Samsung (NASDAQOTH: SSNLF) could manufacture the OLED screen for Apple's (AAPL -0.19%) next Apple Watch, according to a recent report in South Korea news outlet Digital Daily. The new displays will reportedly be thinner, allowing a larger battery to be installed in the device. Samsung probably won't be the sole supplier -- LG Display, which provided all the OLED displays for the first Apple Watch, is also expected to provide an unknown percentage of the displays.

Apple Watch. Source: Apple

What are OLED displays?
OLED pixels emit their own light; traditional LCD pixels must be illuminated by a backlight. As a result, OLED screens have a wider range of brightness and sharper contrast. Several smartphone manufacturers, including Samsung and LG, now use OLED screens in their top-tier smartphones.

OLED screens cost more and have higher margins than LCD ones. But it's cheaper for Samsung and LG -- which produce their own OLED displays in-house -- to install those screens in their own phones. Companies like Apple, however, must purchase OLED screens as third-party components. That's also why its decision to use LG's OLED display in the Apple Watch is so important: If the Apple Watch is a hit, it could make OLED displays the industry standard for high-end smartwatches.

If things go well, Apple might even install OLED screens in its iPhones and iPads. Doing so would not only boost component sales for Samsung and LG, but would also help Universal Display (OLED -1.65%), which licenses the patents to OLED technology and sells the materials for the screens.

A tighter relationship
Apple's decision to go with Samsung for OLED production complements several other recent deals between the two rivals. In April, it was reported that Samsung would produce the majority of A9 processors for Apple's next-gen iPhones. That same month, Samsung assigned a team of around 200 employees to develop new screens for Apple's iPads and MacBooks. Last month, reports indicated that Apple would install Samsung's flash memory in upcoming iPhones, just as it did with its Macs two years ago.

All those developments indicate that the relationship between Samsung and Apple, once frozen by patent lawsuits across the globe, thawed considerably after the two companies dropped all their lawsuits outside the U.S. last August. Yet each of those deals will likely reduce orders from other suppliers. The A9 deal will likely hurt TSMC (TSM 2.04%). The flash memory deal could wound Toshiba, SanDisk (NASDAQ: SNDK), and SK Hynix, and the display deals could steal business away from LG.

Samsung needs Apple
It might seem odd that Samsung is selling components to its biggest rival in the smartphone and smartwatch market. But it's doing so to offset slumping sales and profits at its mobile division, which is being crushed between low-end Android devices and Apple's iPhones.

Last quarter, revenue and operating profit at Samsung's mobile division respectively plunged 20% and 57%. The unit accounted for 55% of Samsung's revenue and 46% of its operating profits. Samsung had hoped that the Galaxy S6 would get sales back on track, but it recently warned that it would post its seventh consecutive quarter of profits declines during its second quarter.


Samsung's Galaxy S6 and S6 Edge. Source: Samsung

With its mobile business still in decline, Samsung hopes that growing its device solutions business, which generated 36% of its revenue and 57% of its operating profit last quarter, will prop up its top and bottom lines. Last quarter, the unit's revenue and operating profit respectively rose 10% and 81% annually. Therefore, a stronger relationship with Apple and a plan to invest $14 billion in new chip-making plants and equipment could strengthen that business unit over the next few years.

Look beyond Apple Watch
If the rumors about Samsung's involvement in OLED production for the Apple Watch are true, investors should look toward a much bigger target -- the iPhone. Rumors about OLED iPhones are a dime a dozen, but analysts believe that Apple will stick with LCD displays for as long as possible. JP Morgan analyst Narci Chang expects Apple to use LCDs through the "iPhone 7," which should arrive in 2016.

But if Apple finally switches to OLED screens, Samsung and LG, being the top display manufacturers for most of its devices, might benefit from bigger orders for higher-margin screens. But on the other hand, OLED prices might drop significantly after Universal Display's key OLED patents expire after 2020. Moreover, if iPhone sales remain strong, Apple's negotiating power in the supply chain could nullify any meaningful margin difference between LCD and OLED screens.