Holding Companies Group’s ownership restructuring scenarios and investment strategy

Samsung Group likely to convert to holding company structure Overweight (Maintain) For Samsung Group, adopting a holding company structure is not an absolute necessity. Nevertheless, it is an appealing way for the group to: 1) cement its control over core Sector Update affiliates, such as (SEC) and Samsung Life, and 2) smooth out t he June 3, 2014 processes of regrouping affiliates and transferring ownership. We believe Samsung Group will opt for a holding company structure after weighing the costs of conversion and the relevant laws and regulations. Daewoo Securities Co.,CCCo., Ltd.

[Holding Companies/IT Services] Ownership restructuring scenario and investment opportunities 1) Conversion to a holding company structure spearheaded by Samsung Dae-ro Jeong Samsung Group’s switch to a holding company structure is likely to be facilitated by a +822-768-4160 merger between Samsung Everland, the majority of which is owned by the group’s [email protected] controlling family, and Samsung C&T. In this case, the controlling shareholders would be

able to increase their direct ownership of SEC through the stake currently held by Samsung C&T. Subsequently, the controlling family would be able to take control over electronics affiliates by transitioning SEC to an intermediate holding structure, and also gain

ownership of financial affiliates by making Samsung Life into an intermediate financial holding company. The controlling shareholders could seek to increase their stakes in the post-merger holding company by buying shares of Samsung Everland or Samsung C&T. 2) Turning SEC into an intermediate holding company Currently, Samsung Group holds a 17.7% stake in SEC (13% by affiliates and 4.7% by the controlling family). Given the government’s ban on new cross-shareholdings and the group’s budget constraints, one of the most effective ways for the group to raise its SEC stake would be to turn the electronics giant into a holding company. Establishing SEC as a holding company—via a spin-off followed by a tender offer—would allow the group to more than double its current stake in SEC (holding company), and ultimately cement its control over the electronics operating subsidiary.

[Investment opportunity] Watch for potential share buybacks and spin-off of SEC

3) Transitioning Samsung Life into an intermediate financial holding company The government’s proposal to allow non-financial holding companies to own financial subsidiaries through the establishment of intermediate financial holding compan ies (beginning in 2H14) should make it easier for Samsung Group to make the holding company transition. Since most of the group’s financial affiliates are tied to Samsung Life, the insurer could be separated into an insurance operating subsidiary and an intermediate financial holding company owning stakes in Samsung Securities and Samsung F&M.

[Investment opportunity] Watch for potential share repurchases by financial affiliates such as Samsung Securities and Samsung F&M

Five key considerations for ownership restructuring

Source: KDB Daewoo Securities Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including t he U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

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Key chart II.. Merger between Everland &&& C&T: Major shareholders can acquire shares of Everland or C&T before merger

Key chart II. SSECECECEC can strengthen control via establishment of intermediate holding cococompanyco mpany

Key chart III. Introduction of intermediate financialfinancial holding company ‰‰‰ control overoverover financial affiliates

Key chart IV. Tax benefits related to holding company conversion

Source: KDB Daewoo Securities Research

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Converting to a holding structure

Why does Samsung Group need to transition to a holding company structure?

Adopting a holding company structure is not an absolute necessity for Samsung Group. Even if a transfer of ownership takes place under the current governance, risks related to management control and legal issues are likely to be limited. Still, we believe that the group needs to choose conversion for the following reasons.

First, under a conversion scenario, the controlling family would be able to cement its control over core affiliates, such as SEC and Samsung Life by increasing ownership in the holding company (without incurring significant additional costs).

Second, a holding structure is likely to allow for the smooth regrouping of affiliates, as was the case with LG Group and GS Group.

Third, due to toughening regulations, such as restrictions on related-party transactions, controlling shareholders are facing tighter budgets. Furthermore, they are struggling with a ban on new cross-shareholdings and high inheritance/gift taxes. Amid these tough regulatory conditions, conversion to a holding company structure appears to be an attractive way to facilitate a smooth transfer of ownership.

In light of the moves that Samsung Group has been making since 2013 (e.g., reorganization, stake changes through related-party M&A deals and business transfers), the group seems to already be working toward conversion. Thus, we believe that, after weighing conversion costs and the relevant regulations, Samsung will finally convert to a holding company structure so as to further reinforce management control.

Meanwhile, we expect the conversion to progress more rapidly than anticipated. Currently, converting to a holding company structure can yield many positives (including tax benefits). If Samsung makes the leap, it could enjoy a not insignificant grace period for meeting holding company requirements (e.g., easing of cross-shareholding structure, separation of financial and non-financial activities, and acquisition of required ownership stakes in subsidiaries). On the other hand, delays to conversion might expose the groups to risks—such as changes in holding company laws and the introduction of new regulations. As such, Samsung Group might opt for a strategy of adopting a holding company structure first and then meeting related requirements.

Table 111.1. Business/ownership stake changes Details

9/23/13 Everland acquired ’ fashion business (worth W1tr) 9/29/13 Merger between Samsung SDI and Samsung SNS 11/4/13 S1 acquired a building management business of Everland Samsung Life purchased a 6.38% stake in (2.54% from Samsung C&T; 3.81% from 12/13/13 SEMCO; 0.03% from SHI) Samsung C&T acquired stake (0% →2.7%), 8/13- (additionally p urchased 5.09 % stake held by SDI on 12 /13 /13 (2.7% →7.79%)) 3/31/14 SDI merged with Cheil Industries 4/2/14 Samsung General Chemicals merged with Samsung Petrochemical 4/22/14 Samsung Life purchased 0.63% stake in Samsung F&M from Samsung Card affiliates (e.g., SEMCO, Fine Chemicals, SDS, ) sold their Samsung 4/22/14 Life stake ( 1.64% ; 3.28mn shares) Samsung Life decided to purchase 100% of Samsung Asset Management (currently holds 5.48%): 5/9/14 62.25% from Samsung Securities, 3.88% from SHI, 1.18% from Samsung F&M, 7.7% from Lee Ja e-yong, 5.13% from Lee Boo -jin, 2.57% from Lee Seo -hyun , etc. Samsung Securities decided to acquire 100% shares of Samsung Futures (currently holds 51%): 5/9/14 41% from Samsung Life, 4% from Samsung F&M, 2% from Samsung Life Public Welfare Foundation, etc. Source: KDB Daewoo Securities Research

