samsung electronics-samsung securities

March 23, 2011

Samsung Securities (Korea) www.samsungfn.com

INDUSTRY IN-DEPTH REPORT

Impact from mobile revolution Smart devices changing semiconductor market

Shipments of smart devices expanding at a rapid clip…

Global shipments of smartphones are expected to increase 46% this year to 437m units,while tablet PC shipments balloon an estimated 175% to 52.5m units—both expandingmuch faster than the anticipated 10% expansion in mobile-handset and PC sales volume.Although growth momentum in the smart-device markets will undoubtedly slow overtime, it should remain higher than in the handset and PC markets. As a result, demand formobile DRAM, NAND flash, and application processors (APs) should continue rising.

…affecting semiconductor demand patterns

Amid such increasing demand for smart devices, the pattern of demand forsemiconductors is shifting from PC DRAM to mobile DRAM, from HDD to NAND flash,and from industry-standard chips to APs. The semiconductor industry is therefore in themiddle of a sea change.

Mobile DRAM and NAND flash demand to grow 101% and 80% this year

Demand for memory used in smartphones and tablet PCs is headed steadily upward,particularly mobile DRAM demand as operating systems and APs become moreadvanced. We estimate that demand for mobile DRAM will soar more than 100% in 2011,extending the robust growth seen last year. NAND flash demand should also surge thisyear, despite projected chip-per-unit growth of only 30.4%, as shipments of smart devicesramp up to an estimated 490m units (from 318m in 2010).

Application processor chips provide new growth opportunity for SEC

Similar to CPUs in PCs, APs are core chips used in consumer IT products such assmartphones, tablet PCs, and personal media players (PMPs). Before the growth in smartdevices, US player Texas Instruments (TI) dominated the AP market with its OMAPseries. However, Samsung Electronics (SEC) has emerged as a strong rival since thelaunch of Apple's iPhone. We see APs becoming a key business for the firm, given theirlow-power superiority, high-speed circuit design, and compatibility with various operatingsystems.

SEC and Hynix to benefit more than most from mobile revolution

Samsung Electronics (SEC) remains our top pick in the semiconductor sector, as it standsto benefit most from expansion in the smart-device market and consequently growingdemand for mobile DRAM, NAND flash, and APs. We also like Hynix Semiconductor forits improving competiveness in both embedded NAND flash and mobile DRAM. SEC'ssystem LSI division should exceed KRW1t in operating profit this year, while the firm’ssemiconductor business should see improvements in competiveness from next year.Given such positives, we reiterate our three-star BUY★★★ on SEC with a 12-monthtarget price of KRW1,250,000, and our BUY rating on Hynix with a target of KRW35,000.

Analysts Dohan Kim [email protected] 822 2020 7787

Sunwoo Kim [email protected] 822 2020 7756

Semiconductors (OVERWEIGHT)

March 23, 2011

Semiconductors

2

1. Expansion in smart-device markets

Still plenty of room for smartphone market to expand

We expect the smartphone portion of the global handset market to reach 31% this year (from 24% in 2010 and 15% in 2009), boosted by: 1) demand for Apple’s iPhone; and 2) an expected supply uptick as the proportion with open-source operating systems increases—such systems include Android and Windows Phone 7.

Chart 1. Expanding global handset market Chart 2. Smartphone shipments vs portion of handset shipments

Source: Samsung Securities estimates Source: Samsung Securities estimates

Once smartphones account for more than 30% of global handset shipments—expected this year—their price range should become wider. Most are now priced high as they enjoy high demand from users relatively insensitive to handset prices and subscription fees. Looking ahead, however, price-sensitive users should become the mainstream, driving further growth in the smartphone market. Telcos will likely insist on mass-market smartphones that can be offered at subsidized prices to induce more data usage by subscribers on budget subscription plans.

Chart 3. Smartphone market trends and forecasts Chart 4. Sales of mobile devices, by category

Source: Samsung Securities estimates Note: Basic devices have limited functionality, low-cost devices sell for less than USD75, premium phones < USD300, premium 2 devices > USD300

Source: Gartner, Samsung Securities estimates

CONTENTS


p2

2. Impact on semiconductor demand

p7

3. Implications for Korean players p12

4. Samsung Electronics p13

5. Hynix Semiconductor p18

Steep growth in smartphone market to continue this year

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March 23, 2011

Semiconductors

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Smartphone OS market-share forecasts

Although Apple's iOS has long led the smartphone operating system (OS) market, backed by its dominant iPhone, Google's Android OS rapidly gained market share in 2010, while major handset makers Samsung Electronics (SEC), HTC, Motorola, Sony Ericsson, and LG Electronics increased their Android-related lineups. Android should see its share of the market reach 22% this year, making it the leading non-Symbian OS for smartphones.

Table 1. Smartphone OS comparison iOS Android Windows Phone 7

Launch Jun 2007 Jan 2008 (open source) Oct 2010

Current version

4.3

2.3 (Gingerbread) 3.0 (Honeycomb)

7.0

Distribution Own devices Third party Third party

Cost (USD) n/a Free 5-20

Devices

iPhone

Models from SEC, LGE, Motorola, and 19 others

Models from SEC, LGE, HTC, and two brands TBD

Application store App Store Android Market Windows Marketplace

Number of applications* 300,000 80,000 1,000

Application registration fee (USD) 99-299 25 99

E-mail Own mail app. Gmail Outlook Mobile

Office program Quick Office Google Docs MS Office 2010 Mobile

Default web browser Mobile Safari Chrome Internet Explorer Mobile

Profit share ratio with developer 3:7 3:7 3:7**

Note: * As of Oct 2010 ** Part of Microsoft’s portion may go to operators

Source: ATLAS Research, Mobile Developer Economics 2010, Samsung Securities

Chart 5. OS market share forecasts (2011) vs 2009 breakdown


Microsoft's new OS Windows Phone 7 is also expected to rapidly gain global market share, possibly making the smartphone OS market a three-way oligopoly. It has the potential to rival Android or Apple iOS due to its seamless compatibility with Microsoft’s Office programs (eg, Outlook) and entertainment platforms (eg, Xbox and Zune). Although Microsoft boasts formidable software development and marketing capabilities, it is a latecomer to the smartphone OS market—first mover advantages having been enjoyed by Apple and Android. This led to Windows Phone 7 having its own ecosystem and secure key applications.

Symbian46.9%

Android3.9%

iOS14.4%

RIM19.9%

Windows Phone8.7%

Other6.1%

2009

Symbian34.2%

Android22.2%

iOS17.1%

RIM15.0%

Windows Phone5.2%

Other6.3%

2011E

March 23, 2011

Semiconductors

4

Table 2. Global smartphone shipment trends and forecasts Smartphone shipment 1Q10 2Q10 3Q10 4Q10 1Q11E 2Q11E 3Q11E 4Q11E 2010 2011E

Global 55.4 62.4 81.0 100.7 100.6 107.1 111.5 118.0 299.5 437.2

% toal mobile device 19.0 20.1 24.6 28.6 31.4 31.4 30.8 30.5 23.3 31.0

Samsung 2.7 3.1 7.5 9.7 15.5 15.7 17.1 18.9 23.0 67.2

smartphone portion (%) 4.1 4.9 10.5 12.0 20.3 19.9 19.7 19.9 8.2 19.9

LG Electronics 0.3 1.0 1.2 3.9 4.4 5.7 7.2 9.1 6.4 26.4


HTC 3.3 5.4 6.9 9.1 9.3 10.0 10.9 12.5 24.7 42.7


Note: Excludes white-box sales from Chinese players producing unknown or unidentifiable brands Source: Samsung Securities estimates

Prerequisites for further smartphone penetration

Two preconditions must be met if smartphone penetration is to continue. First, networks must be capable of accommodating the consequent increase in 3G and Wi-Fi data traffic; Second, the average revenue per user (ARPU) must be sufficiently high to enable telcos to offer handset subsidies—aggressive smartphone marketing is therefore unlikely in low-ARPU countries such as China and India.

Chart 6. Average data traffic per smartphone user, by country/region

Note: Based on monthly use in 2010 Source: Informa Telecom & Media

Networks must be able to handle heavy data traffic, ARPU must be high enough to allow telcos to provide subsidies

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March 23, 2011

Semiconductors

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Tablet PCs gaining presence

Tablet PCs are poised to rapidly gain share in the overall PC market, given two major positives. First, they should continue to snatch market share from netbooks that have overlapping features—eg, portability and low power consumption. Second, Apple has kindled consumer appetite for tablets after bypassing netbooks completely.

