Samsung: 3nm Semiconductor Innovations Driving Market Dominance (OTCMKTS:SSNLF)

Samsung Electronics (OTCMKTS: OTCPK:SSNLF) develops electronics, specifically smartphones, TVs, Computers, Tablets, memory devices, and parts necessary for semiconductor chips. Samsung has shown lots of innovation in the electronics industry. Most recently, Galaxy AI, which is Samsung’s own Artificial Intelligence (AI) product which is in its newer phones and allows users to be both more creative and more productive. Graph 1 below, shows Samsung’s 5 year growth, which is up about 85% over the time period. Currently, on May 20, 2024, the stock is still down 11% from its all time high, with a market cap of 524.95 Trillion KRW. This is a market cap of about $385 billion USD.

The company’s recent growth is showing no signs of slowing down, and I think Samsung’s growth rate may even increase because of new growth in its B-B segment, and a leading market share in both the global cell phone market and TV market. It is no secret that Nvidia (NASDAQ: NVDA) is a leader in semiconductor and AI development. Therefore, Samsung winning back Nvidia’s business for its 3nm Gate All Around (GAA) will drive revenues to new heights. I also believe that Samsung will continue to develop an increased market share in the cellphone industry because it already has its Galaxy AI product available in its smartphones, while Apple (AAPL) is yet to release a smartphone with an AI product in the software of the phone. Because Samsung is ahead of Apple in terms of a consumer AI product within a smartphone, and the potential of having Nvidia as a client for its GAA product will allow Samsung to continue to have success in the smartphone market, I rate the company as a Buy with a target price of $66.57.

Samsung’s 3nm GAA Product

I am a firm believer that the semiconductor and AI industries will drive productivity and growth in the economy in the foreseeable future. Graph 2 below, shows the rapid growth of the AI industry which has a CAGR of 28.46% over the next 6 years, and it is no secret the magnificent seven are leading this charge. With that being said, I’d like to first focus on Samsung’s role in the semiconductor industry, first going back to 2020.

One cm is equivalent to 10 million nm, so as one can imagine reducing the size of an already microscopic device is quite the challenge. In 2020, companies were having trouble going from a 10nm chip to a reliable 5nm chip. Samsung seized this opportunity and created an 8nm chip that was almost twice as powerful, twice as energy efficient, and 10% faster than the 10nm chips that were on the market. Samsung won NVIDIA’s business for its creation of the 8nm GPU that was primarily targeted towards the gaming segment.

Now in 2024, chips have evolved and the next big step is the 3nm chip. Clearly, Samsung’s 3nm chip is smaller than its 5nm chip but the benefits of a smaller chip go beyond size. The 3nm chip will see a 45% decrease in power use, 23% improved performance, and a 16% smaller surface. The 2nd gen of these 3nm chips will reduce power consumption by 50%. Therefore, these new 3nm chips allow for more power in a smaller area, which makes devices more efficient and last longer. In the next few months, Samsung will begin producing its 3nm GAA chip, which will likely be used for its new Galaxy Watch 7 or its Galaxy S25 series. This is a big step in showing potential clients that its 3nm GAA chip is reliable and innovative in the industry. Samsung has already stated it expects profits to increase 10-fold from Q1’23 to Q2’24 because of its success in its semiconductor unit. These expected profits are without the addition of the 3nm chip to the portfolio.

The reason the success of the 3nm chip is so crucial to Samsung’s revenue growth is the potential to onboard NVIDIA as a client once again. Samsung was able to sell its 8nm chip to NVIDIA, unfortunately, NVIDIA sought other manufacturers for a 5nm chip. As the AI industry continues to evolve the hot demand now is for a 3nm chip. Samsung has a special project codenamed “Nemo”. Nemo is an internal project at Samsung dedicated to ensuring its 3nm chips meet the requirements of NVIDIA. I believe because Samsung is ensuring its product will meet NVIDIA’s requirements and NVIDIA is looking to get as many chips as possible, it is highly likely Samsung will have a big uptick in demand for its 3nm chip because of NVIDIA, which will drive profits.