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Figure 111.1. Corporate governance of Samsung Group

Note : Based on date of announcement Source: KDB Daewoo Securities Research

Table 222.2. Holdings of controlling family NameNameName Relation Positions Company Ownership (%)(%)(%) VVValueValue (Wbn) SEC 3.38 7,244 Samsung Life 20.76 4,115 Samsung General Chemical 1.13 18 Lee Kun-hee Samsung C&T 1.37 156 SEC’s president (1942) Samsung Everland 3.72 194 Samsung SDS 0.01 2 2.5 0 Total 11,729 Samsung Everland 25.1 1,311 SEC 0.57 1,222 Samsung SDS 11.25 1,716 Lee Jae-yong Eldest SEC’s vice president Samsung Asset (1968) son 7.7 32 Management Gaccinet 36.69 1 Total 4,282 President and chief executive of Samsung Everland 8.37 437 ; Samsung Petrochemical 33.19 125 Lee Boo-jin Eldest Samsung Everland’s president of Samsung SDS 3.9 595 (1970) daughter business strategy Samsung Asset 5.13 21 Samsung C&T’s advisor in Management commercial segment Total 1,179 Samsung Everland 8.37 437 Cheil Worldwide’s business Samsung SDS 3.9 595 Lee Seo-hyun Second strategy team leader; Samsung Asset (1973) daughter Samsung Everland’s fashion 2.57 11 Management business strategy president Total 1,043 Notes: Based on the June 2 nd closing prices; unlisted company data are based on net asset value (Samsung Asset Management is based on sales value) Source: Dart, KDB Daewoo Securities Research

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Pending tasks

1. Stake transfers

Going forward, Lee Kun-hee’s stakes in Samsung companies (e.g., SEC, Samsung Life, Samsung C&T, Samsung Everland) will likely be transferred to his son Lee Jay-young and other related parties. And these stake transfers will be subject to inheritance/gift taxes.

It should be noted that the use of listed shares to pay inheritance taxes (in lieu of cash) was banned effective February 15, 2013. This ban was implemented because it is relatively easy to cash shares. (Payment in shares is allowed only if the sale of shares is restricted under the Capital Market and Financial Investment Business Act (e.g., lock-up).) Therefore, Samsung Group will need to make cash tax payments.

Under current law, in the case of inheritance in excess of W3bn, the maximum applicable tax is generally 50%. However, for shares held by controlling shareholders, the effective rate can be raised to 65% assuming a possible maximum premium of 30% (management premium). As such, inheritors might consider selling some of their inherited shares.

Meanwhile, if Lee Kun-hee’s stakes are transferred to non-profit foundations, a proportion of gift taxes will be given exempt status (10% if the non-profit foundation meets certain requirements). As such, transferring stakes to non-profit foundations and then repurchasing them might be a good way to ease the tax burden of the controlling family; however, these activities would still incur capital costs.

Table 333.3... Assets that can be used to make inheritance tax paypaymentsments CCCategoryCategory Details

1. Real estate in Korea 2. Government/public bonds, registered shares, bonds and securities issued by domestic/overseas Enforcement corporations or designated by the MOSF ordinance of But there are exceptions as follows: Inheritance Tax Ⅰ. Shares listed on the KRX (excluding shares for which disposal is restricted by the Financial and Gift Tax Act Investment Services and Capital Markets Act). (Article 74) Ⅱ. Unlisted shares (exception: in cases of no other inheritance or insufficient inheritance (for tax payment).

Source: MOLEG, KDB Daewoo Securities Research

Table 4. Inheritance tax rateratessss Tax base Tax rate Progressive deduction Less than W100mn 10% - In excess of W100mn - less than W500mn 20% W10mn In excess of W500mn - less than W1bn 30% W60mn In excess of W1bn - less than W3bn 40% W160mn In excess of W3bn 50% W460mn Source: National Tax Service, KDB Daewoo Securities Research

Table 555.5... Premium to tax rate applicable to shares held by cocontrollingntrolling shareholders Over 50% owowownershipow nership Less than or equal to 50% ownership General corporations 30% 20% Small businesses 15% 10% Source: National Tax Service, KDB Daewoo Securities Research

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2. Listing of Samsung SDS

Samsung Group is working to make Samsung SDS public this year. Given the tightening of regulations on conglomerates operating in the public project market as well as margin deterioration caused by intensifying competition, the listing is aimed at accelerating overseas expansion by securing new technologies in key segments (e.g., Big Data and (IoT)).

Samsung SDS is capable of delivering stable revenue growth on the back of growing IT services demand from its extensive captive market (i.e., Samsung Group). The company generated revenue of W7tr and an operating profit of W505.6bn (OP margin of 7.2%) in 2013. In particular, its 12 overseas subsidiaries generated revenue of W1.4tr (+137% YoY).

Samsung SDS’ overseas smart logistic” services began to expand full swing with the company’s merger with EXE C&T, a consulting firm, in 2012. As a key overseas logistics provider to Samsung Group companies, we expect this smart logistics unit to lead the Samsung SDS’ growth. The smart logistics unit provides fourth-party logistics services, which improve logistics efficiency via cutting-edge IT and existing overseas logistics know-how. (This combination enables easy access to key information such as cargo location and expected transport period.) Once Samsung SDS finishes building its global logistics network, it will likely meet nearly all of SEC’ overseas logistics service needs (vs. the current 50%) starting in 2017. Then, the company will likely expand its customer base to include other affiliates and overseas firms.