We expect global tablet PC shipments to increase a whopping 175% this year to 52.5m units, making them an integral part of the smart-device market. Although Apple's iPad accounted for 90% of such demand last year, the proportion should change this year as handset and PC manufacturers rush to debut their own tablets. RIM unveiled its PlayBook in Sep 2010, Samsung Electronics (SEC) released its Galaxy Tab in Nov 2010, and several major players are about to launch products.

Chart 7. PC tablet market forecasts, by manufacturer


Table 3. PC tablet lineups Company Product Launch OS CPU

Dell Streak7 1Q11 Android 1GHz NVIDIA Tegra T20

HP TouchPad 1Q11 web OS 1.2GHz Qualcomm Snapdragon Dual Core

MSI WindPad 100W 1Q11 Windows 7 1.66GHz Intel Atom

Asus Eee Pad MeMO 2Q11 Android 1.2GHz Qualcomm Snapdragon Dual Core

HTC Flyer 2Q11 Android 1.5GHz Qualcomm Snapdragon Single Core

RIM BlackBerry PlayBook 2Q11 QNX OS 1 GHz TI OMAP Dual Core

Apple iPad2 Mar 2011 iOS 1GHz A5 (ARM-based)

Samsung Galaxy Tab 2 2Q11 Android 1GHz NVIDIA Tegra2 Dual Core

LGE Optimus Pad 1Q11 Android 1GHz NVIDIA Tegra2 Dual Core

Source: Company data, Samsung Securities

Tablets to face hurdles

It would, however, be overly optimistic to think that tablet PCs will take hold as a major segment of the PC market, as they face the same challenges in the initial growth phase as did netbooks. In other words, tablet PCs may lose potential customers to both high-end laptops (complete with tablet functionality) and ever-smarter smartphones.

Tablet PC market set for rapid expansion

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Counterattack likely from high-end laptops

In 2H, we expect major PC makers (eg, SEC) to release high-end laptops with sophisticated features such as solid-state drives (SSDs), as Apple's launch of the new MacBook Air has convinced them that their existing PC lineup will be no match for fast-evolving tablet products. Although the two product types are designed for different needs (and despite the fact that some consumers will stay with their current preference), there will therefore be stiff competition between tablet PCs and high-end laptops boasting a combination of PC and tablet features—eg, fast booting, low power, and slim design.

Table 4. New high-end laptops Model name Apple’s new MacBook Air Samsung SENS Series 9

Size (mm) 325 x 227 x 17 328.5 x 227 x 16.3

CPU 1.86GHz Intel Core 2 Duo 1.4GHz Intel Core Sandy Bridge i5

Storage 128GB or 256GB SSD 128GB SSD

Memory 2GB 2GB

Weight 1320g 1350g

Display 13 inch 13.3 inch

Battery life 7 hours 7 hours


Competition will also likely get fiercer in the high-end PC market in 2H, particularly, between Apple and SEC, both of which have an edge in brand recognition and key-component sourcing. For reference, SEC is the world's fifth largest PC maker by market share (based on 4Q10 data).

Another assault expected from smartphones

Smartphones are getting bigger, speedier, and more sophisticated, with screens exceeding 4 inches, dual-core processors, OS upgrades, and state-of-the-art displays. This poses a risk to low-end tablet PCs.

Table 5. 4G smartphones Company Motorola LGE Motorola Samsung HTC HTC

Model Atrix 4G Revolution Droid Bionic Infuse 4G Thunderbolt 4G Inspire 4G

Image

Dimensions (mm) 117.8 x 63.5 x 10.1 n/a 125.9 x 66.9 x 13.3 8.99 (thickness) 121.9 x 66 x 12.7 122.9 x 68.1 x 11.7

Weight (g) 136 n/a 158 n/a 163.9 163.9

Display 4 inch 4.3 inch 4.3 inch 4.5 inch Super AMOLED 4.3 inch 4.3 inch

OS Android 2.2v Froyo Android 2.2v Froyo Android 2.2v Froyo Android 2.2v Froyo Android 2.2v Froyo Android 2.2v Froyo

Memory 16GB internal, up to 32GB

32GB 16GB internal, up to 32GB

16GB internal 8GB internal 8GB internal, up to 32GB

Camera 5 MP 5 MP 8 MP 8 MP 8 MP 8 MP

CPU NVIDIA Tegra 2 1GHz QSD 1GHz NVIDIA Tegra 2 1GHz ARM Cortex A 1.2GHz QSD 1GHz QSD 1GHz

Source: CNET, GSM Arena, Samsung Securities

Competition between high-end laptops and tablet PCs to heat up

Smartphones becoming ever smarter

March 23, 2011

Semiconductors

7


1. NAND flash

Competition, OS advances raising NAND flash needs in smart devices

The average NAND flash content per smartphone is expected to rise to 7.9GB in 2011 and 10.2GB in 2012 (from 6.1GB last year), and that for a tablet PC to 32.7GB in 2011 and 39.0GB in 2012 (from 26.2GB in 2010). The capacity increases will mainly stem from: 1) fierce competition between players bent on differentiating their products; and 2) a growing number of applications as mobile operating systems become more advanced.

Chart 8. NAND flash content per smartphone Chart 9. NAND flash content per tablet PC


Mobile device portion of NAND flash demand to trend upward

By our estimates, the proportion of demand from mobile device will rise to 55.1% of overall NAND flash demand in 2011 (from 46.1% in 2010).

Chart 10. NAND flash demand, by application

Source: Samsung Securities

CONTENTS


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NAND flash capacity per smart device to increase

Mobile Device46.1

Digital camera16.7

MP321.4

USB drive9.8

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55.1

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MP315.6

USB drive8.6

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2. DRAM

Mobile DRAM content per smart device also on the rise

We expect mobile DRAM content per smartphone to rise to 278MB in 2011 and 392MB in 2012 (from 208MB this year) and that per tablet PC to 507MB in 2011 and 816MB in 2012 (from 275MB in 2010). Smart devices are increasingly in need of more buffer memory, as: 1) rising consumer demand for multitasking warrants the adoption of dual core application processors; 2) OS improvements—eg, Android and Windows Phone—are widening the range of smartphone applications; and 3) full browsing features are needed for smart devices to access web content geared toward conventional PCs.

Chart 11. DRAM content per smartphone Chart 12. DRAM content per tablet PC


Chart 13. DRAM demand, by application


How mobile DRAM demand will impact overall DRAM market

Despite varying widely by company, the die size penalty for mobile DRAM averages 20-30% for 50nm DDR1 units, 5-10% for 4xnm DDR1, and 10-15% for 4xnm DDR2. With mobile DRAM growing twice as fast as PC DRAM, total DRAM capacity should in effect decline, positively impacting supply-demand conditions. We expect actual die size penalties to be higher than industry estimates, given the difficulty in accurately forecasting demand for PC DRAM and mobile DRAM (which are manufactured at different production lines)—this should also help supply conditions in the DRAM segment.

Mobile DRAM capacity per smart device increasing

Growth in mobile DRAM demand positive for DRAM industry as a whole

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Desktop PC21.3%

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March 23, 2011

Semiconductors

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3. Application processor (AP)

An application processor (AP) is a system-on-chip (SoC) unit similar to a CPU in a conventional PC. Previously featured only in consumer goods—including TVs, MP3 players, and PMPs—APs have increasingly been included in smartphones and tablet PCs since Apple's iPhone first triggered growth in the smart device market. As a result, the AP segment has become a new growth driver for the non-memory industry as a whole.

Smart devices change face of AP market

In regular handsets, the core chips have been baseband (BB) and communication processor (CP) units—both supplied by Qualcomm. In high-end multimedia phones, the BB chip supported multimedia applications with the help of multimedia chips (supplied by Core Logic and Mtekvision). However, in smartphones with greater multimedia capabilities, the BB chip faced limitations in supporting multimedia applications. Smartphones have therefore increasingly adopted APs dedicated to multimedia application processing. As mentioned, APs used to be a small, low-value-added segment with only consumer goods makers as clients. But the launch of smartphones and consequent demand for (and competition over) more advanced features and specifications has turned APs into a burgeoning market.

Chart 14. Multi-media processor trend

Source: IDC, Samsung Securities

AP market landscape

US player Texas Instruments (TI) has long dominated the AP market, and still controls the largest market share because of its client relationship with Nokia. However, SEC has emerged as a strong AP player since it began exclusively manufacturing Apple A4, an AP chip designed by Apple (through subsidiary PA Semi). Graphic chip maker NVIDIA has also emerged as a strong player after developing a series of AP chips named Tegra—these are now being supplied to Android-based smartphones and tablet PCs.

