You’d think things couldn’t get worse for Samsung Electronics. About one month ago the company issued a recall of 2.5 million Galaxy Note 7 devices after consumers complained about devices exploding. Replacement phones with new batteries were supposed to fix the problem—but a recent accident on a Southwest airline suggests even this second batch of phones might be faulty. A second recall—unheard of in the industry—might be imminent.
Surely, these incidents have caused some consumers to steer clear of Samsung products. But the explosions haven’t dampened investor enthusiasm one bit. The initial recall caused a sizable dip in Samsung Electronics’ share price, but since then the stock has recovered, and then some. Today (Oct. 7), in fact, it opened at $1,528 per share, an all time historic high, and its third such high this year.
What explains the resilient share price? Phone sales are simply no longer that important to Samsung Electronics, or its investors.
In a research note dated Oct. 9, just as news of the explosions surfaced, Nomura Securities analysts CW Chung and Chris Chang stated they expect the recall to result in an initial drop in revenue of about $1.5 billion from lost smartphone sales. But it still expects the company to bring in about $103 billion in smartphone sales in 2016, meaning the impact will be marginal.
And selling smartphones is just one way Samsung Electronics makes money. The listed company, which is part of the larger Samsung Group, consists of four main divisions:
- IT and Mobile Communications, which includes mobile devices, desktops, laptops, digital cameras, and network equipment
- Display, which makes screens for mobile devices, computers, and televisions sold by Samsung and other manufacturers
- Consumer electronics, which makes appliances like refrigerators, washing machines, and televisions
In 2012, just as consumers were ditching their flip phones for smartphones, Samsung’s profits came primarily from its IT and Mobile Communications unit.
But that’s changed in recent years. Profits this year are expected to be split nearly 50-50 between mobile phones and the display and semiconductor units. The latter two will make up a majority of profits by 2017, according to Nomura.
Two factors are driving this shift. Samsung’s smartphone profits are shrinking, because growth in global smartphones sales is slowing. Along the way, manufacturers are competing more fiercely for customers, which causes prices to go down, which causes profit margins to go down.
Meanwhile, Samsung has a head start over the competition in display and semiconductors, just as the smartphone industry prepares to upgrade these components. It’s a market leader in OLED screens, a superior and more sophisticated screen technology than the LCD screens most phones have now. The company controlled about 95% of the market for OLED screens during Q1 2016, and demand is expected to increase as phone companies like Apple ditch LCD for OLED.
Samsung also remains ahead of the competition in flash memory, which saves data when power is cut. In 2013 the company released the first 3D NAND chip, an improvement upon 2D planar NAND, roughly three years before competitors like Intel and Micron caught up.
Investors see bright prospects for these divisions—so much so that they claim Samsung Electronics’ market cap is lower than it should be. On Oct. 5, activist shareholder Elliott Management issued a lengthy presentation arguing the company is undervalued by 30% to 70%. Samsung should split itself in two separate companies, Elliott said—a holding company that manages stakes in other Samsung divisions and an “operations company” that makes and sells electronics. The split would return more dividends to investors, and bring the company’s opaque corporate structure to something more in line with international transparency standards.
If the exploding phones problem persists, will it eventually bring the stock price down? Nomura’s Chung suggests they could, if the ongoing phone sales drop has a “hard landing.” In Q2 2016, Samsung had 22% of the global market share for shipped smartphones, making it the world’s leader. If consumers look beyond the recall, and keep buying Samsung phones, the division’s stagnant revenues and profits will persist. But if Samsung’s brand image is tarnished beyond repair, income from phones could sink beyond the point where its components divisions can compensate.