With Samsung’s earnings just released, the company appears to have dodged much of the impact of the Note 7 battery fiasco. Yet it’s also apparent that its third-quarter numbers don’t fully account for the cost of getting past this whole saga.
While sales missed estimates by about 4%, operating profit narrowly topped expectations. Whatever financial pain was incurred was masked by better results in other divisions, like semiconductors.
Exactly how much has been absorbed and how much is yet to come is a crucial question for Samsung’s management, and investors. Just as important is how long this financial mess will drag out. Assuming Samsung can control it, the company might choose to spread the damage over multiple periods, or take it in one fell swoop.
The rules on contingent liabilities are clear, and offer a nice amount of flexibility. Companies can, and should, record any potential future liability if it’s both probable and measurable. In this case, the probability hurdle has been passed. The measurability requirement can be met through consulting with lawyers, accountants and other experts to come up with a reasonable figure.
So far it seems the bottom-line costs—replacement, repair and possible legal expenses—will be borne over at least two quarters: the one just past, and the current period. The top-line impact in the form of reduced future sales across all products is something Samsung has less control over and could play out for a while, as Bloomberg News wrote Wednesday. Fresh reports of trouble in replacement handsets released by Samsung could compound the problem.
In as much as Samsung can control the timing of costs, I’d argue it should write off as much as possible as quickly as possible. In other words, take a big bath. There will be short-term financial pain, but like ripping off a Band-Aid, it’d allow the company to move on and avoid dragging out the narrative in full consumer view. On the flip side, a large line item and subsequent reduced net income may be seen to weaken management’s hand as Samsung braces for a possible fight against activist investor Paul Elliott Singer.
A chief challenge, though, is calculating the cost of possible remedies, which may include fines, compensation and anything else required to make the problem go away. It’s not clear that any such redress will be required, and I’m not alleging any civil or criminal breach, but we all know that plaintiff lawyers and regulators will be looking very closely for any opportunity.
To deal with this uncertainty, Samsung and its shareholders would be best served by making a very conservative estimate of the cost—that is, overestimating—and taking a one-off writedown in the current quarter.
Given that damage estimates are already said to be as high as $2 billion, that might mean Samsung would record its worst earnings since the financial crisis. But it would also wipe the slate clean and give everyone the impression it’s a one-time thing, which is exactly the narrative Samsung needs right now. It may also open the possibility of a ninja-like accounting move, such as booking a profit from the fiasco in a subsequent quarter if the final costs fall short of estimates.
Such a strategy does have one important caveat: If Samsung keeps messing up, then no amount of soap and water will be able to wash away the stain. Bloomberg