S/W Emulation

Discrete AP

MMCP(Multi Media

Coprocessor)

Integrated AP

Competition heating over AP market

New entrants quickly gaining ground in AP market

March 23, 2011

Semiconductors

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AP market outlook

Precise estimation of the AP market is difficult, as: 1) most such chips are customized before being sent to clients; and 2) data such as ASP and sales volume are kept confidential. We see the size of the market reaching USD12b this year, with SEC's System LSI business enjoying the steepest growth down the road, backed by two large captive clients (SEC and Apple).

Chart 15. AP market*, by revenue

Note: *Figures show summed revenues from APs and multi-media processors Source: IDC, Samsung Securities estimates

Three determinants of AP's core competence

An AP's core competence lies in its technical prowess—ie, the manufacturers' ability to meet customers' SoC requirements. Product competitiveness can be measured largely by examining factors—clock speed (Hz), core count (dual-, quad-, hexa-, etc), and electricity consumption. Looking at clock speed, smartphone AP leaders SEC and Nvidia have achieved similar levels of competence (1.2-1.5Hz), while in terms of core count, they have rolled out dual-core products almost at the same time.

In terms of low-power circuitry design, the technology gap between rivals is wide. SEC is the most advanced player with its A4/A5 chip, and should remain so for some time, as its chip manufacturing operation offers Apple more than just a foundry service. Combining the technological capabilities of Apple and SEC, the A4/A5 chip is produced by SEC’s System LSI business.

Contrary to some expectations in the market, the likelihood of Apple outsourcing A4/A5 chip production to companies other than SEC is slim. Considering the nature of smart devices, in which a slight difference in chip performance can affect overall product quality, any decision by Apple to switch foundry operator would carry enormous significance—the potential supply shortage following such a switch would be a relatively minor issue. That said, in the long term, the likelihood of Apple outsourcing to TSMC or other makers should rise, given the heavy dependence on SEC, but only after 1H12 in our view. It is possible that Apple will produce the next-generation A6 chip using TSMC's 26nm line from 2H12.

AP makers achieving similar competence in clock speed and core count

Samsung has upper hand in low-power circuitry design

Apple's dependence on Samsung to continue

AP market to reach USD8.8b this year

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Emergence of APs changing landscape—Intel's position under attack

Conventional PC processors are almost all based on x86 architecture, with Intel controlling more than 80% of the market. In contrast, only 15% of tablet PCs use x86 architecture, while the other 85% use an ARM-based architecture. Projected steep growth in the global tablet PC market (175% vs 10% in conventional PCs) therefore poses a serious threat to Intel. The firm’s position should be further undermined, if its business ally Microsoft supports ARM-based architecture in its next version of Windows.

Compared to an ARM-based AP, Intel's CPU is too expensive. Differing by version, customer, and volume, AP prices are difficult to determine, but we estimate the average at USD15-35/unit. By contrast, Intel chips—eg, the Atom CPU and mass-market Pentium chips aimed at the same segment as ARM-based processors—are priced at USD50-70. (Excluded from the Intel average are its high-end 3.0GHz CPUs, which sell for more than USD300/unit.)

The tablet PC and conventional PC markets are indeed very different, but if an ARM-supported version of Windows hits the market, an ARM-based PC market may blossom. Lineup diversification by PC OEMs may also pick up, if they spend what they have saved in CPU costs on upgrades to solid state drives (SSDs, which contain NAND flash) and LPDDR2 memory (mobile DRAM).

Having purchased Infineon's wireless solutions business last year, Intel intends in 1H12 to unveil a new AP (upgraded from its netbook-use Atom CPU), and is developing integrated solutions to properly respond to the tablet PC market. However, uncertainties remain high as to whether the company’s products will be well received in the market. Although few rivals can match the company in the short term, as Intel is still a leading player in the PC-use high-end CPU market, downward pressure on low-end CPU prices should accelerate.

Growth in tablet PC market beleaguers Intel

Intel's price competitiveness losing ground; ARM-based Windows to hasten landscape change

Downward pressure on ASPs accelerating

March 23, 2011

Semiconductors

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3. Implications for Korean players

Sufficient capex funding and strong R&D capabilities key

The growing popularity of mobile devices has effectively created more semiconductor segments and made the R&D capability of firms much more important than in the past. The advent of APs has changed the CPU market landscape and altered the nature of memory demand from smartphones and tablet PCs—increasingly in demand are embedded NAND flash with high technological entry barriers and DDR2-based mobile DRAMs (LPDDR2). This has forced NAND flash and DRAM makers to develop more sophisticated products and optimize capacity allocation. Such tasks can only be handled by companies that can spend heavily on capex investments and boast strong R&D capabilities (in various fields).

SEC the most promising, Hynix also to benefit

SEC's semiconductor business should benefit the most from expansion in the smart-device market, for three reasons. First, volatility in the PC DRAM market should decline as sluggish PC market growth reduces price volatility and subsequently discourages future capacity expansion. Second, increasing demand for NAND flash (from smartphones, tablet PCs and high-end notebooks) should bring forward the point at which SSDs become the mainstream. Third, competition in mobile DRAMs should spread into DDR2 and low-power products, creating a favorable environment for SEC, which boasts strong R&D capabilities and funding.

Hynix should also benefit from expansion in the smart-device market, as: 1) its mobile DRAM sales should increase accordingly; 2) its client base should widen to include more large clients given the firm’s improving competitiveness in embedded NAND flash; and 3) resources can be allocated more efficiently as volatility declines in the PC DRAM cycle—related decisions regarding capex, R&D investments, and debt repayment should improve the firm’s earnings visibility and stability.

Strong funding and R&D capability essential if firms are to compete in future business environment

Expected benefits for SEC

Expected benefits for Hynix

CONTENTS


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March 23, 2011


Samsung Electronics (005930/BUY★★★)

FLASH NOTE

Benefiting most from expansion in smart-device markets

Target price KRW1,250,000

Upside/downside 43.2%

Current price KRW873,000

Analyst Dohan Kim [email protected] 822 2020 7787


AT A GLANCE

Business summary: Samsung Electronics, the flagship of the Samsung Group, is a diversified electronics maker with a business portfolio comprising semiconductor memory, TFT-LCD, mobile handset, digital media, and home appliance operations.

Sector Semiconductors

Market capitalization KRW142.5t/USD127.1b

Shares outstanding (float)

147,299,337 (70.63%)

52-week high/low KRW1,010,000/740,000

Bloomberg 005930 KS

60-day average volume 398,057 shares

Share ownership K.H. Lee, et al (17.56%)

Performance 1M 6M 12M

Absolute -7% +12% +9%

Relative -9% +2% -9%

CONSENSUS (Samsung vs market)

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Smart-device growth upgrading SEC's semiconductor competitiveness

Samsung Electronics (SEC) is the only company in the world that makes NAND flash, mobile DRAM, and application processors (AP). Although a late-starter in the AP segment, the firm boasts world-class technological prowess, supplying Apple with A4/A5 chips and manufacturing dual-core processor Exynos. We expect SEC's non-memory semiconductor sales to reach KRW9.5t this year, with a related operating profit approaching KRW1t. NAND flash should be in steady demand until mid-4Q11, receiving an additional boost in 2H11, when SSD-driven notebooks start competing with tablet PCs and smartphones.

Quarterly operating profit to be affected by slow LCD TV demand in 1Q

We now expect SEC to post an overall 1Q11 operating profit of KRW2.8t (lower than our previous estimate of KRW3.2t), due to an expected operating loss in its LCD business of KRW127b (vs our previous estimate of KRW225) following a drop in yields amid technology migration at its Guri plant and a decline in LCD TV demand. Tablet PC shipments should total 8m units this year, having only a limited impact on earnings— sales should dip at end-1Q11 on a planned model change, but should stabilize after 2Q when the new models make their debut.

Operating profit to edge down in 2011, but core competitiveness to rise

By our estimates, SEC’s overall operating profit will drop 3.1% this year to KRW16.8t, but its ability to produce DRAM, NAND flash and APs should strengthen competitiveness from 2012. With LCD TV demand expected to be sluggish for a while, the company will likely adjust utilization ratios, enhance its product mix (240Hx/3D) and prepare for the time when OLCED TV becomes the mainstream. Although the global market’s response to the firm’s GalaxyS2 product (due for release this month) is crucial, handset sales should remain solid, backed by: 1) Nokia's transition to a Microsoft operating system; and 2) expansion in the Android market. We reiterate our three-star BUY rating on SEC and 12-month target price of KRW1,250,000.

PERFORMANCE RATIOS

Year-end Dec 31 2009 2010 2011E Year-end Dec 31 2009 2010 2011E

EPS (KRW) 57,370 94,905 94,673 Sales growth (%) 15.2 13.4 4.7

BPS (KRW) 421,960 508,831 594,863 EPS growth (%)* 76.6 65.4 (0.2)

ROE (%) 13.4 19.9 16.7 P/E (x) 15.2 9.2 9.2

Asset turnover (x) 1.2 1.2 1.1 P/B (x) 2.1 1.7 1.5

OP margin (%) 8.0 11.2 10.4 EV/EBITDA (x) 6.4 4.7 4.2

NP/OP (%) 1.1 1.1 1.0 Div yield (common, %) 0.9 1.1 1.4

Financial leverage (x) 0.5 0.5 0.4 Net debt to equity (%) 15.7 13.1 12.2

Note: On a consolidated basis (K-IFRS) Source: Company data, Samsung Securities estimates

March 23, 2011

Samsung Electronics

14

Table 1. Earnings forecast revisions (consolidated, K-IFRS) (KRWb) 1Q11E 2011E

Old New Old New

Sales 38,137 37,046 165,514 161,879

Semiconductor* 7,939 7,939 35,015 35,015

TFT-LCD* 8,091 8,091 32,227 32,227

Telecom 11,289 10,197 48,540 44,905

Digital media 12,818 12,818 57,732 57,732

Reconciliation/other (2,000) (2,000) (8,000) (8,000)

Operating profit 3,253 2,826 16,658 16,755

Semiconductor 1,642 1,695 7,936 9,571

TFT-LCD 225 (127) 2,125 947

Telecom 1,257 1,111 5,498 4,936

Digital media 128 147 1,099 1,301

Reconciliation/other 0 0 0 0

Operating margin (%) 8.5 7.6 10.1 10.4

Semiconductor* 20.7 21.3 22.7 27.3

TFT-LCD* 2.8 (1.6) 6.6 2.9

Telecom 11.1 10.9 11.3 11.0

Digital media/other 1.0 1.2 1.9 2.3

Note: * Includes interdivisional sales Source: Company data, Samsung Securities estimates

Table 2. Fair value calculation based on 2011 mid-cycle forecasts (x) Target multiples 2011E (KRW) Fair value (KRW)

P/E 11.2 94,673 1,060,338

P/B 2.4 594,863 1,427,671

Average fair value (2011) 1,244,004

Target price 1,250,000

Note: Multiples equivalent to those seen in mid-cycle year of 2005 Source: Samsung Securities estimates

March 23, 2011

Samsung Electronics

15

Table 5. Quarterly earnings forecasts (consolidated, K-IFRS) (KRWb) 1Q10 2Q10 3Q10 4Q10 1Q11E 2Q11E 3Q11E 4Q11E 2009 2010 2011E

Sales 34,638 37,892 40,229 41,871 37,046 38,127 41,857 44,850 136,324 154,630 161,879

Semiconductor 8,200 9,530 10,660 9,250 7,939 8,253 9,189 9,634 26,800 37,640 35,015

Memory 5,590 6,710 7,490 6,040 5,287 5,423 6,132 6,249 16,770 25,830 23,092

Other 2,610 2,820 3,170 3,210 2,652 2,829 3,057 3,384 10,030 11,810 11,923

LCD 6,850 7,760 8,100 7,200 8,091 7,888 8,220 8,028 25,840 29,910 32,227

Telecom 9,180 8,780 11,120 12,110 10,197 10,412 11,537 12,758 37,600 41,190 44,905

Mobile 8,570 8,050 10,380 11,150 9,180 9,461 10,553 11,364 34,710 38,150 40,558

Others 610 730 740 960 1,018 952 984 1,394 2,890 3,040 4,347

Digital media 12,610 14,540 14,130 15,970 12,818 13,574 14,911 16,430 51,260 57,250 57,732

VD 7,390 8,590 8,050 9,920 7,468 7,994 8,381 9,550 32,820 33,950 33,392

Appliance 2,470 3,170 3,150 2,970 2,600 2,800 3,100 3,300 9,680 11,760 11,800

Other 2,750 2,780 2,930 3,080 2,750 2,780 3,430 3,580 8,760 11,540 12,540

Reconciliation/other (2,202) (2,718) (3,781) (2,659) (2,000) (2,000) (2,000) (2,000) (5,176) (11,360) (8,000)

Operating profit 4,406 5,014 4,865 3,012 2,826 4,088 5,018 4,823 10,925 17,297 16,755

