The Note 7’s Death Will Have an Oversized Impact on Samsung’s Profitability

The loss of unit sales associated with the Galaxy Note 7's discontinuation may seem manageable, but the impact to Samsung's profitability will be much larger after losing such a high-margin device.

In this clip from Industry Focus: Tech, Motley Fool analyst Dylan Lewis and contributor Evan Niu, CFA, discuss how the crisis will affect Samsung's bottom line.

A full transcript follows the video.

This podcast was recorded on Oct. 14, 2016.

Dylan Lewis: I started briefly introducing what the company was expecting for revenue writedown and revised guidance. It looks like analysts were expecting the company to ship about 15 [million] to 19 million units from Q3 2016 through Q1 2017. To put that into context, Samsung shipped between 75 million and 78 million smartphones last quarter. So, while this is a big deal, it's a fancy new line they were really trying to get some momentum behind, in the grander scheme of their product mix, it's actually maybe about 10% or so. I don't think it's as big of a deal as people realize.

Evan Niu: I think the big difference is, a lot of Samsung's volume comes from these low-end, cheaper smartphones in places like India. They sell phones that are $50 to $100. They're not making a lot of money on that, but they ship a lot of units, which helps them keep their rank in the smartphone market. Like you mentioned, it's a lot more than Apple (AAPL 1.27%), 75 million on a non-holiday quarter, that's a ton of phones. But a lot of those are low-margin, low-value units versus these high-end phones -- that's where these companies make their margins. I think it has a leverage effect, in that it seems smaller in terms of units. But it had a pretty big impact on operating profits.

Generally speaking, mobile is about half of Samsung's business, in terms of revenue and operating profit, roughly, before this whole thing. Mobile includes a bunch of things, like tablet and these phones. But the mobile segment itself is incredibly important to them. Within the mobile segment if you look at the margin profile within their mobile business, these high-end phones are quite important in terms of profitability. Those low-end phones get a lot of volume, but considering that Samsung is largely a hardware player, if they sell a low-end phone to someone, it's not like they're capturing that customer on to their platform like Google or Apple would be. They're just trying to sell the phone. So, I think it won't have a huge impact on total volumes. But I think, again, coming back to the brand, it's so damaging for the brand. That's something that's really hard to put a number on right now -- brand valuation. I think that's the bigger thing here. Missing out on one product cycle is one thing, if it's contained within this product cycle. But if there's lasting damage to the brand, they could be hurting for a long time.

Lewis: I think that's why you've seen market reaction to this actually not be so bad. Short-term, if we're to take the company at the guidance that they're giving, and we look at the product mix, and they're able to hold the volumes on those other brands, the drop that we've seen makes sense. I think if you look back to when this story originally broke, the company was down about 4% or 5%, which really isn't all that crazy given that this is one of their most consumer-facing and high-profile lines. They do have so many other offerings in the smartphone market. If those hold, there shouldn't be too much of an issue there. One of the things people might not realize about Samsung is, they're a little bit more diversified than your Apple, in terms of the different hardware arenas that they've planned. To give you an idea of their revenue mix, consumer electronics is about 22% of revenue, and that does not include smartphones. IT and mobile communications, as you said before, a little over 50% of revenue. Device solutions, which is the semiconductor and display panel business, 36% of revenue. The IT and mobile is the highest-margin business that they are in, and having a high-profile phone, a high-ASP phone (average selling price), being removed, might lead to some margin compression there. But if they're able to hold on the other brands, I think this muted reaction from the market makes sense.

Niu: Yeah, I guess we'll just have to see if they can successfully pull off this crisis management. I think it's a good thing to kill those phones, definitely, especially when you don't know what's going on. You have to bite the bullet.