Today, I’d like to share with you an article by Brian Tycangco, a friend and colleague who is the founder of Asia Financial Publishing, which releases a free daily e-letter focused on helping readers better understand the inner workings of Asian markets and companies.
We’ve featured Brian’s analysis before, and I’m happy to present another piece that he’s written.
Here’s why Samsung’s pain is far from over
By Brian Tycangco
My first hands-on experience with a mobile phone was back in 1995.
That was around the time when the Global System for Mobile Communications (GSM) standard completely revolutionised the industry and sent the old analogue systems back into the Stone Age.
Because of its ability to deliver high quality voice calls as well as sending data, such as text messages, GSM quickly became the dominant mobile communication standard.
Finnish cell phone giant Nokia, which also developed the GSM network, essentially had the entire market just about cornered.
It was amazing. Nokia not only created the market, but they also sold the picks and shovels needed for it to work. As a result, Nokia became a US$250-billion behemoth.
Then came Motorola and Ericsson.
You’d think these guys would rule the communications technology world for generations. However, just 2 decades later, all three companies are but a shadow of the giants they once were.
I don’t know anybody other than my 85-year old dad who owns a cell phone made by one of these brands.
The mobile market today
Today, more than a billion mobile phones are sold all around the world each year compared with less than 20 million back in 1995 – that’s 50 times more phones. And it’s now dominated by three totally different names: Samsung, Apple, and Huawei. In that order.
Samsung alone sold 320 million mobile phones last year, giving it a 22.5 percent share of the global market, according to Gartner, Inc.
That was nearly 100 million more than second place Apple, which sold 225 million iPhones.
Huawei, China’s most popular mobile phone brand, sold 104 million phones last year.
This has been the usual pecking order at the top of the global mobile phone arena for several years now. Names for the number 4 to number 10 brands switch places more often than racehorses in the Kentucky Derby.
Samsung is big, fast, beautiful, and affordable… at the expense of profitability
Samsung probably has the widest range of mobile phone designs, specifications, pricing, and capabilities of any mobile manufacturer.
High end, mid-tier, low-priced. They cover all these segments.
If you’ve ever been to a mobile phone carrier’s showroom, they have all sorts of phone brands displayed. The Samsung display is usually the biggest since it needs so much space to showcase all the different models available to customers.
One of their biggest selling points is their screens, which boast some of the biggest sizes, clearest resolutions, and most vibrant colours in the industry.
Indeed, Samsung is one of the world leaders when it comes to manufacturing OLED and AMOLED displays that are an essential part of today’s electronics. They’ve even started pioneering curved mobile phone screens that add depth to a person’s mobile viewing experience.
But in their attempt to capture the biggest slice of the mobile phone market, Samsung had to make their phones affordable enough for the general population.
This came at the expense of profitability.
Indeed, Samsung’s most recent operating profit margin (as of the second quarter of 2016) was 17 percent. Not bad if you consider that 50 percent of mobile phone manufacturers are losing money, and only about 1 in 5 have operating margins over 10 percent.
But that pales in comparison to Apple’s 38 percent operating margin in the same period.
If Samsung didn’t have higher-priced Galaxy Note phablets and Galaxy S-series smartphones to bank on, their operating margins would have been just as bad as the bottom 80 percent of manufacturers.
But then, at the worst possible time for Samsung…
Their high-end Note model caught fire (literally)
In a desperate attempt to take the wind out of Apple’s latest iPhone launch, Samsung apparently pushed up the launch of its latest top-selling high-end smartphone, the Note series.
My wife owned the first rendition of it, and it made my jaw drop. The screen was huge, but didn’t make it impossible to carry around. I could actually read my emails on one of these things without straining my eyes.
It was fast. It was light. And it more than lived up to Samsung’s reputation for quality screens.
Most interesting was that it was priced just like an iPhone. In Manila, Philippines, that meant paying upwards of US$1,000. Cash.
People still went crazy over it. So, it became the company’s flagship device – and profit centre.
But in the 3rd quarter, Samsung launched the Note 7. It was a complete disaster, as reports of phones catching fire while charging or on standby came in by the dozens.
It led to a worldwide recall of all Note 7 phones.
But not before a flimsy, pathetic attempt to sweep the problem under the rug. And not before a ridiculous attempt at a replacement program… that gave customers another phone just as potentially problematic.
Anyone with a Note 7 isn’t even allowed to bring them on airplanes for fear of an explosion midair.
But I read somewhere that despite this recall involving over 2 million phones (given the previous launch sales data, I think the figure is 3 to 4 times higher), U.S. customers remain loyal to Samsung’s brand.
That couldn’t be further from the truth.
Last month, U.S. electronics retailer Best Buy announced that the Note 7 recall would take a big bite out of holiday season sales. This showed up on Samsung’s 3rd quarter smartphone business results, which saw sales drop 14.2 percent versus the previous year.
As you can see from the chart above, Samsung’s mobile phone sales have been sliding since the 3rd quarter of last year.
The longer-term picture isn’t giving them much reason to cheer either.
With global mobile phone shipments now just growing by the high single digits, one company’s misstep is another player’s gain. In this case, Apple and Huawei appear to have capitalised on Samsung’s misfortunes in the 3rd quarter.
So, expect the 4th quarter to be terrible for Samsung and good for Huawei. As for Apple, which already counts the 4th quarter as its strongest, I expect it’s going to be an absolute home run.
With mobile phones accounting for half of Samsung’s revenues and 38 percent of its operating profit, a poor 4th quarter will likely hurt Samsung’s share price along with funds holding a significant stake in them.
That includes the iShares MSCI South Korea ETF (NYSE; ticker: EWY), which holds a humungous 22.5 percent of its portfolio in the form of Samsung Electronics shares.
Manila-based Brian Tycangco is the founder of Asia Financial Publishing Limited. You can sign up to receive his free daily e-letter by clicking here.