Semiconductor 1,960 2,940 3,420 1,800 1,695 2,254 2,886 2,737 2,060 10,120 9,571

TFT-LCD 490 880 520 100 (127) 238 379 456 1,700 1,990 947

Telecom 1,100 630 1,130 1,440 1,111 1,189 1,336 1,301 4,100 4,300 4,936

Digital media 520 360 (230) (170) 147 407 418 329 3,070 480 1,301

Reconciliation/other 336 204 25 (158) 0 0 0 0 (5) 407 0

Operating margin (%) 12.7 13.2 12.1 7.2 7.6 10.7 12.0 10.8 8.0 11.2 10.4

Semiconductor 23.9 30.8 32.1 19.5 21.3 27.3 31.4 28.4 7.7 26.9 27.3

TFT-LCD 7.2 11.3 6.4 1.4 (1.6) 3.0 4.6 5.7 6.6 6.7 2.9

Telecom 12.0 7.2 10.2 11.9 10.9 11.4 11.6 10.2 10.9 10.4 11.0

Digital Media 4.1 2.5 (1.6) (1.1) 1.2 3.0 2.8 2.0 6.0 0.8 2.3

Source: Company data, Samsung Securities estimates

March 23, 2011

Samsung Electronics

16

SEC: Core assumptions 1Q09 2Q09 3Q09 4Q09 2009 1Q10 2Q10 3Q10 4Q10 2010 1Q11E 2Q11E 3Q11E 4Q11E 2011E DRAM Revenue (KRWb) 1,178 1,564 2,135 2,531 7,408 3,114 4,166 4,663 3,057 14,999 2,395 2,341 2,610 2,499 9,845 Change (% y-y) 11.3 21.6 56.2 127.6 53.6 164.3 166.4 118.4 20.8 102.5 (23.1) (43.8) (44.0) (18.2) (34.4) Change (% q-q) 5.9 32.7 36.5 18.5 23.0 33.8 11.9 (34.4) (21.6) (2.3) 11.5 (4.2) Shipment (Mil units, 256Mb equiv) 2,786 3,382 3,708 4,094 13,970 4,629 5,306 6,708 7,080 23,723 8,178 8,917 10,372 10,971 38,438 Change (% y-y) 45.5 44.5 46.4 50.4 46.9 66.1 56.9 80.9 72.9 69.8 76.7 68.0 54.6 55.0 62.0 Change (% q-q) 2.3 21.4 9.6 10.4 13.1 14.6 26.4 5.5 15.5 9.0 16.3 5.8 ASP (USD, 256Mb equiv) 0.57 0.64 0.76 0.84 0.72 0.88 0.96 0.88 0.68 0.84 0.52 0.50 0.49 0.47 0.49 Change (% y-y) (48.2) (42.5) (25.1) 25.3 (29.4) 53.3 50.2 15.2 (19.9) 16.4 (40.9) (47.5) (44.5) (30.2) (41.0) Change (% q-q) (14.8) 11.1 20.2 10.2 4.2 8.9 (7.9) (23.4) (23.0) (3.4) (2.6) (3.5) NAND flash Revenue (KRWb) 885 1,228 1,336 1,499 4,947 1,646 1,890 1,964 1,794 7,294 2,042 2,173 2,592 2,720 9,527 Change (% y-y) (36.0) (10.7) 18.2 74.1 4.2 86.0 53.9 47.0 19.7 47.4 24.0 15.0 32.0 51.7 30.6 Change (% q-q) 2.8 38.7 8.8 12.2 9.8 14.8 4.0 (8.7) 13.9 6.4 19.3 4.9 Shipment (Mil units, 512Mb equiv) 7,500 8,125 9,000 9,550 34,175 11,000 13,750 15,250 16,750 56,750 20,250 23,750 29,000 33,000 106,000 Change (% y-y) 57.9 38.3 20.0 16.8 29.9 46.7 69.2 69.4 75.4 66.1 84.1 72.7 90.2 97.0 86.8 Change (% q-q) (8.3) 8.3 10.8 6.1 15.2 25.0 10.9 9.8 20.9 17.3 22.1 13.8 ASP (USD, 512Mb equiv) 0.10 0.14 0.15 0.17 0.14 0.15 0.13 0.12 0.11 0.13 0.10 0.10 0.09 0.09 0.09 Change (% y-y) (69.3) (46.8) (14.0) 88.4 (27.6) 50.5 (4.6) (17.4) (35.0) (10.2) (32.0) (28.1) (23.0) (17.5) (25.1) Change (% q-q) 13.8 39.8 6.1 11.6 (9.1) (11.4) (8.1) (12.2) (4.9) (6.3) (1.6) (5.9) TFT-LCD (large) Revenue (KRWb) 4,880 5,910 7,760 7,290 25,840 6,850 7,760 8,100 7,200 29,910 8,091 7,888 8,220 8,028 32,227 Change (% y-y) 17.4 31.3 71.3 81.9 50.2 40.4 31.3 4.4 (1.2) 15.8 18.1 1.6 1.5 11.5 7.7 Change (% q-q) 21.7 21.1 31.3 (6.1) (6.0) 13.3 4.4 (11.1) 12.4 (2.5) 4.2 (2.3) Shipment (‘000 units) 22,705 30,952 35,179 35,308 124,144 33,868 36,721 36,815 37,525 144,929 39,585 40,896 43,504 43,998 167,984 Change (% y-y) (0.5) 22.4 42.7 62.7 31.5 49.2 18.6 4.6 6.3 16.7 16.9 11.4 18.2 17.3 15.9 Change (% q-q) 4.6 36.3 13.7 0.4 (4.1) 8.4 0.3 1.9 5.5 3.3 6.4 1.1 Blended ASP (USD) 152 148 178 177 163 177 181 186 169 178 185 182 182 180 182 Change (% y-y) (20.4) (15.2) 3.2 30.5 (1.5) 16.6 22.2 4.4 (4.1) 9.6 4.6 0.1 (2.0) 6.4 1.9 Change (% q-q) 11.9 (2.0) 19.9 (0.7) 0.0 2.6 2.5 (8.8) 9.2 (1.9) 0.3 (1.0) Handset Revenue (KRWb) 7,920 8,450 9,010 9,330 34,710 8,570 8,050 10,380 11,150 38,150 9,180 9,461 10,553 11,364 40,558 Change (% y-y) 53.7 56.5 48.1 34.4 47.2 8.2 (4.7) 15.2 19.5 9.9 7.1 17.5 1.7 1.9 6.3 Change (% q-q) 14.1 6.7 6.6 3.6 (8.1) (6.1) 28.9 7.4 (17.7) 3.1 11.6 7.7 Shipment (‘000 units) 45,800 52,300 60,200 68,750 227,050 64,300 63,809 71,424 80,874 280,406 71,382 74,913 82,677 90,571 319,543 Change (% y-y) (1.0) 14.5 16.2 30.3 15.5 40.4 22.0 18.6 17.6 23.5 11.0 17.4 15.8 12.0 14.0 Change (% q-q) (13.2) 14.2 15.1 14.2 (6.5) (0.8) 11.9 13.2 (11.7) 4.9 10.4 9.5 Blended ASP (USD) 122 126 121 116 120 116 108 123 122 118 116 119 123 124 120 Change (% y-y) n/a n/a n/a n/a n/a (4.5) (13.8) 1.6 4.8 (1.7) (0.1) 9.8 0.2 1.8 2.3 Change (% q-q) n/a 3.0 (3.8) (3.8) 0.3 (7.1) 13.4 (0.8) (4.4) 2.1 3.5 0.7 TV Revenue (KRWb) 6,743 7,025 7,101 8,878 29,747 6,437 7,800 7,190 8,446 29,874 6,315 7,004 7,321 7,876 28,516 Change (% y-y) 36.6 13.6 2.9 (3.1) 9.4 (4.5) 11.0 1.3 (4.9) 0.4 (1.9) (10.2) 1.8 (6.8) (4.5) Change (% q-q) (26.4) 4.2 1.1 25.0 (27.5) 21.2 (7.8) 17.5 (25.2) 10.9 4.5 7.6 Shipment (‘000 units) 7,441 8,095 9,447 12,835 37,819 9,968 10,632 10,720 13,640 44,961 10,665 12,240 12,870 14,330 50,105 Change (% y-y) 2.5 (2.0) 5.6 25.6 9.0 34.0 31.3 13.5 6.3 18.9 7.0 15.1 20.1 5.1 11.4 Change (% q-q) (27.2) 8.8 16.7 35.9 (22.3) 6.7 0.8 27.2 (21.8) 14.8 5.1 11.3 Blended ASP (USD) 639 675 607 592 616 564 630 567 547 575 536 539 548 543 540 Change (% y-y) (10.1) (8.3) (16.2) (9.9) (13.5) (11.7) (6.7) (6.6) (7.7) (6.6) (5.1) (14.5) (3.2) (0.7) (6.1) Change (% q-q) (2.8) 5.6 (10.1) (2.4) (4.7) 11.5 (10.0) (3.5) (2.0) 0.5 1.8 (1.0)


March 23, 2011

Samsung Electronics

17

Income statement Year-end Dec 31 (KRWb) 2009 2010 2011E 2012E

Sales 136,324 154,630 161,879 182,754

Cost of sales 94,595 102,667 108,748 122,585

Gross profit 41,729 51,964 53,131 60,168

SG&A expenses 30,804 34,667 36,376 41,165

Wages & fees 4,946 6,189 6,531 7,383

Marketing expenses 8,476 9,063 9,269 10,486

R&D 7,387 9,099 9,487 10,700

Other 9,996 10,315 11,089 12,595

Operating profit 10,925 17,297 16,755 19,004

OP from operations 10,980 16,662 16,755 19,004

Other operating profit (55) 635 0 0

Non-operating profit – net 1,266 2,032 2,471 2,570

Equity method gain (loss) 1,713 2,267 2,849 2,964

Interest income (expenses) (204) (23) (66) (66)

Forex gain (loss) (243) (212) (312) (328)

Other 0 (0) 0 0

Profit before tax 12,192 19,329 19,226 21,574

Income taxes 2,431 3,182 3,119 3,329

Net profit 9,761 16,147 16,107 18,245

EBITDA 21,500 28,975 32,217 34,573

EPS (KRW)* 57,370 94,905 94,673 107,237

Note: * EPS derived based on sum of common and preferred shares K-IFRS adopted, on a consolidated basis


Balance sheet Year-end Dec 31 (KRWb) 2009 2010 2011E 2012E

Current assets 54,211 61,403 65,132 84,924

Cash & equivalents 20,884 22,480 21,553 35,115

Accounts receivable 17,819 19,153 21,670 24,464

Inventory 9,839 13,365 15,244 18,409

Other current assets 5,670 6,405 6,665 6,936

Non-current assets 57,969 72,886 83,490 83,111

Investments 8,985 11,801 14,649 17,613

PP&E 43,560 52,965 60,503 56,934

Intangible assets 1,256 2,780 2,780 2,780

Other non-current assets 4,168 5,341 5,557 5,783

Total assets 112,180 134,289 148,622 168,035

Debts 9,395 10,775 8,875 8,375

Trade accounts and N/P 8,235 9,149 9,691 10,924

Other accounts & accrued accounts 14,631 15,049 15,941 17,969

Income tax payable 1,124 2,052 2,052 2,052

Unearned revenue & other advances 1,747 1,399 1,297 1,286

Other Liabilities 4,003 6,516 6,780 7,056

Total liabilities 39,135 44,940 44,636 47,661

Common stock 898 898 898 898

Other shareholders' equity 72,148 88,452 103,088 119,476

Total shareholders' equity 73,045 89,349 103,986 120,374

March 23, 2011


Hynix Semiconductor (000660/BUY)

FLASH NOTE

Smart-device penetration to boost earnings from 2Q

Target price KRW35,000

Upside/downside 26.6%


Analysts Dohan Kim [email protected] 822 2020 7787


AT A GLANCE

Business summary: Hynix Semiconductor is a top-tier maker of DRAM and NAND flash chips. In 2010, it was the world’s second-largest DRAM producer (24% market share) and number four in NAND flash (9%).

