Sony Taking Loeb Breakup Advice Better Late Than Never: Real M&A

May 19, 2014 10:23 am ET

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May 19 (Bloomberg) -- One year and about $2 billion in lost market value later, it may be time for Sony Corp. to take Daniel Loeb’s advice about breaking up.

Even after making restructuring attempts such as the sale of its personal computer division, Sony remained 12 percent lower as of last week than when activist investor Loeb first urged a separation of the entertainment business last May so that the company could focus on its struggling electronics business. Last week, Sony forecast an annual loss, its sixth in seven years, mostly because of swelling restructuring charges. The shares subsequently plunged 8.8 percent as of May 16.

“Last year there was some hope, and now we’re seeing a capitulation of that hope,” Daniel Ernst, an analyst at Hudson Square Research Inc. in New York, said in a phone interview. “The worse the electronics part of the company does, the more pressure there will be to look at” Loeb’s suggestion.

While Sony is banking on ultra-high definition, or 4K, televisions and high-end smartphones to reverse the declines in its electronics unit, those products won’t be the saving grace it needs, Ernst said. Separating the entertainment division, which makes the “Spider-Man” films and represents music artists such as Miley Cyrus, would let investors value the more profitable parts of Sony separately while it tries to fix electronics, according to RiverFront Investment Group LLC.

Based on the sum of its parts, Sony could be valued at 2,090 yen a share, 27 percent more than last week, according to Atul Goyal of Jefferies Group LLC. Bedell Frazier Investment Counselling LLC’s estimate suggests an even higher premium of as much as 53 percent.

Good/Bad

A breakup is “long overdue,” Chris Konstantinos, who helps oversee about $4.5 billion as director of international portfolio management at RiverFront in Richmond, Virginia, said in a phone interview. “You could almost do what I would term a ‘good bank/bad bank’ type of scenario.”

Loeb’s Third Point LLC urged Sony last May to sell as much as 20 percent of its profitable entertainment unit in an initial public offering so the Tokyo-based company could focus on the electronics division.

While Sony rejected the plan in August, it said in February it would sell its PC business to buyout firm Japan Industrial Partners Inc. and also split its TV manufacturing unit into a separate operating entity. