Wednesday, May 15, 2013

Sony Is Relatively Cheap, and Opportunistic


Famous hedge fund manager Dan Loeb has come to Japan, targeting one of the biggest Japanese corporations, Sony (NYSE: SNE). Dan Loeb revealed that his firm, Third Point LLC, with 64 million shares, including both direct share ownership and cash-settled swaps, was the largest owner of Sony. Dan Loeb has laid out several steps to unlock the hidden shareholder value, believing that the company has as much as a 60% potential upside.
Two steps to unlock Sony’s value
In the recent letter to Mr. Kazuo Hirai, the President and CEO of Sony, Dan Loeb mentioned that Sony could maximize the company’s shareholder value by two steps: first was to take a part of Sony Entertainment listed, and the second was to focus on industry-leading businesses for the future growth of Sony Electronics.
Indeed, Sony’s business was divided into several segments including Consumer Products & Services, Professional, Device & Solutions, Pictures, Music, Financial Services and Sony Mobile. While the two biggest revenue contributors were the Consumer Products & Services segment and the Professional, Device & Solutions segment, those two segments generated operating losses in 2012. The Financial Services segment was actually the most profitable segment, with ¥131 ($1.31) billion in operating income in 2012. The Pictures, Music and Sony Mobile have also generated consistent positive operating income, with The Pictures, Music and Sony Mobile have also generated consistent positive operating income of ¥34.1 billion ($341 million), ¥36.9 billion ($369 million) and ¥31.7 billion ($317 million), respectively.
Dan Loeb stated that Sony should take around a 15% to 20% stake in Sony Entertainment public so that the public could realize its high profitability with the great asset in television and motion picture production. Moreover, its management could have an incentive to grow the business they control. Sony was advised not to have a standard IPO, dividend or spinoff but rather a subscription right to current shareholders, to ensure the economic interests of Sony’s current shareholders. Third Point was ready to “backstop” the IPO up to $1.5 to $2 billion. According to Dan Loeb, if Sony Entertainment could have the similar margin to its U.S. peers, its EBITDA might rise up to 50%. With a EBITDA multiple of 9, Sony might realize an additional market valuation of ¥625 ($6.25) billion, or ¥540 per share, or 25% of the current trading price.
Sony Electronics and its Japanese peers
Its other business, Sony Electronics, has been producing sluggish returns and losses in the past ten years. However, the company was still undervalued on the market. Sony Electronics was worth around $8 billion, valued at 8 times FY13 EBIT guidance of around $1 billion. Dan Loeb wrote: “When considering Sony’s strong operating profit recovery, favorable product cycles, export orientation, and relative balance sheet strength, we see a strong re-rating potential to multiples of consumer electronics peers like Sharp (NASDAQOTH: SHCAY.PK) and Panasonic(NASDAQOTH: PCRFY).”
Panasonic was also the big Japanese electronics corporation. Most of its revenue, 17% of the total revenue, were generated from the AVC Networks. Appliances and Eco Solutions both ranked second, each accounting for 15% of the total revenue while Industrial Devices was the third biggest revenue contributor, representing 14% of the total revenue. The business keeps innovating new electronics products. Several days ago, Panasonic announced its new Breakfast Collection, including different kitchen appliances including a Coffee Maker, a Kettle and a Toaster. The NT-ZP1 Toaster has different slots for different bread slices. The NC-ZF1 Coffee Maker, with Aroma Selector could let users adjust the water flow for milder or stronger coffee, whereas the NC-ZK1 Kettle let users boil water quite quickly.
Panasonic seems to employ high leverage for its operations. As of Dec. 2012, it had ¥1.34 trillion ($13.4 billion) in equity, ¥515 ($5.15) billion in cash and as much as ¥1.56 trillion ($15.6 billion) in total debt. Panasonic is trading at $8.60 per share on the market, with the total market cap of $19.90 billion. It has quite a low EV multiple of only 4.1 on the market. The P/B stayed at 1.14.
Sharp has been expanding its business into TVs and mobile handsets as well as LCD related business for the past 13 years. The company has just laid out five main strategies for recovering and growing the business. The five main plans included business portfolio restructuring, LCD business profitability improvement, ASEAN market focus, fixed costs reduction and financial position improvement. The company also pushed for strategic partnership with companies from different industries. Recently, it just signed a basic agreement with Makita Corporation, to broaden the business areas including homes (house/rooftop) to premises (grounds). Sharp also announced that it was seeking further collaboration in the robotics business. Sharp was expected to generate around generate around ¥216.8 ($2.16) billion in EBITDA in 2014. With ¥946.9 ($9.46) billion in debt, its 2014 EV/EBITDA was 7.12.
The lowest valuation with an additional value of ¥725 per share
Interestingly, Sony has the lowest valuation among the three. Sony is trading at $20.80 per share, with a total market cap of $21 billion. The market values Sony at only 3.62 times EV/EBITDA. Dan Loeb suggested that there were over ¥525 per share of hidden value that the market had not reflected in Sony’s share price. He also expected that there were over ¥525 per share of hidden value that the market had not reflected in Sony’s share price. He also expected another ¥200 due to “the movement in the EUR/JPY relationship to be reflected in analyst estimates.
My Foolish take
Dan Loeb has pointed out what the greatest asset that Sony has, Sony Entertainment. Sony considered the entertainment business was indeed the important source for the company’s growth and it was not for sale. However, Sony’s spokeswoman said that the company “look forward to continuing constructive dialogue with the shareholders as it pursues its strategy.” Sony looks quite interesting with its low valuation compared to its electronics peers, it could also be considered an opportunistic pick upon Dan Loeb’s activism.

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