Sony shares could be worth 40% more with a single divestiture.
Management simply needs to cast off the company’s oversized and outdated ego as an electronics maker. That means radically shrinking the division for which Sony (ticker:6758.JP ) is best known, and which has fallen hopelessly behind rivals in key products and now generates large losses each year while spending lavishly on research and advertising. This spending is delusional. By slashing its electronics exposure Sony can unlock profits from its healthy movies, music and insurance businesses, while capitalizing on pockets of strength, like games and imaging chips for high-end smartphones.
There’s growing reason for investors to believe that Sony, which replaced its chief executive in 2012 and its chief financial officer this past March, is ready to make needed changes. Last month, Sony announced a 180 billion yen ($1.7 billion) writedown of goodwill from its purchase of Ericsson, completed in 2012. Analysts expected it to make writedowns little by little in coming years. The move suggests Sony is coming to terms with reality on smartphones: It can’t compete with Apple ( AAPL ) and Samsung (005930.Korea) at the middle to high end of the market or with Chinese firms like Lenovo ( 992.HK ) and Xiaomi at the low end to middle. It can still make money in Japan, but that market alone doesn’t offer enough financial scale to support heavy investments in research and development.
Sony also announced it would stop paying a dividend for the first time since 1958. It should arguably have done that years ago; over the past five years it has lost a cumulative JPY844 billion, turning a profit in just one year, and only then with help from a one-time gain. The company will also cut 1,000 workers from its mobile division’s staff of 7,100.
The bad news is now out–and priced into shares, according to Jefferies analyst Atul Goyal. Excluding phones, Sony has just JPY43.5 billion of goodwill left, and most of that is in businesses like imaging chips, which are profitable, growing and not expected to take charges. Wall Street expects Sony to lose JPY173.37 per share in its current fiscal year, which runs through March, and to turn a profit of JPY118.79 per share next year and JPY148.74 the following year. This last figure puts shares, recently JPY1,822, at 12.2 times earnings. Sony also has American depository receipts ( SNE ).
If Sony can cede what little share it holds in smartphones to Apple and Samsung, perhaps it can turn televisions over to rivals like Samsung and LG Electronics; leave cameras to Canon ( CAJ ); and exit smaller businesses, too. Of course, the right way to do this is to sell through inventory first, and announce the exit second. The wrong way is to announce a sudden exit like Sony did with personal computers earlier this year, resulting in a steep loss.
Sony has scheduled a November 25 investor event during which it’s likely to give more details on restructuring plans. There’s much to be gained. Using a sum-of-the-parts analysis, Jefferies’ Goyal reckons the insurance business is worth JPY400 per share; movies, JPY940; music, JPY620; stakes in medical imaging and data companies, JPY310; and games JPY420. He values the electronics division at a negative JPY330 per share, given its potential for endless losses, but also sees near-term opportunities for cost-cutting worth JPY50 a share. That adds up to JPY2,410 per share, or 32% higher than the stock’s recent price.
Shares could be worth even more if Sony can aggressively shrink its electronics business, because spending levels there make little sense. Consider that the company spends more than $22 billion a year on selling, general and administrative expenses. That’s more than its cumulative profit of the past two decades.
The upside to so much bloat is that if Sony can announce the right kinds of changes in November, the improvement could be rapid and dramatic. So could the stock gains.
Author: Jack Though