Sony Corporation (SNE) is one of the world's largest consumer electronics companies. Its mainstay product lines include televisions, video game consoles, PCs, semiconductors, and digital imaging and AV equipment. The company is also in the music and finance businesses, and has extensive entertainment properties. Nonetheless, Sony has had a rough go of it lately. Aside from the financial crisis that contributed to four straight years (2008-2011) of red ink, it was hard hit by the tragic earthquake and tsunami that rocked Japan in March of 2011. Indeed, the twin natural disasters damaged some important factories and led to lengthy production disruptions. They also made the company's operating environment at home chillier by briefly pushing the fragile Japanese economy back into recession.
Sony's troubles, meanwhile, didn't stop there. The firm was also blindsided by a series of embarrassing hacker attacks against its PlayStationNetwork. The cyber attacks, which compromised information on millions of gamers, forced the company to shut down its popular entertainment network for several weeks. They compelled the firm to spend a lot of money to enhance system security and compensate its customers for theft damages, too. And the unforeseen expenses, along with soft LCD TV sales and headwinds from a strong yen, prompted Sony to post a hefty, wider-than-expected loss of $5.55 per ADR in fiscal 2011 (ended March 31, 2012).
All of this misfortune has taken a considerable toll on the company's ADRs, which, near multiyear lows, are currently trading well below book value. That said, we think that now would be a good time for patient investors with a long-term horizon to consider taking a position here. At this entry level, returns over the next 3 to 5 years could be substantial, as Sony regains its bearings and the market comes to appreciate the firm's true earnings power.
Staged For A Comeback
The pieces for a turnaround already seem to be in place. Earthquake-damaged factories are mostly back on line, and the PlayStation Network is fully up and running. What's more, Sony is investing in growing product categories, like high-performance semiconductors and single-lens reflex (SLR) digital cameras, where it hopes to gain market share. And the firm is outlining plans to better leverage its networking prowess.
But Challenges Remain
The biggest challenges for the company will be revitalizing its games and television businesses. The games unit, while barely profitable last year, is slowly returning to form, buoyed by greater software sales, the introduction of new 3D titles, and the success of the Move motion controller for the PlayStation 3. The positive momentum is apt to persist, too, thanks to the recent launch of the PS Vita next-generation handheld gaming device. We are not as optimistic about the TV operations, however.
The television division has been bleeding red ink for a long while. In fact, losses from the high-profile unit have surpassed $12 billion over the past nine years. And a return to the black does not appear imminent, given the pricing headwinds and excess inventory in the channel at present. Still, we are not ready to write off this key segment just yet.
More than ever, management seems intent on cutting fixed costs across the TV unit. This should lead to some welcome bottom-line improvement this year. (Sony hopes that losses from the LCD TV business will halve in fiscal 2012, to around $1 billion.) And we envision a more meaningful recovery over the long haul, driven by product-differentiation efforts; gains in emerging markets; a better handling of inventories and component procurement; a more effective regional-focused sales strategy; and more favorable pricing conditions.
A move to spin off the small-size liquid-crystal display (LCD) business -- primarily serving the smartphone and tablet PC markets -- should also take some pressure off the TV operations.
Announced in mid-2011, the strategy called for three of Japan's largest electronics makers, Sony, Toshiba, and Hitachi (HIT), to transfer their struggling small-size LCD units into a government-backed joint venture. The newly formed entity, Japan Display, which debuted this past spring and is expected to have an initial public offering by early 2016, ought to help Sony and its Japanese peers to better compete with the South Korean and Taiwanese LCD producers, particularly at a time when the yen is so strong. It should also enable Sony, which has retained a 10% stake in the new company, to focus more attention on larger TV displays.
Notably, Sony cannot just walk away from its unprofitable television business. That's because TVs are a key part of consumers' home entertainment systems, and they are integral to the company's new networking and 3D-related initiatives. As such, we see the firm taking the hard steps necessary to make the unit an earnings contributor.
Adding It All Up
All in all, though turning around the TV division is sure to be a slow process, we like Sony's prospects to 2015-2017. Indeed, looking beyond the earthquake and hacking episode, the company appears headed in the right direction. And, as we have suggested, its ADRs seem inexpensive relative to the firm's intrinsic value and long-term earnings potential. (The issue is trading at only about four and a half times our 2016 earnings estimate of $3.00 per ADR.) With this in mind, we encourage investors to take a close look at this equity. We think it would make a fine addition to many diversified portfolios.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.