In the meantime, Samsung SDS is owned by SEC (22.6%; the largest shareholder), Samsung C&T (17.1%), and Samsung Electro-Mechanics (SEMCO; 7.9%). Most importantly, the children of Lee Kun-hee hold a combined 19.1% stake in Samsung SDS. If the value of Samsung SDS grows following its IPO, the controlling family is highly likely to use the proceeds to finance inheritance tax payments and the acquisition of stakes in major affiliates.

Figure 222.2. O. OwnershipO wnership of Samsung SDS Figure 333.3. OTC price of Samsung SDS

(W) Denial of IPO Announced IPO Lee Boo-jin, Lee Seo-hyun, Treasury stock, 250,000 (1/11/11) (5/8/14) 3.90% 3.90% 0.04% Reported impending Acquired Credu; IPO (2/21/14) 200,000 IPO expected (10/26/10) Lee Jae-yong, SEC, Lee Kun-hee, 11.25% 22.58% IPO expected Merged with Samsung 0.01% 150,000 due to IPO of SNS (9/27/13) Samsung Life (7/1/10) Merged with Samsung 100,000 Networks (1/1/10) Other, Samsung C&T, 17.08% 33.36% 50,000 SEMCO, 7.88% 0 07 08 09 10 11 12 13 14 Source: Dart, KDB Daewoo Securities Research Source: JStock KDB Daewoo Securities Research

Figure 444.4. Revenue of Samsung SDSSDS’’’’ ininin-in ---househouse businessbusinesseseseses (non(non(non-(non --- Figure 555.5. SDSSDSSDS’SDS ’’’ service revenue as a % of SESESEC’SE C’C’C’ss overseas consolidated) logistics costs (Wbn) System integration ICTO (Wbn) SEC's overseas distribution costs (L) (%) 7000 Distribution IT Education 5,000 Samsung SDS' distribution revenue (L) 100 ICT infrastructure ICT solutions Samsung SDS' proportion (R) 6000 2010-17 CAGR: 12.3% 4,000 75 5000

3,000 4000 50 3000 2,000

2000 25 1,000 1000

0 0 0 09 10 11 12 13 14F 15F 16F 17F 10 11 12 13 14F 15F 16F 17F

Source: Dart, KDB Daewoo Securities Research Source: Dart, KDB Daewoo Securities Research

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3. Potential forceful conversion into a holding structure for Samsung Everland

Under the Monopoly Regulation and Fair Trade Act (MRFTA), firm A will be forced to become a holding company for firm B, if: 1) A’s stake in B accounts for more than 50% of its assets, and 2) A is the largest shareholder of B. As such, if the transfer of Lee Kun-hee’s 20.76% stake in Samsung Life causes Samsung Everland to become the largest shareholder of Samsung Life, Samsung Everland might be forced to become a holding company—specifically a financial holding company with financial subsidiaries (e.g., Samsung Life) under its umbrella.

Under current law, an insurance subsidiary of a financial holding company is not allowed to hold (or control) a non-financial firm as a subsidiary. Thus, Samsung Life will need to dispose of its 7.6% stake in SEC (or W16tr), which is too big for the controlling family and its affiliates to absorb. This is likely to prove to be a headache for Samsung Group considering its insufficient control over SEC.

However, we do not expect this scenario to materialize for the time being. Samsung Everland’s assets grew at end-2013 due to an increase in liabilities related to acquisition of Cheil Industries’ fashion division and loans. As such, the ratio of the Samsung Life stake in Samsung Everland’s assets fell below 50% at end-1Q. As such, even if Samsung Everland meets the second condition under the MRFTA (largest shareholder status), it can avoid becoming a holding company. Unless the value of Samsung Everland’s Samsung Life stake surges, forceful conversion is unlikely.

Figure 666.6. Samsung Life stake relative to Samsung EverlandEverland’’’’ssss totaltotaltotal assets

(Wtr) Total assets of Samsung Everland (L) (%) 10 Value of Samsung Everland's stake in Samsung Life 100 Ownership stake (R)

8 80

6 60 56.8% 50% 47.5% 4 40

2 20

0 0 End-June 2013 End-March 2014

Source: Dart, KDB Daewoo Securities Research

4. Samsung Life’s stake in SEC

Within the Samsung Group, Samsung Life holds the largest stake (7.6%) in SEC. However, should the insurer attempt to dispose of its stake in the electronics giant, it would be forced to pay dividends to participating policyholders. Under the Insurance Business Act, gains on investment securities that an insurer holds are to be split among shareholders and participating policyholders. In addition, a certain portion of any realized gains on the disposal of investment securities is required to be paid out as dividends to participating policyholders. Given the reserve fund that Samsung Life has set aside for its participating insurance contracts, at least 20-30% of realized gains would be paid out as dividends.

In light of this dividend payout issue, Samsung Group is unlikely to make full use of Samsung Life’s stake in SEC. In our view, it would be advantageous for the group to leave Samsung Life’s stake in SEC intact.

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The ownership restructuring puzzle

1. Things to watch for in the event of conversion

1) Completion of third-generation governance structure Currently, Samsung Everland, in which the controlling family (including vice chairman Lee Jae- yong) holds a majority stake, manages the Samsung Group via its ownership of Samsung Life. Therefore, Samsung Everland is expected to form the core of the group’s holding company going forward. If this scenario materializes, the conversion process is likely to focus on raising the controlling family’s stake in the holding company.