NVIDIA is going to use Taiwan Semiconductor Manufacturing’s 3nm (NYSE: TSM) for its Blackwell Architecture. NVIDIA’s Blackwell Architecture is will accelerate computing in Generative AI, which will have 208 billion processors which will allow for Generative AI products with power that hasn’t been seen. I expect NVIDIA will use Samsung’s 3nm chips for similar products as Samsung continues to make improved 2nd generation of its 3nm chip, which will allow NVIDIA to add even more computing power to its Blackwell Architecture. Samsung is selling its 3nm chips at 27 million won which is about $20,000 USD. Last fiscal year Samsung’s semiconductor revenue was down 48% YoY, I think revenue will have double-digit growth next year as it begins to mass produce its new generation 3nm chips.

Memory Products

AI is the phrase that is on the tip of everyone’s tongue these days whether it be adding AI to one’s daily life or businesses looking to implement an AI product. Samsung is well positioned to grow its revenue because Samsung is the world’s largest memory chip maker and there is a growing demand to create Generative AI models. Generative AI will grow the demand for memory chips globally because Generative AI needs memory chips for storing model parameters and activation values.

Model parameters require memory chips because these parameters are the guidelines for what the output the AI is going to provide based on the user’s input. Chat GPT is probably the most widely known generative AI, but there are plenty of other examples of generative AI products. As these products become more advanced, I believe that more memory chips will need to be used inorder to store the newly learned parameters. Furthermore, activation values require memory chips because activation values are essentially intermediate values stored within the generative AI. An example of an activation value would be background information a user would provide the generative AI model to improve the output the model generates.

Reports suggest that the memory device market will have a CAGR of 14.1% over the next seven years. However, I expect this number to be higher because I think as AI models become more advanced, the demand for memory chips will increase exponentially. Moreover, I think the economy is in the early stages of AI, and AI is not yet a staple of the average consumer’s daily life. Graph 3 below shows the impact of AI on GDP. I think as people see their productivity increase with AI, there will be a push to further implement AI in order to automate as many tasks as possible.

As Graph 4 below shows, I also believe the generative AI market will boom because I think as AI models get better there will be a higher demand to use these models. Through my observations, I have already seen more people wanting to use GPT 4.0 than not using GPT 3.5 because GPT allows users to import Excel files and other data sets to enhance the model’s output. Furthermore, more model parameters have improved the model’s ability to do math, which has increased the demand to use GPT 4.0.

Samsung has positioned itself as the global leader in producing memory chips and is continuing to improve its products to be faster and smaller. Samsung’s new memory products are specifically small enough so that they can be placed on AI chips. I believe Samsung’s revenue will increase and be driven by correlated growth between Generative AI and memory products in the near future.

Smartphone Sales

Samsung has been in the cell phone business since 1988. Now it has the second highest global market share of cell phone sales around the world at 24%, just behind Apple’s leading 28% market share. Samsung has over double the market share of Xiaomi, which holds the third most percent of the industry. In 2023, Samsung’s sales dropped in the United States. This allowed Apple to become the leader in the industry. In 2024, this year’s release, the S24 is beating S23 sales by double digits in some markets. Most importantly, in the US Galaxy S24 sales grew by 14%. I believe this metric is important because most of this growth is taking away market share from Apple, its biggest competitor in the industry. By growing its US market share, Samsung will once again be the industry leader in market share.

Table 1 above shows MX making up 53% of Samsung’s 1Q24 operating profit. The MX division represents the division that cell phone sales are in for Samsung. I think this number will continue to increase throughout 2024 because currently, Apple does not have a similar product with the AI capabilities the Galaxy S24 has. One of the main features of AI, in the Galaxy S24, is its translation feature which will translate both your voice calls and text conversations into your native language. Moreover, the Galaxy AI enhances user experience by helping with photo and video editing.

