Samsung – Uncharted territory.

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Samsung’s loss could be Huawei’s and Google’s gain.

• As a result of making a complete mess of the Galaxy Note 7 recall, Samsung is more likely to lose a large number of high end users to other Android handsets rather than to Apple.
• Samsung has halted production of the Galaxy Note 7 and requested that the channel cease selling and exchanging the device as it looks as if the replacement devices are suffering from a similar problem to the original.
• This is the first time that I have seen a product recall go this badly wrong and when it comes to the damage that it will do to Samsung’s brand we are in uncharted territory.
  • First: cost.
  • Samsung has replaced roughly 70% the Note 7’s that it originally shipped which suffered from a battery defect caused by Samsung SDI (see here).
  • The replacement devices use the same battery as the other 30% of the original batch which comes from the Chinese company Amperex.
  • However, if it turns out that these batteries are also faulty than Samsung will have to recall not only the replacement devices but also the original 30%.
  • This could easily add another $1.0bn – $1.5bn to the cost of the recall bringing the total to $2.0bn – $2.5bn but who will bear the full cost of that is unclear at this time.
  • Second: the real issue is brand and reputation.
  • I have been of the opinion that as long as Samsung carried out the recall smoothly and kept users very happy, the issue would eventually blow over (see here).
  • Unfortunately, this is very far from the case and the fact that Samsung appears to still be shipping defective devices could trigger a large loss of faith in Samsung products.
  • It also ensures that when there are problems with its other products (such as washing machines) they will be brought into laser focus by the media.
• The net result is that Galaxy Note 7 owners are now likely to end up with devices from other manufacturers.
• I do not think that these users are likely to move to Apple in any meaningful way.
• This is because I think that the high end users that still use Android do so because they prefer it and with a lot of apps already purchased, there will be meaningful switching costs.
• This is why Samsung’s meltdown is a big opportunity for Google to do far better with Pixel than it has with its previous Nexus devices.
• To do this, Google needs to be present at retail and with operators in volume in time to meet this demand.
• With the device only becoming available on October 20^th, Google may miss the window which is why it needs to accelerate the launch as much as it can.
• LG, Huawei and others may also be able to benefit, but I think that this particular opportunity is Google’s to lose.
• The real loser here is Samsung which may suffer long lasting damage to its brand across all of its products as well as a loss of share.
• Samsung’s superb profitability in Android handsets is based on the fact that it out-ships its nearest competitor by more than 2 to 1, and a big loss of brand equity will give Huawei an opportunity to close the gap.
• This will be highly detrimental for Samsung’s profitability in handsets (see here) leading me to be much more nervous with regard to the long term outlook.
• Samsung has had a superb 2016 so far and the share performance has been excellent.
• With the shares still not very far from my KRW1.8m estimate of fair value, I think that the risk is now on the downside leading me to be increasingly keen on taking profits now.
• I would prefer Microsoft, Apple or Baidu over Samsung at least until the real fallout from this issue can be quantified.