Dan Loeb has put forward a proposal to Sony Corporation (NYSE:SNE) (TYO:6758), as a leading shareholder with a 6.5% equity stake (over $1 billion according to Jonathan Soble in Tokyo and Sam Jones in London of the Financial Times). The proposal has also been published. It includes (1) suggesting taking 15-20% of Sony Entertainment public, (2) a focus on industry-leading businesses for Sony Electronics, and (3) an offer to take a seat on the board of directors. The heart of the proposal lies in realizing the intrinsic, embedded enterprise value of competitive businesses such as Sony’s entertainment and CMOS sensor operations. Most analysts agree with Dan Loeb on this one. Earlier we brought you commentary from CLSA Asia. BAML and Nomura also side with Loeb. However, Goldman believes that Loeb’s proposal for a spinoff/IPO cannot help the company that much. Below BAML, Nomura and Goldman weigh in on the debate.
We think Mr. Loeb’s bold proposal bears consideration. He is correct that in our report of 2 April, we had not really considered the latent value in the entertainment businesses. We recognise this latent value may indeed exist.
- We have been increasingly bullish on Sony Corporation (NYSE:SNE) (TYO:6758)’s shares due to its strong product execution and progress with internal reforms. If additional latent value exists and can be unlocked, we would envisage even more upside to the shares. We maintain our Outperform rating and ¥2,100 TP and see a strong near-term boost to the shares from Mr Loeb’s surprise proposal, and his suggestion of 60% upside potential if their plan is properly executed.
Sony Corporation (SNE) Making A Strong Comeback
We broadly agree with the points made by Mr. Loeb. As we wrote in Emerging from Skyfall (2 April), we too envision Sony making a strong comeback in its consumer electronics (CE) business through superior product and marketing execution. In The future of Japan’s CE sector – Sony Corporation (NYSE:SNE) (TYO:6758) to preside over a smaller industry (2 April) we had argued that Sony is to become the only globally-relevant Japan-headquartered CE firm. In Let the games begin (7 May) we described the large profit opportunity in the PS4. In The sun is setting on Japan’s handset industry, with a notable exception in Sony (2 May), we noted Sony’s return as a force in smartphones.
- If Sony Corporation (NYSE:SNE) (TYO:6758)’s reformation of its electronics businesses succeed, the entertainment and financial services businesses would be increasingly ancillary. We cannot bring ourselves to count on (largely-absent) synergies between the electronics and non-electronics businesses to create value, as is reflected in our forecasts.
- Squeezing out value in entertainment. We think Sony’s entertainment businesses (Music and Pictures) may obtain ~¥107bn in EBITDA this year. If we assume 9x EV/EBITDA (a slight discount to peers) we can calculate that they comprise >45% of Sony’s ex-financial services EV. Third Point makes a valid point that if the businesses could be prodded to boost margins similar to those of peers, substantial value for Sony shareholders would be created. For example, Time Warner’s Film & TV Entertainment segment in 2012 obtained an EBITDA margin of 13%, above Sony’s 8%. Third Point’s suggestion of a ¥625bn market value boost (¥540/Sony share) is not unreasonable, we think.
The plan puts forward ideas to boost Sony Corporation (NYSE:SNE) (TYO:6758)’s share price, which is subject to a conglomerate discount. We think the idea to lift the entertainment business’s valuation by listing and thereby revealing its potential value would likely be effective. The CEO Hirai sees entertainment business as a core operation, and we think efforts to realize the value of this will accelerate still further. Valuations could be rerated depending on how Sony approaches this, even if it does not actually list the business. Effective responses by Sony include setting out a growth strategy and disclosing data that allow comparisons with industry peers.
In our view, there is currently little synergy between Sony’s movies/music and electronics. However, even if Sony had cash from a hypothetical sale of movies and music, we do not currently see any potential electronics investments that could deliver higher returns. Given this, we believe it would make more sense under present conditions for Sony to keep the entertainment businesses and their potential contributions to operating profits and cash flow. Last year Sony had liquidity concerns, but it now has more than ¥100 bn free cash flow, excluding the financial segment, as a result of yen depreciation and company efforts. We expect Sony to deploy its current cash flow in turning electronics around and investing in the
Will Sony listen? Most people think not, but Nomura says there is a decent chance
- It is not clear to us whether Sony’s management would accept Mr Loeb’s proposal, but we note that it seems sensible and not actually very earth-shattering. Sony Music Entertainment (Japan), Sony Corporation (NYSE:SNE) (TYO:6758)’s domestic music business, was after all a listed company between 1991 and 2000. In 2000, the business became a wholly owned subsidiary of Sony via a share exchange.
- While the media seems inclined to couch this development as a “test for Abenomics” and Japan’s commitment to structural change, we think this is really less about Japan and more about Sony.
- After all, the usual “sacred cows” of Japan like lifetime employment or control over technology do not apply, given that the bulk of the businesses are really located abroad (Sony Pictures Entertainment is based in Culver City).
- In addition, we would point out that Sony’s new Board (soon to be approved by the AGM in June) seems fairly open from an outsider’s standpoint. Of the 13 proposed Board Members, only Sony’s CEO Mr. Hirai and the CFO Mr. Kato are from management. The remaining 11 members are outsiders. This setup does not guarantee that Mr. Loeb’s proposal will be due consideration, but neither does it suggest that the Board will be pliant defenders of the status quo.
- Our impression of Mr. Hirai is that he would provide fair consideration of the proposal. In a different era, say that of Akio Morita, such a proposal might well have been dismissed outright. However we think today’s Sony is both a different creature, and is faced with very different circumstances.
- We think the probability of Sony accepting the proposal (or something similar) is not zero, though we are not yet comfortable enough to suggest a probability greater than 50%.