Sony's Diversification is a Blessing and a Curse

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It’s been a trying five years for Japanese conglomerate Sony (NYSE: SNE), which has lost 70% of its market value since the onset of the global recession. A stagnant Japanese economy, a strong yen, natural disasters and the rise of Samsung have all led many analysts and investors to proclaim that the age of Sony - which revolutionized consumer electronics with the Walkman and the Playstation - had come to an inglorious end. Yet Sony recently posted better than expected third quarter earnings, with surprising strength in mobile phone and motion picture sales, and released its next generation video game console, the Playstation 4. Is Sony setting up for a grand comeback in 2013, or is rising bullish sentiment premature? Let’s take a look at the challenges facing Sony today.

Third Quarter

During the third quarter of 2012, Sony posted an operating profit of $534 million - a huge improvement over the billion dollar loss it posted in the previous year. After taxes, however, that amount was reduced to a loss of $128 million. Yet the company expressed confidence in the results, reiterating its fiscal 2012 profit forecast of $1.4 billion.

Revenue rose 6.9%, completely carried by feverish growth in its mobile and motion picture business segments.

Smartphones and Movies

Sony’s mobile division, which creates the Xperia line of smartphones, posted 94.4% growth over the previous year. Sony is currently the third largest smartphone manufacturer in the world, trailing only Samsung and Apple.

Sony’s motion picture segment, the third largest studio in the world, owns such franchises as Spiderman, The Karate Kid and Men in Black. It posted 30% growth from the prior year quarter.

Analysts have long speculated that Sony would eventually have to sell Sony Pictures, along with its Sony Music Entertainment division, if the company’s cash reserves continue declining into 2013. Sony of America chief Michael Lynton dismissed those claims, stating on CNBC, “The studio is absolutely not for sale.”

While growth at those two segments is encouraging, Sony posted declining sales in cameras, TVs and video games - which together still generate the majority of its revenue.

Cameras and TVs

Sony’s cameras business has suffered from the increased adoption of higher-end smartphones, which include comparable digital cameras. The business is also being cannibalized by its own smartphones. It would be wise of Sony to decrease its dependence on this segment by either downsizing the cameras segment, or to merge it with its smartphone division.

Sony’s television sales have suffered for two primary reasons - a strong Japanese yen that has crimped its ability to export competitively and increased competition from South Korean giants Samsung and LG. Japanese premier Shinzo Abe’s recent threat to strip the Bank of Japan of its independence - unless it agrees on inflationary targets - have weakened the yen, which could be a boon to Sony’s exports across the board. If Abe can successfully soften up the yen, then Sony could regain much needed pricing power against its South Korean rivals.

Video Games

Sony recently unveiled the Playstation 4, launching a preemptive strike against its primary rivals Microsoft and Nintendo. The eagerly anticipated console is expected to be released during the current quarter and help revive lagging video game sales.

The most significant change, besides more powerful hardware, is a cloud-based gaming service that streams games hosted on servers to users. This technology was acquired from U.S. cloud-based gaming company Gaikai for $380 million last July. Its new controller, the ‘DualShock 4’, will feature a touch pad along with traditional analog and digital controls.

The Playstation 4 will also be able to synchronize with Sony’s handheld console, the PS Vita, which has been recently discounted to 19,980 yen ($214), due to lower than anticipated sales throughout the year. The Vita primarily competes against Nintendo’s Wii U, the handheld successor to its seminal motion control console, the Wii.

Versus Competitors

Being a conglomerate sprawled across so many industries, Sony does not have any direct competitors. Yet individually, it competes with Canon (NYSE: CAJ) for the camera market, Nintendo (NASDAQOTH: NTDOY) for the video game one, and Panasonic (NASDAQOTH: PCRFY) for home electronics. How does Sony fare fundamentally against these rivals?

<table> <tbody> <tr> <td> </td> <td><strong>Forward P/E</strong></td> <td><strong>5-year PEG</strong></td> <td><strong>Price to Sales</strong></td> <td><strong>Debt to Equity</strong></td> <td><strong>Return on Equity</strong></td> <td><strong>Profit Margin</strong></td> </tr> <tr> <td><strong>Sony</strong></td> <td>38.03</td> <td>N/A</td> <td>0.17</td> <td>55.83</td> <td>-9.71%</td> <td>-4.61%</td> </tr> <tr> <td><strong>Canon</strong></td> <td>14.42</td> <td>4.10</td> <td>0.93</td> <td>0.14</td> <td>8.50%</td> <td>6.45%</td> </tr> <tr> <td><strong>Panasonic</strong></td> <td>13.70</td> <td>0.01</td> <td>0.18</td> <td>109.89</td> <td>-57.44%</td> <td>-14.51%</td> </tr> <tr> <td><strong>Nintendo</strong></td> <td>N/A</td> <td>N/A</td> <td>0.19</td> <td>No debt</td> <td>1.67%</td> <td>3.10%</td> </tr> <tr> <td><em>Advantage</em></td> <td>Panasonic</td> <td>Panasonic</td> <td>Sony</td> <td>Nintendo</td> <td>Canon</td> <td> <p>Canon</p> </td> </tr> </tbody> </table>

Source: Yahoo Finance

Canon, which specializes in cameras, camcorders and printers, has the sturdiest financials. Panasonic’s home electronics business, its core competency, has been decimated by Samsung and LG, and it is faring far worse than Sony. Meanwhile, Nintendo, which only creates video games and consoles, has been crushed by waning demand for its products, which peaked in 2007 with the launch of the Wii.

These fundamentals of these companies also paint a picture of vastly different demand for different products.

They tell us that there is still a market for high-end cameras, which Canon produces, while low-end ones, such as Sony’s Cybershot series, are being gobbled up by smartphones. We also see Panasonic’s fate as a cautionary tale of being too highly exposed to consumer electronics, which don’t stand a chance against the pricing power of South Korean manufacturers. Lastly, Nintendo’s stagnation shows us that it wouldn’t be prudent to put too much fate in Sony’s video game business.

The Foolish Bottom Line

Sony’s exposure to such a wide variety of businesses is both a blessing and a curse. Like a diversified mutual fund, Sony’s worst losses are often offset by its better performing segments. Yet as a result, the company misses out on major gains because it is weighed down by non-performing businesses. For Sony, the most important macro factor is a weaker yen. If the Japanese government can successfully weaken the yen, then it can regain pricing power - which will generate sales, margin and earnings growth. While the worst of times may be over for Sony, the best of times are still a distant goal.


Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. You can follow Leo Sun on Twitter at https://twitter.com/leokornsun for more investing ideas.

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