Samsung – Uncharted territory.
Samsung’s loss could be Huawei 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 we 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.
o First: cost.
o Samsung has replaced roughly 70% the Note 7’s that it originally shipped which suffered from a battery defect caused by Samsung SDI.
o The replacement devices use the same battery as the other 30% of the original batch which comes from the Chinese company Amperex.
o 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%.
o 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.
o Second: the real issue is brand and reputation.
o We 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.
o 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.
o 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.
• We do not think that these users are likely to move to Apple in any meaningful way.
• This is because we 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 20th, 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 we 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, we think that the risk is now on the downside leading me to be increasingly keen on taking profits now.
• We would prefer Microsoft, Apple or Baidu over Samsung at least until the real fallout from this issue can be quantified.
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