SONY CORP. $47 (New York symbol SNE; WSSF Rating: Above average) is one of the world’s largest makers of consumer electronic products such as TV sets, DVD players and stereo equipment. This business supplies two-thirds of its revenues. The remaining third comes from its PlayStation video game players, its film and TV studios, and its financial services division.
In the past few years, Sony failed to anticipate the strong demand for big screen TV sets that use either plasma or LCD (liquid crystal display) technologies. That let other companies cut into its market share.
Meanwhile, its famed Walkman portable music players lost market share, mainly to Apple’s iPod. Now, however, Sony is restructuring its TV business, to focus on new flat screens. This will cost roughly $900 million, but should cut way back on its operating costs, starting with a $50 million saving in fiscal 2007 (fiscal years end March 31).
Sony earned $1.37 per ADR (total $1.43 billion) in its third fiscal quarter ended December 31, 2005 up 2.2% from $1.34 per ADR ($1.40 billion) a year earlier. Excluding the impact of changes in foreign exchange rates, net income rose 17.5%. (Sony’s American Depository Receipts trade on the New York Exchange. Each ADR represents one common share.)
Sales grew 2.5%, to $20.6 billion from $20.1 billion, due to strong Christmas demand for flat-panel TVs, music devices and its new PlayStation Portable video game player (disregarding exchange rates, sales grew 10.2%). Sony’s new focus on flat screens helped it recapture its position as the top seller of TV sets in the United States and Japan.
The company spends about 7% of its sales of $64.50 a share on research. Accounting rules force it to write off these costs immediately, so it is more profitable than it appears. But this spending provides Sony with new products, particularly the PlayStation 3 video game console, which should drive its sales and profits much higher in the next few years.
Game profits set to jump
Sony’s games division supplies just 10% of its revenue but 40% of its profit. The PlayStation 3 could increase this division’s revenue by 50% in the next two years, and double its profits.
The PlayStation 3 will use the new “Cell” chip, which Sony developed with IBM and Toshiba. Cell runs 10 times faster than current computer chips, and will let designers create more life-like games. Developing its own chips also helps Sony keep costs down.
The new machine will also showcase Sony’s new “Blu-ray” DVD format for high-definition video. The high cost of developing these new features means that Sony will initially lose money on every unit it sells, but royalties from game sales and online game services should eventually make it worthwhile. PlayStation 3 sales could also spur demand for its other products, such as high-definition TV sets, digital cameras and DVD movies.
Sony planned to launch the PlayStation 3 in the first half of 2006, but the product’s high technical requirements may force a delay. Based on Microsoft’s recent problems with its new Xbox 360 game console, including over-heating and chip shortages, Sony is wise not to rush this new product to market.
Sony Reader could be the next iPod
Sony also has high hopes for its Sony Reader, a new electronic book reader that it plans to launch this spring. The Sony Reader can store and display books and other printed matter, including PDFs and other computer files. Users will be able to download books, for a fee, from Sony’s new online bookstore.
Unlike current book readers, the Sony Reader uses a unique screen that electronically manipulates tiny ink capsules to appear as either black (text) or white (background). That makes it as easy to read as a printed page, even in sunlight. It mainly draws power to “turn” the page, and its battery can perform 7,500 page turns on one charge.
The Sony Reader is about the size of a paperback book, and weighs less than nine ounces. It should find wide appeal among students and professionals who have to carry and refer to large textbooks and technical documents, as well as air and train travelers and commuters. We think it could become as popular as the iPod.
Balance sheet gives Sony flexibility
The company’s balance sheet is also strong. It has $9.7 billion ($9.72 per ADR) in cash, and long-term debt of just $5.5 billion (or 0.2 times equity). Goodwill and other intangible assets account for just 5% of Sony’s total assets. That gives it plenty of room to expand its research or make acquisitions.
Sony got as high as $157 in 2000, but fell to $23 in 2003. It now trades at 58.0 times the $0.81 per ADR that it will probably earn in fiscal 2006. However, it trades at just 10.4 times its forecast cash flow of $4.50 per ADR. The $0.23 dividend yields 0.5% (note that Japan has a 7% withholding tax on dividends paid to American stockholders.)
Sony is a buy.