Note 7 Recall: A Near-Term Blow To Samsung’s Resurgent Smartphone Unit

Samsung Electronics (OTC:SSNLF) announced a recall of its latest Galaxy Note 7 devices after reports that some units were exploding during charging. The firm has also halted distribution of the device, which was launched on August 19, and indicated that customers could swap their current device for a new one in the coming weeks.           ^[1] The latest developments create a significant overhang on Samsung’s smartphone business, at a time when profitability has been surging, driven by a string of well-received new handset launches. The cost of the recall exercise could be sizable, and it could create near-term perception issues, hurting the company’s recent momentum in the smartphone market.

We have a $1370 price estimate for Samsung, which is roughly 10% ahead of the current market price.

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Financial Impact Could Be Large

Samsung attributes the issue to a battery cell problem and said that 35 episodes had been reported worldwide. While batteries are a relatively inexpensive component of a smartphone’s manufacturing cost (typically under $5 apiece), battery issues can prove costly for manufacturers. Although an unnamed Samsung official previously estimated that the defect was present in less than 0.1% of all the Note 7 devices sold, Samsung has said that it would be difficult to isolate the devices which were impacted and indicated that it would be replacing close to 2.5 million Note 7 devices that it has sold to date. Samsung has not disclosed the potential financial impact of the recall exercise, but we believe that it could run into several hundred million dollars, given the potentially high bill of materials of the Note 7 and the logistics involved.

Hurting The Perception Of A High Profile Device 

The smartphone markets are very perception-driven, and news of hardware issues could have a negative impact on future sales. While the Note lineup has typically been a high-margin/low-volume play targeted at power-users, the Note 7 appealed to mainstream customers as well, with its premium industrial design and features such as water proofing. Pre-orders for the device in South Korea alone exceeded 400k units, roughly double pre-orders for the Galaxy S7. Samsung has been counting on the device – priced at $850+ in the United States – to shore up its mobile ASPs, which stand at roughly a third of Apple’s. The timing of the recall is also problematic for Samsung, given that Apple is expected to unveil its new iPhone 7 next week. The negative news-cycle around Samsung’s product could steer potential customers towards Apple’s new offerings.

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1. [Statement] Samsung Will Replace Current Note7 with New One, Samsung Electronics [↩]