Sector Semiconductors

Market capitalization KRW16.4t/USD14.7b


590,281,560 (86.41%)

52-week high/low KRW30,150/KRW20,300

Bloomberg 000660 KS

60-day average volume 9,168,364

Share ownership KEB & creditor banks (15.9%)


Absolute -3% +6% +13%

Relative -5% +15% -6%

CONSENSUS (Samsung vs market)

0

50

100

150

0

20

40

Mar Jul Nov Mar

(KRW'000) (Indexed)Hynix Semiconductor (LHS)

Relative to Kospi (RHS)

20,000

30,000

40,000

50,000

14,000 15,000 16,000 17,000 18,000

Samsung

Target price

BPS

Earnings contributions from mobile DRAM and NAND flash rising

Mobile DRAM sales at Hynix Semiconductor should grow more than 100% this year, extending last year's robust growth, while embedded NAND flash sales, which have been sluggish until now, should jump in 2H. Multi-chip package (MCP) sales should also surge, as the company obtains embedded NAND flash certification from large customers. Growth in the mobile memory market should limit expansion in PC-use commodity DRAM capacity, boding well for leading PC DRAM makers such as Hynix and SEC.

Quarterly operating profit to beat market expectations

We expect 1Q operating profit to come in at KRW259b, beating the market consensus of KRW223b, backed by: 1) stabilization in PC DRAM ASPs this month; 2) the continuing NAND flash upcycle; and 3) solid demand for specialty DRAM—eg, mobile DRAM. The NAND flash contributions to Hynix's sales and operating profit are thought to have picked up in 1Q, with ASPs down an estimated 2% and supply up 14%. The proportion of NAND flash profit should this year soar to 21% (from 10% in 2010), lending stability to the firm's overall earnings.

Annual operating profit to reach KRW1.8t—reiterating BUY

Hynix should see quarterly operating profit bottom out at KRW275b in 1Q, then steadily rise to KRW411b in 2Q, KRW545b in 3Q and KRW657b in 4Q. Supporting positives include: 1) limited growth in DRAM capacity across the industry; and 2) expectations of DRAM demand growth in 2Q and a resulting supply shortage in 2H. The firm may also see earnings growth if the firm’s 38nm production yield improves from 2Q. We therefore maintain our BUY rating and 12-month target price of KRW35,000.

PERFORMANCE RATIOS

Year-end Dec 31 2009 2010 2011E Year-end Dec 31 2009 2010 2011E

EPS (KRW) (620) 4,458 3,124 Sales growth (%) 15.9 53.0 (7.5)

BPS (KRW) 8,898 12,916 16,385 EPS growth (%)* nm nm (29.9)

ROE (%) (6.6) 38.6 20.1 P/E (x) nm 6.5 9.3


OP margin (%) (1.5) 25.5 16.7 EV/EBITDA (x) 14.9 4.3 4.7

NP/OP (%) nm 1.2 1.0 Div yield (common, %) 0.0 0.0 0.0

Financial leverage (x) 1.5 0.9 0.6 Net debt to equity (%) (63.3) (33.2) (18.1)

Note: Parent-based, except for 2009-2011 OP and NP (consolidated) Source: Company data, Samsung Securities estimates

March 23, 2011

Hynix Semiconductor

19

Table 1. Earnings forecast revisions (consolidated) (KRWb) 1Q11E 2011E

Old New Old New

Sales 2,564 2,598 11,152 11,186

Operating profit 231 259 1,811 1,872

Net profit* 286 243 1,757 1,844

Note: * Minority interest excluded Source: Company data, Samsung Securities estimates

Table 2. Target price calculation (KRW) 2011E

BVPS 16,385

Target multiple (x) 2.1

Fair value 34,409

Target price 35,000

Source: Samsung Securities estimates

Table 3. Quarterly earnings forecasts (consolidated) (KRWb) 2010 2011

1Q 2Q 3Q 4Q 1QE 2QE 3QE 4QE

Sales 2,821 3,279 3,250 2,748 2,598 2,666 2,896 3,026

Operating profit 799 1,045 1,011 418 259 411 545 657Net profit* 817 660 1,061 93 243 522 543 537Note: * Minority interest excluded Source: Company data, Samsung Securities estimates

March 23, 2011

Hynix Semiconductor

20

Income statement Year-end Dec 31 (KRWb) 2007 2008 2009 2010 2011E

Sales 8,434 6,495 7,521 11,974 10,739

Manufactured goods 8,434 6,495 7,521 11,974 10,739

Merchandise and other 0 0 0 0 0

Cost of goods sold 7,139 7,482 6,337 7,507 7,625

Manufactured goods 7,139 7,482 6,337 7,507 7,625

Merchandise and other 0 0 0 0 0

Gross profit 1,295 (987) 1,185 4,467 3,113

SG&A expenses 1,037 1,215 1,301 468 1,359

Labor 112 109 112 166 147

Depreciation 48 53 47 13 48

Other 877 1,054 1,141 289 1,164

Operating profit 257 (2,202) 191 3,273 1,872

Non-operating income 639 878 1,248 926 603

Interest income 86 80 30 70 76

Forex gains 155 464 789 545 310

Other 398 334 429 311 218

Non-operating expenses 479 3,482 1,530 1,346 496

Interest expenses 145 273 324 301 300

Forex losses 156 1,581 519 571 0

Other 178 1,628 687 474 196

Pre-tax profit 417 (4,805) (398) 2,668 1,978

Taxes 0 0 0 0 0

Profit from continuing ops 0 0 0 0 0

Profit from discontinued ops 417 (4,805) (398) 2,668 1,978

Taxes 88 (86) (50) 38 134

Net profit 329 (4,720) (348) 2,630 1,844

EBITDA 2,223 (1,594) 1,380 4,582 4,052

EPS (KRW) 716 (10,273) (620) 4,458 3,124

Cash flow Year-end Dec 31 (KRWb) 2007 2008 2009 2010 2011E

Operating cash flow 2,766 (872) 445 3,894 4,849

Net profit 329 (4,720) (348) 2,630 1,844

Depreciation 1,694 1,850 1,701 1,600 2,100

Severance payments 97 66 79 99 60

Forex losses (gains) 36 952 24 181 80

Associate losses (gains) (170) (196) (237) (151) 40

Change in working capital 447 (567) (694) (784) 55

Other 333 1,743 (79) 319 670

Investment cash flow (3,962) (1,186) (621) (4,215) (4,293)

Capex (3,141) (1,946) (388) (2,300) (2,300)

Change in investment assets (1,618) 208 (70) (1,287) (453)

Other 797 552 (163) (628) (1,540)

Financing cash flow 908 1,041 921 (265) (507)

Change in short-term debt 196 541 49 (603) 487

Change in long-term debt 34 156 (2) 199 (44)

Change in bonds 851 840 199 661 (39)

Change in current maturities 0 0 0 544 (1,119)

Dividends 0 0 0 0 0

Rights issues 0 0 1,031 0 0

Other (174) (495) (356) (1,067) 208

Adjustments 0 0 0 0 0

Change in cash (288) (1,017) 745 (586) 50

Cash at beginning of year 1,647 1,359 341 1,086 500

Cash at end of year 1,359 341 1,086 500 550

Note: Parent-based, except for 2009-2011 OP and NP (consolidated) Source: Company data, Samsung Securities estimates

Balance sheet Year-end Dec 31 (KRWb) 2007 2008 2009 2010 2011E

Current assets 3,547 1,680 3,568 4,615 4,798

Cash & equivalents 1,359 341 1,086 500 550

Financial goods 327 48 243 1,304 1,403

Marketable securities 0 0 0 0 0

Accounts receivable 550 290 984 1,389 1,336

Inventories 702 767 784 926 726

Other current assets 610 233 471 496 782

Non-current assets 11,320 11,520 9,857 11,177 11,803

Investment assets 2,118 2,736 2,658 3,247 3,700

Tangible assets 8,397 7,678 6,325 7,133 6,907

Intangible assets 529 496 461 549 549

Other 276 610 413 248 647

Total assets 14,867 13,199 13,425 15,792 16,601

Current liabilities 2,793 4,131 4,652 4,461 3,463

Accounts payable 646 748 943 868 755

Short-term borrowings 224 935 958 349 836

Current portion of long-term debt 425 586 1,107 1,651 532

Other current liabilities 1,498 1,862 1,644 1,593 1,339

Non-current liabilities 3,037 3,979 3,321 3,160 2,918

Bonds 1,431 2,261 1,909 1,635 1,596

Long-term debt 942 1,070 806 880 836

Other long-term liabilities 663 647 606 645 486

Total liabilities 5,831 8,109 7,972 7,621 6,381

Capital stock 2,314 2,316 2,966 2,969 2,969

Capital surplus 852 929 1,304 1,411 1,411

Capital adjustments 15 6 6 6 6 Accumulated other comprehensive income

(53) 484 171 148 354

Retained earnings 5,909 1,356 1,006 3,636 5,481

Total equity 9,036 5,090 5,452 8,170 10,220

Financial ratios Year-end Dec 31 2007 2008 2009 2010 2011E

Growth (% y-y)

