Why Did Sony Get Such a Big Boost?

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Sony (NYSE: SNE) is a household name in Asia, but currently earns almost two-thirds of its annual revenue from its operations outside Japan, and is considering a corporate restructuring plan proposed by its largest shareholder Daniel Loeb. Mr. Loeb is the head of Third Point hedge fund and has earned quite a reputation for shareholder activism in recent years. Incidentally, Third Point currently owns around a six percent share in Sony, making them the biggest single stakeholder in Sony at this time.

Incorporated in 1946, Sony operates in the consumer electronics industry and is a giant by any measure. They also have a well-diversified product portfolio catering to the consumer, professional and industrial markets. As a group of companies, they are worth $21.2 billion, and unlike most closely knit Japanese conglomerates, Sony has a combination of large shareholders from abroad.

The Spinoff Plan

In their consumer segment, Sony has two operational arms - entertainment and consumer electronics. Both segments have been the core vision of Sony in terms of developing products, and they have built good brand equity in the western market. However, in May 2013, Mr. Daniel Loeb sent a letter to Sony’s CEO Mr. Kazuo Hirai to consider a proposal where Sony would sell part of its entertainment business. His proposal is to reduce Sony’s TV, movies and music operations by 15% to 20%. According to Mr. Loeb, the cash generated from the sell-off should be invested to revitalize its consumer electronics operation to better compete with the likes of Philips, Panasonic and other brands that have been taking the upper hand in recent years as far as sales are concerned.

Mr. Hirai, a western educated chief executive who is open to “ideas,”  made a nonaligned remark that the plan to sell off one-fifth of its entertainment business will affect “a core part” of Sony’s business. He also mentioned that he will allow the board to give it “thorough consideration.”

Market Reaction to Spinoff Plan or Industry Trend?

Analysts from all sectors commented that investors took the spinoff news as positive for Sony, and its share price has been soaring since early May. On May 1, Sony’s stock was trading at $16.25. By May 22 it had climbed to $22.91, up by a staggering 40.98%. Sure, Sony has been on the right track and their 5 year average gross margin is 31.52%. As a result of the last quarter, their year-to-year gross margin has improved to 34.05%, although that's still behind the industry’s 36.70%. The stock price has turned into sort of a bubble based on optimism from the spinoff proposal. As of May 31, the stock price had undergone minor corrections and come down to $20.15. However, looking closely at the entire industry, we might uncover a different story.

Panasonic (NASDAQOTH: PCRFY) is one of Sony’s rivals in key markets, as both companies compete for market share in electronic products on a range of consumer, as well as business and industrial applications. Unlike Sony, Panasonic is only in the production and sale of electronic goods. Currently, the company’s year-to-year gross margin is only at 25.79% compared to the industry average of 36.70%, and without any restructuring rumors, its stock price moved in similar pattern to Sony’s. A fundamental difference for these companies is that Sony is churning a profit where as panasonic has been suffering.  In the last four quarters, Panasonic had a loss of -$9.5 billion.  A loss of that size is large for any company but especially one like Panasonic with a market cap of $17.6 billion.  On May 1, Panasonic’s stock was trading at $7.18; it mounted $9.25 on May 21, but then gave away most of its gains by May 31 as it fell back down to $7.69.

Sharp (NASDAQOTH: SHCAY.PK) is also another Japanese giant and a major competitor of Sony in the electronics market. Compared to Sony, Sharp had been severely unprofitable in the industry, as their gross margin hovered around 8.77% compared to the industry’s 36.70%. Sharp, like Panasonic, also experienced a massive loss--over the last 4 quarters, the company lost almost $7 billion.  A large part of their problems are due to their massive debt load of $14.5 billion.  However, their stock price was also boosted during May. It climbed $3.21 on May 1 to reach $5.80 on May 21, but then lost most of its gains by May 31 when it was trading at $4.65.

When most major publications and websites reported Sony’s spinoff proposal, they indicated that its stock price would move based on preliminary talks about the restructuring plan. This phenomenon was also seen among Sony’s competitors. This brings us to the question: was this price move specific to Sony, or are there any underlying bullish trends forming in the consumer electronics industry?

Conclusion

Sony’s new Android-powered Xperia has been earning good reviews and sales from its 4K Ultra HD TV. Since the new CEO was installed, Sony has drastically increased its gross profit margin. The spinoff plan to revive its electronics segment will certainly provide Sony free cash to invest in R&D and marketing. However, at the end of the day, the plan is still in the preliminary stages, and there is no concrete evidence that it will be carried through by Sony’s board. Meanwhile, the entire Japanese electronics industry is showing signs of improvement as far as stock prices are concerned. It would be wise to wait for a clearer trend confirmation in the industry before jumping the gun and buying at the top of a broader bearish market.

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