Samsung – Kitchen sink.
Samsung kitchen sinks the note 7 with a massive $5.4bn hit to profit.
• The note 7 disaster is going to cost shareholders $5.4bn in lost profit and heads are almost certain to roll, but underneath it all we think Samsung has been extraordinarily unlucky.
• Samsung has updated its guidance for Q3 16 as well as indicating the impact that the note 7 will have on Q4 16 and Q1 17 EBIT.
o Q3 16 revenues / EBIT will now be KRW2tn / KRW2.6tn lower than Samsung forecast just a week ago.
o This amounts to total Q3 16 revenues / EBIT of KRW47tn / KRW5.2tn.
o EBIT will be US$2.3bn lower than previously forecast.
o Q4 16 EBIT is expected to lower by KRW2.5tn or US$2.2bn.
o Q1 17 EBIT is expected to be lower by KRW1.0tn or US$885m.
• This means that over the next 2 quarters EBIT and cash flow will take a $5.4bn hit.
• We also suspect that by the end of the year, there will be a changing of the guard at the handset business as Samsung tries to draw a line under this disaster.
• On the surface this looks like very bad management by Samsung but to be fair the company, we think that in the same situation, Apple would have done the same thing.
• It is certainly a fair argument to say that Apple would have never got itself into this mess in the first place but it is important to remember that Samsung and Apple compete for users very differently.
• Apple users buy its products because they want to have access to an ecosystem that is exclusively available on iOS devices whereas Samsung competes directly on hardware specification.
• This means that Samsung is forced to push the boundaries of hardware performance whereas Apple has more time to thoroughly explore new features before it deploys them.
• It was this pressure that now looks to have sunk Samsung.
• The most likely explanation now is that the culprit was the fast charging algorithm which combined with an unknown factor or factors that triggered the fires.
• This is where we think Samsung has been extraordinarily unlucky.
• Every event of this nature in the past has always been caused by the battery and given that all the early events involved devices carrying the Samsung SDI battery, this looked almost certain to have been the cause.
• The problem is that to have definitively worked out exactly what the problem was would have taken weeks and Samsung simply did not have that kind of time.
• We are certain that if the device had been pulled for 6 weeks with users being left high and dry, there would have been a substantial loss of share anyway.
• This is why Samsung had to act quickly and because it could be more than 90% certain that the cause was the battery, its move to replace Samsung ADI batteries with Amperex was the right move at the time.
• This is why we are pretty sure that if Tim Cook had been sitting in DJ Koh’s seat, he would have done the same thing.
• With this $5.4bn hit, we think that Samsung has drawn a line underneath the immediate impact but the hit to its brand and market share has yet to be felt.
• Samsung depends on the fact that it out-ships its next Android competitor Huawei by 2.7 devices to one for its high profitability and if Huawei can close the gap due to this mess, then the damage could be much greater.
• Huawei and Google are in pole position to benefit from Samsung’s woes but we continue to believe that these users are unlikely to go to Apple (see here).
• Although Samsung’s valuation remains undemanding, the damage to its brand and market share has yet to be quantified which is why we feel no urge to get back into Samsung following recent declines.
• We continue to prefer Microsoft and Baidu.
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