It has been widely reported that Samsung (NASDAQOTH:SSNLF) Display is the sole supplier of the advanced organic light emitting diode (OLED) displays incorporated in Apple's (NASDAQ:AAPL) flagship smartphone, the iPhone X.
According to Nikkei Asian Review, a publication that has routinely reported accurate information about Apple supply chain machinations, Samsung now expects to build just 20 million display panels for the iPhone X in the January-March quarter, down from expectations of between 45 million and 50 million units.
The report also says that Samsung Display is "looking to offset the impact" of the Apple iPhone X shortfall "by securing more orders from Chinese and other customers."
Let's take a look at what this means for Apple and Samsung.
Apple's iPhone X shortfall
There will be many who will be quick to write off this report from Nikkei Asian Review as "fake news," but the reality is that the writing has been on the wall for quite some time: Apple's iPhone X fell significantly short of Apple's own expectations.
Not only did Apple seemingly confirm this in comments made on its most recent earnings conference call, but numerous key iPhone suppliers have indicated that iPhone X component orders have fallen short of expectations.
For example, Qualcomm (NASDAQ: QCOM), which supplies cellular modems for a large portion of the iPhone 8-series and iPhone X smartphones, claimed that it saw a "larger than typical sequential correction" in orders for thin modems. Apple is the only Qualcomm thin modem customer that could have a significant impact on Qualcomm's financial results.
Broadcom (NASDAQ: AVGO), which supplies Wi-Fi chips, touch controllers, and radio frequency chips to Apple, said on Jan. 31 that it expects to see a "greater than seasonal decline" in its wireless chip business during the quarter that ended on Feb. 4.
It's hard to tell what drove the mismatch between Apple's original expectations and reality, and unfortunately, Apple management isn't going to give investors that kind of insight.
My guess is that Apple was hit by a combination of a slowing overall smartphone market as well as, perhaps, a weaker customer reception to the new technologies in the iPhone X -- at least for the price that Apple is asking for the device -- than the company had hoped.
Apple will need to find ways to both improve the competitiveness of its future devices that are priced similarly to the iPhone X while also dramatically enhancing its offerings at more traditional iPhone price points.
Impact to Samsung
Samsung Display seems to have been left holding the proverbial bag. The reality of the situation is that Apple's shipment volumes are generally so high that Apple suppliers need to put in a significant amount of production capacity to serve the demand they anticipate from Apple.
The amount of demand those companies anticipate is, unsurprisingly, based on signals that Apple itself provides to them. My guess is that Apple informed Samsung Display that it expected peak iPhone X shipments to hit between 45 million and 50 million units per quarter, which led Samsung Display to put in capacity to support that kind of demand.
Samsung seems to have bet on Apple's demand forecasts being good, but because they weren't, Samsung now apparently has significant excess OLED display production capacity.
The problem with having excess production capacity is that the equipment is already bought and paid for, and the cost of that equipment flows through to Samsung Display's financials in the form of depreciation costs. If those depreciation costs are spread out over a high number of displays, then the per-unit depreciation costs aren't too bad, and Samsung Display's manufacturing costs are reasonable.
However, if the factories are producing and selling far fewer displays than what the factories are equipped to produce, then that equipment depreciation expense becomes spread out over significantly fewer display panels. This ultimately means higher effective per-display costs, which translates into substantially reduced per-display profits.
That's why it's not surprising that Samsung Display is reportedly scrambling to try to fill its excess capacity with "orders from Chinese and other customers," according to Nikkei Asian Review -- it wants to limit the damage to its profitability that the iPhone X shortfall is causing.