Samsung flags $5.3 billion profit hit from Note 7 failure

© Reuters. Workers take a billboard of Samsung Electronics' Galaxy Note 7 off from atop a building in central Seoul

By Hyunjoo Jin and Joyce Lee

SEOUL (Reuters) - Samsung Electronics (KS:005930) Co Ltd on Friday said it expected to take a hit to its operating profit of about $3 billion over the next two quarters due to the discontinuation of its fire-prone Galaxy Note 7 smartphone.

The outlook brings to about $5.3 billion the total losses the global smartphone leader has forecast as a result of the overheating issues, after it said on Wednesday it would suffer a $2.3 billion hit to third-quarter profit.

The premium device that was meant to compete with Apple (NASDAQ:AAPL) Inc's latest iPhones at the top end of the smartphone market had to be scrapped earlier this week, less than two months after its launch, due to safety fears.

The South Korean tech giant said in a statement on Friday it expected the blow to profit to be in the mid-3 trillion won over the next two quarters - in the mid-2 trillion won range in the October-December period and about 1 trillion won ($900 million) for the first quarter of 2017.

Samsung shares, which have fallen about 8 percent this week, edged up 0.6 percent as of 0228 GMT on Friday, versus a 0.5 percent gain on the broader market.

To make up for the lost revenue, Samsung said it would expand sales of gadgets like the Galaxy S7 and S7 edge phones, and make "significant changes" in its quality assurance processes to improve product safety.

Investors and analysts said that while the company had to move quickly to reassure the market about the potential financial costs, deeper losses from one of the tech industry's most spectacular product failures could not be ruled out.

Reputational damage remained the great unknown and potentially more harmful than recall costs, with rivals in the cut-throat industry eager to pounce on any sign of weakness in the market leader's standing among consumers.

"The sales impact on other models remains unclear," said Kim Sung-soo, a fund manager at LS Asset Management, which owns Samsung Electronics shares.

"The end of the premium model will damage Samsung's brand, and hurt demand for its other models. It is difficult to measure such impact."

Samsung posted earnings of $7.2 billion in the second quarter, with mobile profits - its biggest earner - soaring 57 percent.

REBUILDING TRUST

The Note 7 debacle has come at an awkward time for South Korea's biggest family-run conglomerate, which is in the middle of a leadership succession and is facing calls for a major restructuring from U.S. hedge fund Elliott Management.

Park Jung-hoon, a fund manager at HDC Asset Management which owns shares in Samsung affiliates, said that although future losses would not be as bad as the third quarter the company had to work hard to rebuild confidence.

"What's important is whether the flagship S7 can fill the gap left by the Note 7, and how much trust Samsung can regain from consumers by the time the S8 comes out," he said. Analysts expect the S8 to be released in the first quarter.

Key to brand recovery would be rapidly finding out and communicating what went wrong with the Note 7, which was recalled when some devices were found to be combustible and finally discontinued when customers reported similar faults in their replacements.

The company blamed faulty batteries for the original problem but it has given no inkling about the cause of overheating in the replacements.

"Samsung must announce clearly what the reason was and dispel uncertainty," Park said.

Investors were also expecting the company to show its "commitment to shareholders" by announcing share buybacks or higher dividends, he said.

Samsung has announced financial incentives for U.S. and South Korea customers who exchange Note 7s for other Samsung products, as part of efforts to stem customer defections.