Coverage: Samsung spends amid profit drop

Samsung is planning to invest $15 billion in a new semiconductor factory as profits from smartphones decline. It’s a move that could save the company and help diversify its profit.

Quartz had these details in its story:

The South Korean tech giant, facing sharp declines in profits from its smartphone division, is investing 15.6 trillion won ($15 billion) in a new semiconductor factory to build chips for mobile devices.

The timing of the announcement is no coincidence. Samsung releases guidance for its third-quarter results tomorrow, and analysts are bracing for the company’s biggest drop in operating profit in five years, as devices like the Samsung Galaxy get squeezed at the top of the market by Apple’s iPhone, and at the bottom by low-margin Chinese competitors (paywall) that also use Google’s Android operating system.

The new focus on chipmaking is a tacit acknowledgement that the company’s days of massive profits from selling its own smartphones—which currently make up about 60% of operating profits—may be drawing to a close. But the sprawling tech giant has other ways of profiting from the mobile device boom.

Even as it battles against rival smartphone makers, Samsung is also among their biggest suppliers, providing memory chips and processors for the iPhone, among many others. It makes about 30% of the A8 chips that go into Apple’s iPhone 6 and 6 Plus (it had hoped to be responsible for much more than that), and last week ZDNet reported that the company has also agreed to make Apple’s A9 chip, for use in next year’s iPhones.

Jungah Lee wrote for Bloomberg that Samsung that investors seem to believe that profit will grow as they introduce new products:

Samsung is rolling out new products in the battle to stay on top as Apple wins customers with larger-screen devices, an area the Galaxy maker has dominated, and Xiaomi Corp. and Lenovo Group Ltd. (992) pack features into cheaper models. Declining share of shipments in China and India plus lower demand for Samsung’s high-end products are eroding profit from the units supplying displays and processor chips.

“The market thinks this is the worst profit they can expect from its mobile business, it won’t go any lower from here as more product line-ups are expected throughout this year into next year,” Claire Kim, a Seoul-based analyst at Daishin Securities Co., said today. “Samsung is better positioned than any other players out there to bring out new phones with upgraded hardware features.”

Shares of Samsung rose 1.6 percent to 1,169,000 won at 9:58 a.m. in Seoul trading, paring this year’s decline to 15 percent.

Se Young Lee said in a story for Reuters that the chip business could be a good bet for the company:

Samsung Electronics said its chip production capacity was expected to rise by a “low double-digit percentage.” Construction of the new plant is scheduled to be completed by the second half of 2017.

Any capacity increase can be ominous for competitors in a deeply cyclical industry. Shares in domestic rival SK Hynix Inc fell more than 8 percent at one point on Monday after Samsung’s announcement.

Market conditions for memory chips have remained favorable this year partly due to stronger-than-anticipated demand from personal computers and servers. Industry players like Samsung Electronics have so far been careful about capacity expansion, keeping supply conditions on a tight leash.

Besides SK Hynix Inc, competitors in the memory industry include Micron Technology Inc and Toshiba Corp.

“While the plant won’t enter production until 2017, Samsung’s investment plan hurts sentiment because it suggests that Samsung wants to make further market share gains,” IM’s Lee said.

Some analysts said investors may be over-reacting on SK Hynix shares, given how output from the new Samsung plant won’t materialize for several years and it is not yet clear what chips will be made there.

The Wall Street Journal’s Min-Jeong Lee said the company is struggling to find its way after some setbacks:

It also sounded a cautious note for the fourth quarter noting the outlook remains uncertain.

The weak earnings guidance comes as Samsung struggles to figure out its broader growth strategy and amid expectations of a major restructuring later this year, according to people familiar with the situation.

Chairman Lee Kun-hee remains ill following a heart attack in May. While Samsung said Mr. Lee ’s health is improving, critics said the company lacks a visionary to steer the company into new growth areas especially at a challenging time.

Meanwhile, Samsung affiliates have been carrying out a series of financial transactions that will help heir-apparent and Mr. Lee’s only son, Jay Y. Lee, inherit the company from his father. The younger Mr. Lee, a vice chairman of Samsung Electronics, remains the biggest shareholder of a de facto holding company of the Samsung Group, South Korea’s biggest conglomerate.

Samsung has a lot to figure out. It looks like initially investors are happy with the news, despite the profit issues. But the company still needs to figure out its management issues as well as if the chip business will be the way for it to diversify for the long term.