 117M units and Nokia second with 63M.

Yes, there is a real “Clash of the Titans” going on in the smartphone industry, but rather than focus on the tech I focused on the financials to do a head-to-head and see which company came out ahead.

You need to look at numerous free cash flow ratios (boring, I know!) including: CapFlow, Price to Free Cash Flow, Growth Rate, Free Cash Flow Payout Ratio, Free Cash Flow Reinvestment Rate … yadda yadda yadda.

Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. I will not blind you with the ratio details and how each of these ratios is calculated. When used together, these unique ratios generate a quantitative picture of a company’s underlying fundamentals, taking into account both strengths and weaknesses. The key ratio is FROIC (Free Cash Flow Return on Invested Capital). Basically FROIC tells us how efficient operations are as it zeros in on how much free cash flow is generated for every $1 of total capital employed.

Some general points:

* Apple has a FROIC of 30%, which means that for every $100 of invested capital, they generate $30 in free cash flow

* Samsung has a FROIC of 22%, which means that for every $100 of invested capital, they generate $22 in free cash flow

By replacing net income in the payout and reinvestment ratios with free cash flow, you are able to make an analysis more precise by incorporating capital spending (Cap Ex) into the equation.

Therefore we can determine that Apple has a reinvestment rate of 75% and went on to use 25% of its free cash flow to pay out its dividend. Thus by taking 30% (FROIC) x 75% = 22.5% (rounded off at 23%). From there we add the dividend yield of 2.3% (rounded off at 2%) and we have a growth rate of 23% + 2% = 25%.

Samsung has a reinvestment rate of 96% and went on to use 4% of its free cash flow to pay out its dividend. Thus by taking 22% (FROIC) x 96% = 21.12%. From there we add the dividend yield of 0.54% and we have a growth rate of 21.12% + 0.54% = 21.66% (rounded off at 22%).

When you knock the numbers about some more you come up with Apple’s Free Cash Flow per share of $58.85, take its then current market price of $560.02 and divide it by $58.85 and get a Price to Free Cash Flow result of 9.51.

Samsung’s Free Cash Flow per share of ₩225,134, its then current market price of ₩1,428,000, yields a Price to Free Cash Flow result of 6.34.

From an investment standpoint, a Price to Free Cash Flow per share result of less than 15 is good for purchase, and anything under 7.5 to be excellent. The higher you go above 15, the more overvalued a company becomes. I never sell but brokers who trend this stuff tell me that a Price to Free Cash Flow per share result of 22.5 is their sell price, and 45 is their short price. So an appropriately priced stock should trade around a Price to Free Cash Flow per share result of 15. [ This benchmark result is determined by back testing.]

So, where are we? Had you made an investment in December 2011, in either of these companies, you would have made about 40%. Both companies are generating an incredible amount of free cash flow and that is why each has a very low Price to Free Cash Flow per share, thus making each a bargain.

Apple, for its part, has a CapFlow that is about half as much as Samsung’s, making Apple the safer bet, even though Samsung is trading at a much lower Price to Free Cash Flow per share. I say this because as Apple moves into China for example, on a large scale, they will grow their free cash flow at twice the rate that Samsung would, as Apple spends half as much in capital spending (CapEx) as a percentage of cash flow.

But I believe that both companies are great bargains right now. And as you will see in my upcoming 2014 piece, the fundamental stuff backs that up even more, with the edge going to ….. [to be continued]


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"The mind that lies fallow but a single day sprouts up follies that are only to be killed by a constant and assiduous culture."
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