Samsung’s Galaxy Note 7 – When “Blowing Up Your Phone” Isn’t Good

“One death is a tragedy, a million is a statistic,” is one of Josef Stalin’s more sinister quotes (and he had a lot of them).  Samsung is witnessing not the deaths of people (thank goodness) but of its phones and has a bad statistic for its shareholders.   The Galaxy Note 7 was released on August 19, 2016, skipping the Note 6 moniker for some reason, and making my Note 5 obsolete 6 months after I purchased it. Thanks a lot.  When released, the Note 7 received many, highly positive reviews.  The Note 7 improved upon the Note 5 by giving it the edge glass that the Galaxy series has, and by returning to removable batteries and expandable memory, features that Samsung omitted in the Note 5 – apparently trying to do an Apple impression.  Looking back, perhaps the compromises were necessary in the last-generation Note…  

This generation of Note, of course, has an unexpected “feature”.  They catch on fire.  And not just when you charge them, either.  They just like to burn.  Galaxy Note 7’s were declared safety hazards on passenger aircraft and passengers were not allowed to use them on airplanes.  After a failed recall, Samsung determined they were unable to fix the problem, and Samsung has taken the phone off the market.  You don’t often see product introductions this bad, but the do happen.  Remember the Apple Newton?  Microsoft’s Zune?  Google Glass?  For sports fans, how about the Extreme Football League? (though the XFL did give us Rod “He Hate Me” Smart, perhaps the strangest name ever put on the back of a jersey.)  I wonder if Hillary Clinton will ever get around to mentioning the New Jersey Generals of the USFL as one of Donald Trump’s business ventures…

But the difference between all of these failed market introductions and the Note 7 is that none of these ventures were central to their respective companies’ businesses.  These other market introductions were, for lack, of a better word, experiments.  The Newton was nearly 10 years ahead of the requisite technology to make it work.The Zune was a half-hearted attempt to jump into the portable music market that Apple conquered with an innovative blitzkrieg, and in any event, wasn’t taking away from Microsoft’s Windows platform.  Google Glass was perhaps as much about market validation as it was an actual product initiative.  The WWE and NBC were not staking their futures on the XFL, and Donald Trump’s real estate and bankruptcy attorneys would be kept plenty busy whether the Generals succeeded or not (spoiler alert – they didn’t).  The Galaxy Note 7 is different.  The Note is a flagship product line for Samsung, one of two product lines that go head to head with iPhones.  Now, that product is dead, and Samsung is likely to find itself 2-3 years behind its innovation schedule.

What happens to your company’s value when one of your flagship products crashes and (literally) burns?  You lose $17 billion of market capitalization, or 8% of your value.  Measured against the cost of the recall ($920 million, or a little over 0.5% of annual revenue), that’s a multiplier of over 18x.  If you think this conclusion is obvious – I suggest you reconsider.  Rarely does a new product flop result in this dramatic a stock move.  Even The Coca-Cola Company’s stock increased in value in the years after the introduction of New Coke.

Interestingly, the bulk of those losses occurred right after Samsung made the announcement that it would quit making the Note 7.0.  The market clearly had confidence in Samsung’s ability to correct the problem and move forward, and was surprised when Samsung threw in the towel.  The 18x multiplier implies that more was at stake than making or missing earnings targets.  There was reputational damage, doubts about Samsung’s ability to continue to innovate at the highest level, a years’ worth of phone buyers that would move to competitors or, in a best-case scenario, wait until a new Galaxy Note that isn’t a blow torch that makes phone calls and plays PokemonGo is available.

A key beneficiary of the Note 7.0 fiasco is, of course, Apple.  Apple just introduced its own device, the iPhone 7, and a strong competitor has been removed from the market.  When Samsung made its announcement that it was pulling the Note 7 from the market, Apple’s shares jumped 1.5%, adding roughly $9.0 billion to Apple’s market capitalization.  That’s a $26 billion value swing for those two companies alone (and you can bet that Apple, in the midst of a high-stakes fight with Samsung over intellectual property infringement is collectively smiling somewhere).  We haven’t even considered other phone makers, such as Google with its recent introduction of the Pixel.  Windows phones, as is generally the case, are not relevant to this (or any other) discussion.

Painful though the decision to pull the Note 7 from the market must have been, it’s clearly the right thing to do.  There’s liability for injury, and the reputational damage that Samsung would have suffered would have been magnified are more and more phone failures were reported, and more YouTube videos surfaced of the devices becoming silicon torches.  Now, Samsung can get out of the headlines, figure out what went wrong, and step up efforts to introduce the Note 8.  Plus, you wouldn’t want to suffer the fate of the Whizzo Chocolate Company

Anyway you slice it, the Note 7.0 introduction and subsequent cancellation is a full-on disaster for Samsung.  However, thanks to its size and product diversification (two factors to be explicitly explored in the valuation of a business), Samsung will weather this storm.  They make lots of products other than the Note phone series, including the Galaxy phone series, which is actually even more important than the Note to Samsung.  Still there was significant damage done to the Company by this incident.  The company’s risk is up, now that technical risk is on the table.  Growth will be slowed as Samsung is left with a gaping hole in its product lineup, but there will be some successor phone for sure.  But, if you’re a Samsung shareholder, you’re definitely not left with burning love.

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4 Comments

  1. Given the boos that Apple got for the iPhone 7, they should also be breathing a sigh of relief. What effect do you think the Note 7 woes will have on Apple’s value?

    • I think they are. Apple’s stock has risen around 1.5-2% since the fiasco. Doesn’t seem like much but on an annualized basis that’s over 24% – which is a huge return for a blue chip stock.

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