I believe that the Galaxy S24 will start to help Samsung capture some of the US market share that it has been losing in the past few years. In my opinion, I believe many people in the US look for devices that will improve their day-to-day lives. I think having built-in AI that improves everyday life will attract more users to the Samsung ecosystem of products. Apple has plans to release its AI products to its iPhone 16 in Q4 of this year with a new iOS update. Apple has submitted eight Large Language Models (LLM) to the Hugging Face hub, which helps with implementation. One issue I think Apple will run into is the current hardware of the iPhone 16 isn’t Apple to handle running the new LLM efficiently. Moreover, recently Apple has been struggling with various data security issues including secret encryption key leaks because of issues with its chips. Therefore, I believe Apple will struggle to implement a positive experience with AI in its iPhones compared to Samsung which has already implemented its Galaxy AI product successfully in its phones. I think the barrier to entry into this market is the loyal fan base Apple has built up which has all of their data and preferences in a vast amount of Apple products and the problem of not being able to be in group chats because of the green text bubble that Samsung phones cause with iPhones in a group chat. However, Samsung has made it as easy as possible for users to switch their data over to their new Samsung phone from an iPhone by creating a Smart Switch, which allows for an easy transfer of data. If Samsung can start to win over some of the loyal Apple customers, which I think they will because of the built-in AI in the Galaxy S24 customers, then I believe many more people will make the switch from Apple to Samsung.

Valuation

Revenue Growth Rate Projections

In my DCF Model, I estimate a base case revenue of 5% in 2024 as revenue decreased last year for Samsung, but I expect Samsung to turn it around this year. However, in the coming years, I expect AI to both drive demand for Samsung’s semiconductor products and its cellphones. This will lead to increased revenue growth in the coming years.

Terminal Value Projections

I then took a terminal growth rate of 4% because GDP growth rates have historically been 3%, but I expect that with the use of AI in the economy, it will improve productivity and drive future growth to be 4%.

Weighted Average Cost of Capital (OTC:WACC)

To calculate WACC, I first took the interest rate of Samsung’s current debt which is 5.58%. I then multiplied by the weight of debt to get a weighted cost of debt of 2.12%. To calculate the cost of equity I used the 10-year U.S treasury bond rate. I then used the S&P 500’s average return over the last 20 years as the market return, and I used Samsung’s beta of 0.85. After multiplying by the weight of equity I arrived at a Weighted Cost of Equity of 8.87%. After adding the Weight Cost of both Equity and Debt together, I arrived at a WACC of 8.99%.

Intrinsic Value

Finally, I summed the 5 years of projected cash flows and present terminal value to find the enterprise value and subtracted it from net debt. After dividing by the total shares outstanding, I was led to a target price of ₩90,977 per share, representing a 15.31% potential upside.

Risk

The main risk I see in Samsung is its 3nm chip not meeting NVIDIA’s standard. Failing to win NVIDIA’s business would result in a lot of sunk R&D costs and its revenue would take a massive hit. However, because Samsung has project Nemo, I believe Samsung will win back NVIDIA’s business for its chip project. I think Project Nemo will ensure Samsung’s 3nm chip is up to the quality NVIDIA is looking for. Moreover, it is known that NVIDIA is looking to get its hands on any chip insight. Therefore, I believe it will be a successful match of Samsung to provide its 3nm chip to NVIDIA.

Takeaways

I would like to conclude this report with a Buy Recommendation for Samsung stock, with a target price of ₩90,977/$66.57 with an upside of 15.31%. I believe that the growing demand and the development of Artificial Intelligence will power Samsung’s growth. Semiconductor chips will continue to be produced and therefore memory and GAA chips will need to be made, which will be a catalyst for Samsung’s growth moving forward. Furthermore, I do not expect the market for Semiconductor Products to slow down or competitors to take away Samsung’s market lead in the memory chip industry.

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