Sales 11.4 (23.0) 15.8 59.2 (10.3)

Operating profit (86.3) nm nm 1615.6 (42.8)

Pre-tax profit (77.2) nm nm nm (25.9)

Net profit (83.7) nm nm nm (29.9)

EBITDA (28.3) nm nm 232.0 (11.6)

EPS* (83.9) nm nm nm (29.9)

Margins (%)

Operating profit 3.1 (33.9) 2.5 27.3 17.4

Pre-tax profit 4.9 (74.0) (5.3) 22.3 18.4

Net profit 3.9 (72.7) (4.6) 22.0 17.2

EBITDA 26.4 (24.5) 18.4 38.3 37.7

ROE 3.7 (66.8) (6.6) 38.6 20.1

ROA 2.3 (33.6) (2.6) 18.0 11.4

Ratios

Net debt/equity (%) 14.8 87.7 63.3 33.2 18.1

Liabilities/equity (%) 64.5 159.3 146.2 93.3 62.4

Interest coverage (x) 4.3 nm 0.6 14.1 8.3

Receivables turnover (x) 8.5 15.5 11.8 10.1 7.9

Per share data (KRW)

Sales 18,367 14,138 13,410 20,292 18,194

Book value 18,527 10,000 8,898 12,916 16,385

Dividend 0 0 0 0 0

EBITDA 4,841 (3,469) 2,461 7,766 6,865

March 23, 2011


Nepes (033640/not rated)

COMPANY VISIT NOTE

WLP business to drive growth

WLP benefiting from growth in smartphone market

Nepes’s operations can be divided into two divisions: semiconductors and process chemicals. In the semiconductor division, its wafer-level packaging (WLP) business has become a growth driver, and the division has benefitted from recent growth in the smartphone market. WLP involves bumping and packaging semiconductors directly on to a wafer before cutting it to make a chip. We expect high-end mobile devices to increasingly adopt WLP technology (vs conventional packaging methods), as it can improve productivity and reduce chip size.

WLP customers to expand capacity

Samsung Electronics (SEC) and Broadcom send chips to Nepes for WLP. The packaged chips are then shipped to end-users, SEC and Apple. Nepes should benefit from the positive conditions at its customers. First, both handset makers plan to launch new flagship smartphone models in 2011, so demand should remain strong. Second, SEC is focusing on its foundry business, which requires WLP, and plans to expand its foundry capacity aggressively in 2011. Third, SEC’s capacity expansion will concentrate on 12-inch wafers, which most of Nepes’s WLP fabs are capable of processing.

WLP entry barrier high

Core technology—a fine-patterning process and circuit-integrating technology—acts as an entry barrier for WLP, so Taiwanese packaging companies such as ASE and Spil have the largest market shares. Foundry companies also have WLP businesses, but investment in expanding WLP capacity is a low priority, since: 1) such firms are focusing on investing in foundry capacity, rather than back-end packaging processes; and 2) financial conditions at second-tier companies are likely deteriorating.

Structural improvement expected

Nepes forecasts 1Q sales of KRW56b, with operating margin at 11%. The company forecasts 2011 parent-based sales of KRW280-300b, with operating margin at 13%. The stock is trading at 12x 2011 P/E, a premium to its peers. SEC’s aggressive investment in its foundry business, however, should pave the way for Nepes to grow as a global packaging player. An increase in WLP sales has diversified and helped stabilize Nepes’s total sales, which have heretofore depended largely on display industry conditions, causing volatility in the shares.

not rated

Target price n/a

Upside/downside n/a


Analyst JungHoon Chang [email protected] 822 2020 7752

Research Associate JongWook Lee [email protected] 822 2020 7793

AT A GLANCE

Business summary: Nepes offers a back-end packaging process service for semiconductors. The firm also produces process chemicals, such as developer.

Sector

Electronic Products & Components

Market capitalization KRW435.4b/USD387.2m


21,825,174 (71%)

52-week high/low KRW13,650/KRW6,160

Bloomberg 033640 KS

60-day average volume 611,362 shares

Share ownership B.K. Lee, et al (27.8%)


Absolute +4% +4% +57%

Relative +1% -4% +32%

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Relative to Kosdaq (RHS)

PERFORMANCE RATIOS

Year-end Dec 31 2008 2009 2010 Year-end Dec 31 2008 2009 2010

EPS (KRW)* 170 924 585 Sales growth (%) 21.6 16.5 8.1

BPS (KRW) 5,772 7,025 7,127 EPS growth (%)* nm nm (32.5)

ROE (%) (4.3) 17.2 9.6 P/E (x) 111.8 20.6 32.5


OP margin (%) 10.7 11.3 10.9 EV/EBITDA (x) 9.7 4.5 11.1

NP/OP (%) (0.2) 0.8 0.5 Div yield (common, %) 0.0 0.5 0.3

Financial leverage (x) 1.9 1.7 1.9 Net debt to equity (%) 32.6 8.9 20.7

Note: * Fully diluted Source: Company data, Samsung Securities estimates

March 23, 2011

Nepes

22

Chart 1. Sales and operating margin


Chart 2. WLP manufacturing process


Chart 3. Historical P/E bands Chart 4. Historical P/B bands

Note: Based on trailing P/E Source: Company data, Samsung Securities

Note: Based on trailing P/B Source: Company data, Samsung Securities

Wafer Wafer packaging Dicing

Wafer Dicing IC packaging

Conventional packaging

Wafer-level packaging (WLP)

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Semiconductor Process chemicals Operating margin (RHS)

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March 23, 2011

Nepes

23

Income statement Year-end Dec 31 (KRWb) 2006 2007 2008 2009 2010

Sales 146.6 155.8 189.4 220.7 238.5

Cost of goods sold 123.3 127.4 155.2 177.0 193.8

Gross profit 23.3 28.5 34.2 43.7 44.7

(Gross margin, %) 15.9 18.3 18.0 19.8 18.8

SG&A expenses 13.6 14.5 13.9 18.7 18.7

Operating profit 9.7 14.0 20.3 25.0 26.0

(Operating margin, %) 6.6 9.0 10.7 11.3 10.9

(D&A expenses-to-sales, %) 0.4 0.3 0.2 0.2 0.1

Net interest income (2.0) (2.0) (1.9) (1.3) (3.9)

Net forex-related gains 3.1 (1.4) (10.9) 1.2 (2.4)

Net equity-method gains (3.1) (3.4) (5.4) (0.9) (5.0)

Other 0.9 4.8 (7.8) 0.7 3.4

Pre-tax profit 8.6 12.1 (5.6) 24.8 18.0

Taxes 1.6 2.9 (1.2) 4.9 4.4

(Effective tax rate, %) 18.5 24.0 20.8 20.0 24.5

Net profit 7.0 9.2 (4.5) 19.8 13.6

(Net margin, %) 4.8 5.9 (2.4) 9.0 5.7

Operating net profit* 4.9 6.1 3.4 18.4 11.9

(Operating net margin, %) 3.4 3.9 1.8 8.3 5.0

EBITDA 26.5 32.3 13.8 43.4 40.5

(EBITDA margin, %) 18.1 20.7 7.3 19.7 17.0

Reported EPS (KRW) 348 455 (224) 996 672

Adjusted EPS (KRW)** 246 304 170 924 585

DPS (common, KRW) 0 0 0 50 50

DPS (preferred, KRW) 0 0 0 0 0

Dividend payout ratio (%) 0.0 0.0 0.0 4.6 7.9

Cash flow Year-end Dec 31 (KRWb) 2006 2007 2008 2009 2010

Cash flow from operations 9.1 27.6 30.7 29.6 36.3

Net profit 7.0 9.2 (4.5) 19.8 13.6

Depreciation & amortization 15.9 18.3 17.5 17.4 18.6

Net forex-translation income (2.4) 1.2 9.4 (1.6) 1.4

Net equity-method income 3.1 3.4 5.4 1.1 5.1

Gross cash flow 23.8 29.0 31.3 36.6 34.3

(-) Change in working capital (14.7) (1.4) (0.6) (6.9) 2.0

Other 0.0 0.0 (0.0) 0.0 0.0

Cash flow from investments (7.0) (13.3) (21.3) (25.1) (44.1)

