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Burn Notice: Samsung Killing Off Note 7

After some of the 2.5 million recalled Note 7's replacements have caught fire, including one on a plane, Samsung is terminating production on the iPhone's chief rival. What will happen to the company once the smoke clears?

Authors: Yoolim Lee and Sohee Kim

Samsung Electronics Co. is ending production of its problematic Galaxy Note 7 smartphones, taking the drastic step of killing off a smartphone that became a major headache for South Korea’s largest company.

Samsung had already recalled the Note 7 once last month after early models exploded and the latest move comes after customers reported that replacement phones were also catching fire. Samsung will be without its highest-end smartphone that was supposed to compete against Apple Inc.’s iPhones and other premium devices during the holiday shopping season.

The crisis has left Samsung scrambling to figure out the cause of the battery fires and to explain how a company known for manufacturing expertise could have missed such a critical product flaw twice. Samsung originally blamed one battery supplier for the problems and switched to an alternative company, but that did not end the problems.

"Samsung needs to act swiftly and move on to protect their brand image," said Mark Newman, an analyst with Sanford C. Bernstein in Hong Kong.

Bag 'em and tag 'em.
Photo: Getty Images

Samsung Electronics shares fell 8 percent in Seoul Tuesday, wiping out about $17 billion of market value, before the Note 7 termination was announced. The stock dropped further in London trading after the news, sliding as much as 9.5 percent.

The company has not said how many new or replacement phones will be affected by the latest announcement. Analysts estimated that the original recall would cost between $1 billion and $2 billion, but that figure will now certainly rise.

So the Phone You Bought Might Explode? What to Do With a Note 7

Samsung had asked for a halt to Note 7 sales earlier on Tuesday under pressure from regulators and wireless operators that sell its phones. Consumers had reported problems with supposedly safe phones in the U.S. and China, and carriers such as AT&T Inc. and Australia’s Telstra Corp. halted sales. In one case, a Southwest Airlines Co. flight from Louisville, Kentucky, was evacuated because a replacement Note 7 began dispersing smoke and burned carpet flooring.

The U.S. Consumer Product Safety Commission warned users not to use the Note 7 due to concerns over more incidents of overheating. The Korea Agency for Technology and Standards also asked Samsung to stop selling or exchanging the Note 7 after the regulator confirmed possible defects in the new phones.

Responsibility for leading the company through crisis has fallen to Jay Y. Lee, vice chairman and heir apparent at Korea’s largest conglomerate. His father Lee Kun-hee, the family patriarch who remains chairman, has been hospitalized for more than two years after a heart attack. The phone unit is run by D.J. Koh, who took over in December.

"This is a catastrophe and it will put Jay Y.’s leadership skills to test," said Kim Sang Jo, professor at Hansung University.

The Note 7 debuted to rave reviews in August, but the plaudits turned to criticism within weeks as phones exploded and images of charred handsets began appearing on social media. Samsung announced the first recall in Korea on Sept. 2, calling back the initial shipment of 2.5 million phones and then replacing them with what it said were safe devices. The flaw, it explained, was with the primary battery supplier, which a person familiar with the matter identified as affiliate Samsung SDI Co. All new phones would have batteries from another manufacturer.

The drama may give an opening to activist investor Paul Elliott Singer, who is advocating for a break up of South Korea’s biggest company. Singer proposed that Samsung separate into an operating company and a holding company, dual-list the former on a U.S. exchange, pay shareholders a special dividend of 30 trillion Korean won ($27 billion) and improve governance by adding three independent board members.

The decision to scrap the Note 7 for good will affect suppliers inside and outside the conglomerate. Beyond that, the company will have to assess the impact on future phones.

"What happens to the next version of the phone when it comes out and how much this is going to impact the sales?" said Dan Baker, an analyst at Morningstar Inc. in Hong Kong. "It’s not just the phone; their whole ecosystem is behind this -- displays, memory chips. If their phone sales drop, then their sales of other parts of the business will be impacted. It’s a spiral."

The debacle may lead to management changes at the Samsung conglomerate. The group typically shuffles executives at the end of the year, especially if there are losses or other problems.

"Samsung needs a new start," Chung Sun-sup, chief executive officer of Chaebul.com, a website that tracks Korean conglomerates. "If the new start comes along with changes in the group, they may regain trust from the markets. Right now, incremental patching up of problems is a worst choice."

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