Please ensure Javascript is enabled for purposes of website accessibility

It's Official: Samsung Axes the Galaxy Note 7

By Evan Niu, CFA – Oct 11, 2016 at 3:03PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Just in time for the holiday shopping season.

Don't buy one of these. Image source: Samsung.

Just like the saying goes: If at first you don't succeed in fixing your exploding phone, you should probably just stop.

Samsung has now made the tough -- but correct -- call to completely discontinue all production and sales of its beleaguered Galaxy Note 7, its fire-prone phablet that was launched in August. After widespread reports of devices exploding and catching fire, Samsung issued a formal recall of 2.5 million units (that it didn't handle very well in the first place). Unfortunately for the South Korean conglomerate, replacement devices were also catching fire, reinvigorating the crisis.

The company didn't have much choice here. The Galaxy Note 7 is extremely dangerous for consumers, and the best way to attempt to minimize damage to the brand is the axe the product altogether.

This will hurt in the fourth quarter

Surprisingly, Samsung's third-quarter earnings guidance was pretty solid considering the crisis that it now finds itself in. Just a few days ago, the company said it expected operating profit to rise 10%, despite a modest decline in sales. The initial recall was announced in September, so some of the related costs should have been included in the third quarter.

But considering the timing of how massive global recalls unfold, combined with Samsung's massive distribution network of third-party retailers and carriers, the bulk of those costs should fall into the fourth quarter. However, beyond direct costs associated with the recall, the real hit is going to be in lost sales. Some analysts estimate that we could be talking about anywhere from $5 billion to a massive $17 billion in combined lost sales and recall-related costs after everything is said and done. Samsung, which had established itself as a phablet leader, will now have no flagship phablet to sell during the busy holiday shopping season.

Samsung hopes that it can nudge consumers toward the Galaxy S7, and has increased production in light of the Note 7's untimely demise.

The most expensive iPhone we've ever made

The most obvious beneficiary is Apple (AAPL -0.40%), which has meaningfully differentiated the iPhone 7 Plus this year. I was already expecting a bump in iPhone average selling prices (ASPs), which have been trending lower over the past two quarters following the introduction of the $400 iPhone SE.

Starting at $769, the iPhone 7 Plus is the most expensive iPhone that Apple has ever made. Inventory shortages suggest that demand is highly concentrated on the larger model as well. Yesterday, S&P analyst Angelo Zino estimated that Apple could enjoy 14 million to 15 million in additional sales due to Samsung's flaming mess. This morning, Drexel Hamilton analyst Brian White said it could be 8 million additional units.

Apple shares have been rallying on the news, hitting fresh 2016 highs as its biggest competitor falters.

The real question will be whether or not Samsung's Galaxy brand suffers from any lasting damage, after the company has poured tens of millions of dollars into marketing to build it. If the brand is permanently tarnished, Apple will enjoy some upside for a lot more than just one quarter.

Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.