Samsung – Physical razzmatazz

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Samsung is rapidly becoming a component company again.

• Demand for the Galaxy s6 is reasonable but unfortunately it does not appear to be nearly good enough to return Samsung to profit growth.
• In January 2014, Samsung gave up all of its ambitions to compete in the ecosystem (see here) and instead decided to compete only on hardware specification, form factor and price.
• This decision has cost it dear as margins rapidly collapsed from 18% to 7% and a large slice of market share was lost.
• Samsung’s reaction to this was to cut costs, which it has done very effectively, and to release the Samsung Galaxy s6.
• The Galaxy s6 is a triumph of hardware.
• It has the fastest processor, the best RAM, flash storage optimised for performance and funky screens.
• Despite this physical razzmatazz, the s6 is selling more slowly than the very ordinary Galaxy s5 in its most important market, the US.
• I am also concerned that it is not shipping as well as would have been liked in many other territories.
• This is a strong indication that competing with form factor and hardware specification is now ineffective and that users care more about the ecosystem than they do about the device.
• The biggest problem is that the ecosystem that is offered on Samsung’s devices, Google, is also available on the iPhone, giving users little incentive to go for a Samsung product.
• Samsung has been trying to mitigate this problem with the launch of its own payment platform (Samsung Pay) but the fact that Google has launched one of its own (Android Pay) will make Samsung’s life very difficult.
• This is because Samsung has agreed not to compete with any of Google’s services (see here) meaning that the future of its own payments platform is questionable.
• Personally, I am far from convinced that either Samsung Pay or Android Pay have much chance of gaining traction, but this illustrates the bind that Samsung has put itself in.
• Samsung has been able to react to this new reality by very quickly cutting costs, meaning that margins should be able to stay around 10%.
• With growth in the smartphone market also rapidly slowing, it will be very difficult for the IT and Mobile Communications division of Samsung to really contribute to growth going forward.
• Consumer Electronics seems set to constantly hover around break-even meaning that future growth in earnings will be determined by Device Solutions (DS).
• In DS resides the world leading RAM and Flash memory business as well as Samsung’s fledgling foundry business.
• The outlook for growth here is reasonably good but even with the excellent profitability that memory generates, high growth will be hard to achieve.
• Consequently, I am sanguine about the outlook for Samsung and am not tempted to use recent weakness as an excuse to get back into the stock.
• I continue to prefer Microsoft and Google.