2) Securing firm control over SEC Securing firm control over SEC is essential to both the generational ownership transfer and the holding structure conversion. However, it should be noted that the controlling family will not be able to gain direct ownership in SEC under a holding structure. Therefore, turning SEC into an intermediate holding company could be a viable solution. If the SEC intermediate holding company controls SEC (an operating subsidiary) and the primary holding company (Samsung Everland) controls the intermediate holding company, the controlling family should be able to exercise firm control over SEC.

3) Samsung Life’s stake in SEC Within the Samsung Group, Samsung Life holds the largest stake (7.6%) in SEC. However, considering the aforementioned dividend issue, the Samsung Group is unlikely to make full use of Samsung Life’s stake in SEC. In our view, it would be advantageous for the group to leave Samsung Life’s stake in SEC intact.

4) Regrouping of affiliates after the completion of a holding structure conversion After the completion of its holding structure conversion, the Samsung Group will likely be split into three parts, with each division controlled by one of Lee Kun-hee’s children. If this scenario materializes, the Lee heirs’ stakes in Samsung Everland would be utilized to smooth out the regrouping process.

5) Minimization of costs related to holding company conversion Among the biggest reasons why controlling shareholders often opt not to pursue ownership restructuring are high capital gains and corporate taxes arising from the stake sale and related share exchanges. However, the government has announced temporary tax benefits for holding company conversions, encouraging controlling shareholders to seek conversion.

Figure 777.7. Samsung ownership restructuring puzzlpuzzleeee

Source: KDB Daewoo Securities Research

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2. Turning SEC into an intermediate holding company

1) Securing firm control over SEC Currently, Samsung Group financial affiliates hold a 17.65% stake in SEC. Since the MRFTA restricts financial companies’ voting rights in non-financial affiliates to 15%, the financial affiliates cannot fully exercise their voting rights (relative to their stakes).

Therefore, in order to increase control over SEC, non-financial affiliates or the controlling shareholders should purchase additional stakes in SEC. Given that SEC’s market cap is around W200tr, the purchase of a 1% stake in the electronics giant would require as much as W2tr, which could pose a huge financial burden on the controlling family and affiliates. Even if some affiliates could afford it, they would find it difficult to increase their stakes in SEC due to the implementation of the ban on new cross shareholdings.

As such, one of the most effective ways for the group to raise its SEC stake would be to turn the electronics giant into an intermediate holding company. Establishing SEC as a holding company— via a spin-off followed by share exchange—would allow the group to more than double its current stake in SEC, and ultimately cement its control over the electronics operating subsidiary.

Table 666.6. SECSECSEC’SEC ’’’ss major shareholders (%, Wbn) NameNameName SSSharesShareshareshares Ownership ValueValueValue Lee Kun-hee 4,985,464 3.38 7,254 Hong La-hee 1,083,072 0.74 1,446 Controlling family (1) Lee Jae-yong 840,403 0.57 1,123 Total 6,908,939 4.69 10,053 Samsung Life 11,123,876 7.55 16,185 Samsung C&T 5,976,362 4.06 8,696 Samsung F&M 1,856,513 1.26 2,701 Samsung Welfare 89,683 0.06 130 Affiliates(2) Foundation Samsung Foundation of 37,615 0.03 55 Culture Cheil Industries 9,679 0.01 14 Total 19,093,728 12.96 27,781 Holdings in the group (1) + (2) 26,002,667 17.65 37,834 Treasury stock 16,360,561 11.11 24,805 National Pension Service 11,359,651 7.71 16,528 Others Other 93,576,458 63.53 136,154 Total 147,299,337 100.00 214,321 Note: Ownership as of 1Q14; Value as of June 2nd Source: Dart, KDB Daewoo Securities Research

Figure 888.8. Establishment of SEC intermediate holding company

Source: KDB Daewoo Securities Research estimates

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2) Likelihood of SEC share repurchases Turning SEC into an intermediate holding company would mean splitting SEC into an intermediate holding company (with stakes in electronics affiliates) and SEC (operating subsidiary) via spin-off.

During this process, the SEC intermediate holding company would acquire stakes in SEC via a tender offer to meet regulatory requirements. Then, Samsung Group affiliates with stakes in SEC would receive new shares of the holding company via a rights offering in return for their shares in SEC, leading to an increase in the primary holding company‘s stake in the SEC intermediate holding company. However, it would be difficult to utilize Samsung Life’s stake in SEC due to the fact that some related gains would have to be allocated to dividends for participating policyholders. Instead, treasury shares of SEC (11.1%) and SEC stakes held by Samsung affiliates (10.1%), excluding Samsung Life, could be mobilized to meet the regulatory requirements.

In addition, SEC also needs to buy back its shares to increase the group’s ownership. Treasury shares could be a useful tool in the SEC intermediate holding company’s efforts to exercise control over the SEC operating company, as they would be transferred to the intermediate holding company during the holding structure conversion. Treasury shares and Samsung affiliates’ stakes in SEC stand at 21.2%, slightly over the regulatory requirement of 20%. Therefore, there is ample reason for considering a share buyback in order to ease the burden of a tender offer or firm up control over the SEC operating subsidiary after the holding company conversion.

Currently, SEC holds 16.36mn common shares (11.1%) and 2.98mn preferred shares (13.1%) in its treasury. SEC has conducted share buybacks on nine occasions since 2000, with the most recent buyback in 2007. As of end-1Q14, SEC holds cash and cash equivalents of around W35tr under non-consolidated K-IFRS, indicating ample room for share repurchases.

