Samsung Note 7 recall will be pricey, but probably worth it

Samsung Electronics's recall of millions of big-screen smartphones isn't going to be cheap.

The South Korean company may spend as much as $1 billion, after deciding to replace all of the 2.5 million Note 7 phones that were shipped since they went on sale two weeks ago, according to estimates compiled by Bloomberg. Samsung would only say the amount was "heartbreaking.'' About three dozen of the devices were found to have batteries that caught fire and exploded.

The timing couldn't have been worse. Samsung was on a roll, with the success of its flagship Galaxy S7 helping to drive its shares to a record last month and lifting quarterly profit to the highest in two years - all of this in a sputtering global smartphone market. The Note 7 was supposed to complete a product lineup that would go head-to-head with new Apple. iPhones due to be unveiled this week. As the market leader in Android-based smartphones, Samsung couldn't risk any injury to its brand.

"The potential damage to reputation is far greater than short-term financial losses,'' said Chang Sea Jin, a professor at the National University of Singapore.

Estimates from Credit Suisse Group, Daishin Securities and Pelham Smithers Associates put the recall's cost at around $1 billion or less. Asked about the financial impact, Koh Dong Jin, the head of Samsung's smartphone business, said at Friday's press conference in Seoul that it was a "heartbreaking amount.''

Still, the estimated impact only represents less than 5 per cent of Samsung's projected net income of 23 trillion won ($20.6 billion) this year. And it's unclear whether part of the cost, if any, will be shouldered by Samsung SDI, the company's affiliated battery manufacturer. While Samsung hasn't said who supplied the Note 7's batteries, the battery company will probably also bear some of the cost of the recall. Samsung SDI supplied 70 per cent of the batteries to Samsung Electronics, which stopped ordering them, while Chinese battery maker Amperex Technology provided 30 per cent, the Korea Economic Daily reported.

SDI shares fell 3.2 per cent to 105,000 won at 9:30 am in Seoul on Monday, bringing their two-week decline to about 11 per cent. Samsung Electronics' stock was little changed.

Samsung Electronics gets about $600 of revenue and $108 of operating profit for every Note 7 it sells, Credit Suisse estimates. The company was probably aiming for shipments of 4 to 5 million units in the current quarter and 8 to 9 million in the final three months of 2016, said analysts led by Keon Han.

The bigger question in the coming weeks is how much damage the recall might inflict on Samsung's brand. After painful legal disputes with Apple, the Suwon-based company has worked hard to rebuild its reputation for quality and innovation through the pioneering of large-screened devices and curved displays. When the Note 7 was released, it garnered favourable reviews and early sales were seen capitalising on the absence of new iPhones. Now, sales are being halted in 10 countries where the Note 7 is available.

"The time advantage that they had on the iPhone, that's evaporated now,'' said Bryan Ma, an analyst at IDC in Singapore. "It'll hit them this quarter obviously, but if it's something they immediately address and immediately turn around, then there won't be a long-term impact.''

While the recall is a black mark for Samsung, it's a relatively quick response to a serious product defect. Samsung Electronics, a sprawling empire with more than 320,000 employees, makes everything from semiconductors and networking equipment, to smartphones and air conditioners and microwave ovens.

Sanghyun Park, equity analyst at Pelham Smithers Associates, said he's convinced that the global recall decision came directly from Samsung Vice-Chairman Lee Jae Yong, the son of Chairman Lee Kun Hee. The younger Lee has been filling in for his father since he was hospitalised after suffering a heart attack in May 2014.

''There is really no one at Samsung who can make this kind of a bold decision other than him,'' Park said. As a member of Samsung's founding family, Lee would want to protect the reputation of the company founded by his grandfather, Park said.