Capex (21.5) (16.9) (13.3) (14.0) (47.6)

Free cash flow (12.4) 10.6 17.4 15.6 (11.3)

Change in investment assets (2.1) 5.0 (3.4) (1.4) (9.4)

(Dividends***)

Other 16.6 (1.4) (4.5) (9.8) 12.9

Cash flow from financing 2.7 (12.6) (8.0) (1.3) 41.1

Change in debt 6.0 (8.2) (6.9) (11.2) (6.2)

Change in equity 0.0 0.0 0.0 0.0 29.2

Dividends 0.0 0.0 0.0 0.0 (0.9)

Other (3.3) (4.4) (1.1) 10.0 19.0

Change in cash 4.8 1.6 1.5 3.2 33.3

Cash at beginning of year 3.5 8.2 9.9 11.4 14.6

Cash at end of year 8.2 9.9 11.4 14.6 47.9

Note: * Excluding one off items ** Fullly diluted, excluding one-off items *** From companies subject to equity-method valuation


Balance sheet Year-end Dec 31 (KRWb) 2006 2007 2008 2009 2010

Current assets 60.8 66.6 71.8 98.9 116.1

Cash & equivalents 8.1 9.8 10.9 13.9 47.2

Accounts receivable 26.0 28.1 23.1 33.5 31.8

Inventories 5.0 6.4 11.5 13.9 11.7

Other current assets 21.7 22.3 26.3 37.6 25.5

Fixed assets 122.5 120.3 118.9 115.2 177.2

Investment assets 19.5 16.3 15.7 15.0 35.7

(Equity in affiliated companies) 16.5 13.5 13.0 12.5 34.5

Tangible assets 97.4 98.0 93.7 90.6 117.8

Intangible assets 1.6 0.7 1.1 1.0 1.1

Other long-term assets 4.0 5.2 8.5 8.7 22.6

Total assets 183.3 186.9 190.8 214.1 293.3

Current liabilities 32.7 38.8 57.3 65.9 99.7

Accounts payable 8.8 10.4 11.5 17.0 15.0

Short-term debt 10.7 8.1 11.7 14.0 12.8

Other current liabilities 13.1 20.3 34.2 34.9 71.8

Long-term liabilities 50.0 42.5 30.9 20.2 39.2

Bond & long-term debt 49.0 41.5 30.0 17.6 25.1

Other long-term liabilities 1.0 1.0 0.9 2.6 14.1

Total liabilities 82.7 81.3 88.2 86.1 138.8

Capital stock 9.4 9.4 9.4 9.4 11.0

Capital surplus 42.4 42.4 46.1 48.5 77.5

Retained earnings 49.8 58.9 53.3 73.1 68.4

Other (0.9) (5.1) (6.2) (3.0) (2.5)

Total equity 100.6 105.6 102.6 128.0 154.5

Net debt 43.2 34.1 33.5 11.5 31.9

Book value per share (KRW) 5,017 5,481 5,365 6,543 7,127

Financial ratios Year-end Dec 31 2006 2007 2008 2009 2010

Growth (%)

Sales 30.6 6.3 21.6 16.5 8.1

Operating profit (47.3) 43.9 45.3 23.3 3.7

Pre-tax profit (61.5) 40.0 nm nm (27.2)

Net profit (62.1) 30.5 nm nm (31.3)

Operating net profit* (66.3) 23.6 (44.4) 441.3 (35.5)

EBITDA (27.0) 21.8 (57.3) 215.4 (6.8)

Adjusted EPS** (70.1) 23.6 (43.9) 442.3 (36.6)

Ratios

ROE (%) 7.2 8.9 (4.3) 17.2 9.6

ROA (%) 3.8 4.9 (2.4) 9.8 5.4

ROIC (%) 5.5 7.6 11.8 14.4 10.5

Net debt to equity (%) 42.9 32.3 32.6 8.9 20.7

Interest coverage (x) 3.3 4.2 (1.0) 8.6 3.9

Receivables turnover (days) 61.1 63.4 49.4 46.8 50.0

Payables turnover (days) 22.4 22.5 21.1 23.6 24.5

Inventory turnover (days) 11.7 13.3 17.2 21.0 19.5

Valuations (x)

P/E 46.2 29.3 29.1 10.9 32.5

P/B 0.0 0.0 0.0 0.0 2.7

EV/EBITDA 9.7 6.2 9.7 4.5 11.1

EV/EBIT 24.1 14.4 (35.5) 7.6 20.4

Dividend yield (common, %) 0.0 0.0 0.0 0.3 0.3

March 23, 2011

Semiconductors

24

Compliance Notice

- As of Mar 22, 2011, Samsung Securities shared group affiliation with Samsung Electronics. - During the six months prior to Mar 22, 2011, Samsung Securities had participated as a financial advisor in a merger or acquisition for Samsung Electronics. - As of Mar 22, 2011, Samsung Securities had issued equity-linked warrants with shares in Hynix Semiconductor as underlying assets. - As of Mar 22, 2011, Samsung Securities' holdings of shares and debt instruments convertible into shares of each company covered in this report would not, if such

debt instruments were converted, exceed 1% of each company's outstanding shares. - As of Mar 22, 2011, the covering analyst(s) did not own any shares, or debt instruments convertible into shares, of any company covered in this report. - This report has been prepared without any undue external influence or interference, and accurately reflects the views of the analyst(s) covering the company or

companies herein. - All material presented in this report, unless specifically indicated otherwise, is under copyright to Samsung Securities. - Neither the material nor its content (including copies) may be altered in any form, or by any means transmitted, copied, or distributed to another party, without prior

express written permission from Samsung Securities. - This memorandum is based upon information available to the public. While we have taken all reasonable care to ensure its reliability, we do not guarantee its

accuracy or completeness. This memorandum is not intended to be an offer, or a solicitation of any offer, to buy or sell the securities mentioned herein. Samsung Securities shall not be liable whatsoever for any loss, direct or consequential, arising from the use of this memorandum or its contents. Statements made regarding affiliates of Samsung Securities are also based upon publicly available information and do not necessarily represent the views of management at such affiliates.

Target price changes in past two years

Samsung Electronics Hynix Semiconductor

Nepes

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March 23, 2011

Semiconductors

25

Rating changes in past two years

Samsung Electronics

Date 2009/4/2 4/25 7/2 7/25 9/2 12/7 2010/1/30 3/10 3/18 6/19 10/21 2011/1/28

Recommendation BUY(M) BUY(M) BUY(M) BUY(M) BUY(M) BUY BUY BUY★★☆ BUY★★☆ BUY★★☆ BUY★★★ BUY★★★

Target price (KRW) 540,000 645,000 710,000 805,000 845,000 845,000 930,000 930,000 970,000 1,150,000 1,150,000 1,250,000

Hynix Semiconductor

Date 2009/4/17 7/26 9/11 10/23 12/7 12/8 2010/1/21 3/17 6/19 7/23 10/21 2011/1/18

Recommendation BUY(M) BUY(M) HOLD(M) HOLD(M) HOLD HOLD HOLD HOLD BUY★★☆ BUY★★☆ BUY BUY

Target price (KRW) 16,000 18,500 22,000 20,000 20,000 17,500 22,000 23,500 36,000 32,000 32,000 35,000

Nepes

Date 2011/3/23

Recommendation not rated

Target price (KRW) n/a

Samsung Securities uses the following investment ratings.

Company

BUY★★★ Expected to increase in value by 30% or more within 12 months and is highly attractive within sector BUY Expected to increase in value by 10% or more within 12 months HOLD Expected to increase/decrease in value by less than 10% within 12 months SELL Expected to decrease in value by 10% or more within 12 months SELL★★★ Expected to decrease in value by 30% or more within 12 months

※ On Oct 21, Samsung Securities changed the ratings in its five-tier system to BUY★★★, BUY, HOLD, SELL, and SELL★★★ from BUY★★★, BUY★★☆, BUY★☆☆, HOLD, and SELL.

Industry

OVERWEIGHT Expected to outperform market by 5% or more within 12 months NEUTRAL Expected to outperform/underperform market by less than 5% within 12 months UNDERWEIGHT Expected to underperform market by 5% or more within 12 months

March 23, 2011

Semiconductors

26

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