Table 777.7... History of SECSECSEC’SEC ’’’ss share buybackbuybackssss (%, W, Wbn) Total Total cost Disclosure Start End Number % of treasury Average ClassClassClass number of of share dadadateda tetete datedatedate datedatedate of shares shares purchase pricepriceprice treasury shares buyback 10/16/00 10/20 12/26 Common stock 3,000,000 6,449,625 4.26 167,564 503 Preferred stock 400,000 1,269,693 5.31 73,930 30

3/25/02 3/29 4/23/02 Common stock 1,330,000 7,779,625 5.12 380,176 506 Preferred stock 210,000 1,479,693 6.19 207,345 44

8/2/02 28/06 8/28 Common stock 2,660,000 10,439,625 6.80 331,130 881 8/27 Preferred stock 400,000 1,879,693 7.87 162,067 65

3/7/03 3/11 4/10 Common stock 3,100,000 10,439,625 8.81 293,890 911 Preferred stock 470,000 1,879,693 9.83 142,164 67 10/17/03 10/21/03 1/13/04 Common stock 2,150,000 10,303,515 8.33 447,840 963 Preferred stock 330,000 1,879,693 9.43 254,434 84 4/7/04 4/12 4/30 Common stock 3,060,000 9,993,792 6.72 613,470 1,880 Preferred stock 260,000 1,879,693 9.27 362,274 94 9/13/04 9/17 11/18 Common stock 4,000,000 13,965,342 9.47 451,823 1,807 6/10/05 6/14 8/29 Common stock 3,800,000 17,576,494 11.93 534,966 2,033 8/17 Preferred stock 300,000 2,179,693 9.55 363,347 109

1/12/07 1/16 03/16 Common stock 2,800,000 21,210,630 14.40 585,853 1,640 Preferred stock 400,000 2,979,693 13.05 448,866 180 6/13- Common stock 16,360,561 11.11 present Preferred stock 2,979,693 13.05

Source: Dart, KDB Daewoo Securities Research

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Meanwhile, some market watchers are considering a scenario in which SEC will directly purchase shares held by group affiliates for the purpose of expanding its treasury stock holdings. However, we do not believe that this is feasible. Under Korea’s Commercial Act, companies’ treasury stock holdings are not allowed to exceed the level of profits available for dividends (under specific conditions). If a company’s treasury shares are listed and traded on the Korea Exchange (KRX), the shares should be acquired on the exchange. If a company wants to make direct purchases from shareholders, prices must proportional to the number of shares held by each shareholder (so as to facilitate fair and equal treatment of all shareholders). Accordingly, SEC is unlikely to be able to selectively acquire treasury stock held by specific shareholders. Furthermore, if a company wants to dispose of treasury shares, it can choose an appropriate buyer via a board resolution.

Accordingly, the scenario of SEC’s directly purchasing treasury shares from its affiliates cannot be considered. Given the government ’s ban on new cross-shareholdings and the group ’s budget constraints, Samsung Group should be able to raise its stake in SEC only through SEC’s treasury share buyback on KRX.

Table 8. Commercial Act allows companies to acquire tretretreasurytre asury shares Commercial Details ActActAct (1) A company may acquire its own shares on its own name and account, in accordance with the following methods: 1. In cases of shares having market values on the stock exchange, the method of acquisition at the Article 341 exchange; 2. The methods of acquisition under equal conditions in proportion to the number of shares owned by each shareholder as determine d by presidential decree Source: MOLEG, KDB Daewoo Securities Research

Figure 999.9. SEC is unlikely to be able to acquire treasury stocstocksks held by group affiliates

Acquisition of treasury shares held by affiliates

Samsung Life Insurance

SEC is unlikely to be able to Samsung C&T (X) acquire treasury shares held by SEC affiliates

Samsung F&M

SEC pays for treasury shares with cash or shares

Source: KDB Daewoo Securities Research

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2) Lee family’s control over SEC holding company If Samsung Group turns SEC into an intermediate holding company, Samsung C&T is likely to secure the largest stake in the new entity among group affiliates (assuming that Samsung Life transitions into an intermediate financial holding company). Accordingly, controlling shareholders are likely to pursue a merger between Samsung Everland and Samsung C&T in order to strengthen their control over the latter company. The controlling family is facing difficulties in raising its stake in SEC under current conditions, and such a union would allow it to directly control Samsung C&T’s stake in SEC at a low cost. (As mentioned earlier, the controlling family owns a majority of Samsung Everland.) In addition, a merger could also lead to the restructuring of Samsung Group’s construction businesses.

Currently, Samsung C&T’s market cap stands at W11tr. The fair value of Samsung Everland shares (held by Samsung Card, KCC, etc.) is estimated at W2.09mn per share, which translates into a market cap of W5.2tr. As the controlling family owns only a marginal stake in Samsung C&T and the value of Samsung Everland is weak compared to that of Samsung C&T, the family’s post- merger stake would be relatively low (compared to the pre-merger stake in Samsung Everland).

To minimize the dilution, Samsung Group might consider the following approaches.

First, the group could endeavor to improve the value of Samsung Everland, while the controlling family works to ensure a higher stake in the company.

If Samsung Everland’s market cap is revised up to W10tr after reflecting the value of its assets, the share exchange ratio for the merger could reach 1:1. However, the controlling family should still see its stake slide from 46% to 23% (post-merger). Accordingly, Samsung Everland’s controlling shareholders are likely to aggressively expand the company’s value. Meanwhile, before increasing the value of Samsung Everland, the controlling family might secure shares held by group affiliates (a combined stake of 19.4%). In that case, however, the merger could become subject to strict domestic regulations on backdoor listings. To avoid such regulatory risks, the Samsung Group could consider listing Samsung Everland.

Figure 101010.10 . Merger between Everland and C&T: (1) Controlling familyfamily acquires Everland shares held by group affiliates

Source: Dart, KDB Daewoo Securities Research

Second, the controlling family might expand its stake in Samsung C&T ahead of the merger.

Currently, Samsung Group holds a 14.29% stake in Samsung C&T (worth W1.4tr). If the controlling family manages to get its hands on this stake, it would face less pressure to improve the value of Samsung Everland. If the merged entity makes a tender offer after splitting the new entity into holding and operating companies, the controlling family’s stake in the merged entity could rise to over 30%.

Of note, if this scenario materializes, Samsung Group would not have to address the Samsung Life-Samsung C&T cross-shareholding structure. In addition, the regulatory burden related to potential the backdoor listing requirements would be lightened.

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Figure 111111.11 . Merger between Everland and C&T ((2222)))):::: Controlling family increaseincreasessss its stake in C&TC&TC&T

Source: Dart, KDB Daewoo Securities Research

Table 9. Samsung C&TC&T’’’’ssss mamamajorma jorjorjor shareholders (%, Wbn) NameNameName Shares Ownership VVValueValuealuealue Controlling family (1) Lee Kun-hee 2,206,110 1.41 161 Samsung SDI 11,547,819 7.39 843 8,217,576 5.26 600 Affiliates (2) Samsung Welfare Foundation 231,217 0.15 17 Samsung Foundation of Culture 123,072 0.08 9 Total 20,119,684 12.88 1,469 Total holdings in the group (1)+(2) 22,325,794 14.29 1,630 Treasury stock 9,007,557 5.77 658 National Pension Service 20,188,198 12.92 1,474 Other Other 104,696,215 67.02 7,643 Total 156,217,764 100.00 11,404 Notes: Stakes as of end-1Q14; values as of June 2 nd Source: KDB Daewoo Securities Research

Table 10. Samsung EverlandEverland’’’’ss mas majorma jorjorjor shareholders (%,Wbn) NameNameName Number of shares Equity stake Equity value Lee Jay-yong 627,390 25.10 1,311 Lee Boo-jin 209,129 8.37 437 Lee Seo-hyun 209,129 8.37 437 Controlling family (1) Lee Kun-hee 93,068 3.72 194 Lee You-jeong 12,000 0.48 25 Total 1,150,716 46.03 2,405 Samsung Card 124,999 5.00 261 SEMCO 100,000 4.00 209 Samsung SDI 100,000 4.00 209 Cheil Worldwide 100,000 4.00 209 Affiliates (2) Samsung C&T 36,997 1.48 77 Samsung Foundation of 22,020 0.88 46 Culture Total 484,016 19.36 1,011 Total holdings in the group (1)+(2) 1,634,732 65.39 3,416 Treasury stock 380,676 15.23 795 KCC 425,000 17.00 888 Other Other 59,592 2.38 125 Total 2,500,000 100.00 5,224 Notes: Stakes as of end-1Q14; values based on W2.09mn per share (reflecting Samsung Card’s stake) Source: Dart, KDB Daewoo Securities Research

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2. Converting Samsung Life into an intermediate financial holding company

1) Bill introducing intermediate financial holding companies to pass into law by year-end In early March, the Korean government unveiled a number of measures to boost M&A activities as part of its three-year economic innovation plan. One of the proposed measures would allow non- financial holding companies to own financial subsidiaries; however, companies that fall into certain categories

would have to establish intermediate financial holding companies. As related bills are currently pending in the National Assembly, the government is likely to enact the measure by the end of the year.

Table 111111.11 . EEEstablishmentEstablishment of intermediate financial holding compcompaniesanies Category Details Allow non-financial holding companies to own financial subsidiaries but mandate the Proposed MRFTA revision establishment of intermediate financial subsidiaries to block capital flow (Article 8-5 (9/26/12) to be added) National agenda of Allow non-financial holding companies to own financial subsidiaries and mandate presidential transition establishment of intermediate financial holding companies committee (3/21/13 ) Policy briefing by the FTC (4/24/13) Allow non-financial holding companies to own financial subsidiaries via the Method to activate M&A establishment of intermediate financial subsidiaries under certain conditions market (3/6/14 ) Source: FTC, MOSF, KDB Daewoo Securities Research

2) Samsung Group to consider establishment of intermediate financial holding company Currently, Samsung Group holds 13 financial companies under its umbrella. As the MRFTA prohibits non-financial holding companies from owning financial subsidiaries, Samsung Group cannot convert to a holding company structure unless it disposes of its financial subsidiaries. Accordingly, the expected allowance of non-financial holding companies to own financial subsidiaries through the establishment of intermediate financial holding companies should encourage Samsung Group to adopt a holding company structure.

Since most of the group ’s financial affiliates are tied to Samsung Life, the group could separate the insurer into an insurance operating subsidiary and an intermediate financial holding company owning stakes in Samsung Securities and Samsung F&M. Samsung Life’s current stake in SEC is likely to be moved to the operating subsidiary due to a recent decline in its risk-based capital (RBC) ratio.

Figure 121212.12 . Prior to the establishment of an intermediate Figure 131313.13 . After the establi shment of an intermediate financial financial holding company holding company

Source: Dart, KDB Daewoo Securities Research Source: Dart, KDB Daewoo Securities Research

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Meanwhile, even if the establishment of an intermediate financial holding company is allowed, the intermediate financial holding company would only be able to hold stakes in financial subsidiaries. Financial subsidiaries are banned from having stakes in non-financial affiliates. Accordingly, Samsung Group would need to overhaul its governance structure before establishing an intermediate financial holding company. However, the holding company conversion method that is the most likely to materialize would enable Samsung Life to keep its stake in SEC (via the operating subsidiary), helping Samsung Group maintain its control over SEC and reducing the concerns related to paying dividends to participating policyholders.

Under the Financial Holding Companies Act, an operating subsidiary of an intermediate financial holding company is allowed to hold the shares of affiliates if the subsidiary does not intend to control the affiliates.

If Samsung Group turns SEC into an intermediate holding company, the SEC holding company would become the largest shareholder of the electronics operating subsidiary. As a result, the insurance operating subsidiary would no longer be the largest shareholder of SEC. Accordingly, the insurance operating subsidiary of Samsung Group’s intermediate financial holding company would be able to hold onto its stake in the electronics operating subsidiary of the SEC holding company.

Under the Act on the Structural Improvement of the Financial Industry, however, the insurance operating subsidiary would have to dispose of its holdings in the SEC holding company in excess of 5%. In addition, the subsidiary would be required to pay out part of the gains from the stake disposal to participating policyholders.

Figure 141414.14 . If ananan intermediate financial holding company is establestablishedishedishedished,, Samsung Life could maintain its control overoverover SECSECSEC

Source: Dart, KDB Daewoo Securities Research

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3. Samsung Group holding structure

In sum, Samsung Everland is expected to merge with Samsung C&T to facilitate the establishment of a holding company controlling: 1) SEC (operating company) and other electronics affiliates under the SEC intermediate holding company and 2) financial/insurance affiliates under an intermediate financial holding company.

The three children of Lee Kun-hee are highly anticipated to take the reins of Samsung Group’s businesses. Currently, none of them own meaningful stakes in the affiliates that they are expected to control. This suggests that they need to buy additional stakes and/or dispose of equities that they no longer need. Eventually, Samsung Group is projected to be divided into three groups following the holding company conversion, with each heir taking control of one of the divisions. However, this process may take longer than most market watchers expect, as the actual conversion will command the bulk of attention for the time being.

Figure 151515.15 . Projection of Samsung GGGroupGrouprouproup’’’’ssss structure

Source: KDB Daewoo Securities Research estimates

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Measures to minimize conversion costs

1. Taxation on securities trading by major shareholders

As conversion to a holding structure requires the transfer of share ownership, tax issues invariably arise during the process. Generally speaking, the capital gains tax (or income tax for corporations) causes the most significant financial burdens.

Capital gains from the trading of listed stocks on the market are usually not subject to taxation. However, if large shareholders trade such stocks, taxes are imposed. Under Korean tax law, persons owning equities in excess of a certain percentage or value are considered large shareholders. It should be noted that shares owned by relatives and affiliated parties (as set forth by law) are included in the stake of the shareholder in question. As such, the families of controlling shareholders often face hefty capital gains taxes.

Table 121212.12 . LLLargeLargeargearge shareholder eligibility requirements LiLiListedLi sted corporationcorporationssss KOSDAQKOSDAQ----registeredregistered corporationcorporationssss

Share ownership 2% or higher 4% or higher Market cap W5bn or higher W4bn or higher Source: KDB Daewoo Securities Research

Table 131313.13 . Capital gains taxes on stockstockstock trading Tax rate Category (((1/1/02 ---pppresent) Stock issued by small businesses 10% Stocks held for at Large Stocks issued 20% Marketable securities, least 1 year shareholder by large listed stocks Stocks held for less corporations 30% than 1 year Minority shareholders (trading on exchange) Tax-free Issued stocks by small businesses 10% Stocks held for at least 1 year Stocks issued 20% Unlisted stocks (minority, large shareholders) by large Stocks held for less than 1 year corporations 30% (large shareholders) Note: 10% of capital gains tax is additionally imposed as local income tax Source: KDB Daewoo Securities Research

2. Tax benefits

The Korean government provides tax benefits for companies adopting holding structures under the Restriction of Special Taxation Act. Under the act, shareholders that receive shares in the holding company in return for their shares in the subsidiary are not subjected to capital gains/income taxes until such time as they dispose of the holding company shares (Article 38-2). Since very few large shareholders sell off their holding company shares (in order to maintain control), tax burdens can be manageable.

Although this tax deferral encourages groups to switch to holding structures, it is a sunset provision; specifically, in order to be eligible for tax benefits, conversion must take place by December 31, 2015.

The tax deferral provision was first introduced in 2000 and has since been extended every three years. At this point in time, we cannot say for sure whether it will be extended again after end- 2015. In our view, the key takeaway here is that tax benefits can be a strong incentive for Samsung Group to adopt a holding structure.

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Figure 161616.16 . EEExtensionExtension of tax deferraldeferral????

Source: KDB Daewoo Securities Research

Figure 171717.17 . TTTaxTax deferral provision to expire at endend----DecemberDecember 201520152015

Source: KDB Daewoo Securities Research

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Investment opportunities

1. SEC’s spin-off to provide investment opportunities

SEC’s switch to an intermediate holding company seems inevitable, given the company’s aim of gaining firm control over group affiliates. In this case, the company will be divided into a holding company that owns stakes in affiliates, and a company that will continue to operate current businesses.

For those seeking investment opportunities, examining the cases of SK and can offer some insight. After each of these corporations was relisted following spin-off, the combined market cap of the holding company and the subsidiary exceeded the pre-spin-off level .

Theoretically, enterprise value should not change before and after spin-off. Thus, the post-spin- off market cap increases seem to reflect expectations for greater efficiency in management following holding structure conversions. For controlling shareholders, an increase in the market cap of the subsidiary is positive, because it means that more shares are available for exchange with holding company shares.

Figure 181818.18 . MMMarketMarket cap changes after holding structure conversionconversionssss

(Wbn) Nongshim Holdings (Wtr) SK Innovation (Wbn) 2,000 Nongshim 35 SK 12,000 Hankook Tire Worldwide

Trading suspension 30 Trading suspension 10,000 (6/17/03-7/17/03) Trading suspension (8/29/12-10/3/12) 1,500 25 (6/28/07-7/24/07) 8,000 20 1,000 6,000 15 4,000 10 500

5 2,000

0 0 0 1/03 7/03 1/04 7/04 1/05 1/07 4/07 7/07 10/07 1/08 1/12 7/12 1/13 7/13 1/14

(Wbn) Aekyung Petrochemical (Wbn) Korea Kolmar (Wbn) Dong-A ST 1,200 AK Holdings 1,200 Korea Kolmar Holdings 2,000 Dong-A Socio Holdings Trading suspension (2/15/13-4/7/13) 1,000 1,000 Trading suspension 1,500 (9/27/12-10/18/12) 800 800 Trading suspension (8/30/12-9/16/12) 600 600 1,000

400 400 500 200 200

0 0 0 1/12 7/12 1/13 7/13 1/14 1/12 7/12 1/13 7/13 1/14 1/13 4/13 7/13 10/13 1/14 4/14

Source: KDB Daewoo Securities Research

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2. Treasury buyback by financial affiliates

The government is planning to allow holding companies to own financial subsidiaries through intermediate financial holding companies beginning in 2H14. As explained earlier in this report, the establishment of an intermediate financial holding company can help facilitate Samsung Group’s conversion.

The equity stake requirements for financial holding companies (at least 30% for listed subsidiaries, and at least 50% for unlisted subsidiaries) also apply to intermediate financial holding companies. Samsung Group currently owns 27.88% of Samsung F&M and 22.31% of Samsung Securities. As such, Samsung’s financial affiliates are anticipated to buy back treasury shares to increase the group’s equity stake. (Samsung F&M and Samsung Securities can sell back their treasury stocks to the intermediate financial holding company.) These treasury buybacks, should they materialize, are likely to be positive for investors, as they could drive share price advances.

TableTableTable 141414.14 ... Samsung FF&M&M&M&M’’’’ss major shareholders (%, Wbn) NameNameName SSSharesShareshareshares Ownership ValueValueValue Affiliates Samsung Life 4,905,718 10.36 1,273 Samsung Card 298,377 0.63 77

Samsung Foundation 1,451,241 3.06 377 of Culture Samsung Welfare 170,517 0.36 44 Foundation Total holdings in the group TotalTotalTotal 6,825,853 14.41 1,771 Treasury stock 6,381,534 13.47 1,656 Other 34,167,450 72.12 8,866 Total 47,374,837 100.00 12,294 Note: Stakes as of end-1Q14; value as of June 2nd Source: KDB Daewoo Securities Research

TableTableTable 151515.15 . Samsung SecuritiesSecurities’’’’ major shareholders (%, Wbn) NameNameName SSSharesShareshareshares Ownership ValueValueValue Samsung Life 8,513,524 11.14 350 Samsung F&M 6,133,252 8.02 252 Affiliates Samsung C&T 201,731 0.26 8 Samsung Foundation 195,992 0.26 8 of Culture Total holdings in the group TotalTotalTotal 15,044,499 19.68 619619619 Treasury stock 2,011,793 2.63 83 Other 59,378,873 77.69 2,443 Total 76,435,165 100.00 3,415 Note: Stakes as of end-1Q14; values as of June 2 nd Source: KDB Daewoo Securities Research

Figure 191919.19 . Equity stake rrequirementequirement for (ifor (intermediate)(i ntermediate) Figure 202020.20 . CCCorporateCorporate governance ofofof Samsung Group financial fffinancialfinancial holding compancompaniesiesiesies affiliates

Source: KDB Daewoo Securities Research Source: KDB Daewoo Securities Research

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APPENDIX 1

Important Disclosures & Disclaimers

Disclosures As of the publication date, Daewoo Securities Co., Ltd. has acted as a liquidity provider for equity-linked warrants backed by shares of Samsung Electronics as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies. As of the publication date, Daewoo Securities Co., Ltd. issued equity-linked warrants with Samsung Electronics as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies.

Analyst Certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. Daewoo Securities Co., Ltd. policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. No part of the compensation of the Analysts was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report but, like all employees of Daewoo Securities, the Analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Daewoo Securities Co., Ltd. except as otherwise stated herein.

Disclaimers This report is published by Daewoo Securities Co., Ltd. (“Daewoo”), a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled from sources believed to be reliable and in good faith, but such information has not been independently verified and Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the Korean language. If this report is an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising from the use hereof. This report is for general information purposes only and it is not and should not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws and regulations or subject Daewoo and its affiliates to registration or licensing requirements in any jurisdiction should receive or make any use hereof. Information and opinions contained herein are subject to change without notice and no part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Daewoo. Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. The price and value of the investments referred to in this report and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur.

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KDB Daewoo Securities International Network

Daewoo Securities Co. Ltd. (Seoul) Daewoo Securities (Hong Kong) Ltd. Daewoo Securities (America) Inc. Head Office Two International Finance Centre 320 Park Avenue, 31st Fl. 34-3 Yeouido-dong, Yeongdeungpo-gu Suites 2005-2012 New York, NY 10022 Seoul 150-716 8 Finance Street, Central Korea Hong Kong United States Tel: 82-2-768-3026 Tel: 85-2-2514-1304 Tel: 1-212-407-1000 Daewoo Securities (Europe) Ltd. Daewoo Securities (Singapore) Pte. Ltd. Tokyo Representative Office Tower 42, Level 41 6 Battery Road, #11-01 7th Floor, Yusen Building 25 Old Broad Street Singapore, 049909 2-3-2 Marunouchi, Chiyoda-ku London EC2N 1HQ Tokyo 100-0005 United Kingdom Japan Tel: 44-20-7982-8016 Tel: 65-6671-9845 Tel: 81-3- 3211-5511 Beijing Representative Office Shanghai Representative Office Ho Chi Minh Representative Office Suite 2602, Twin Towers (East) Unit 13, 28 th Floor, Hang Seng Bank Tower Centec Tower B-12 Jianguomenwai Avenue 1000 Lujiazui Ring Road 72-74 Nguyen Thi Minh Khai Street Chaoyang District, Beijing 100022 Pudong New Area, Shanghai 200120 Ward 6, District 3, Ho Chi Minh City China China Vietnam Tel: 86-10-6567-9699 Tel: 86-21-5013-6392 Tel: 84-8-3910-6000

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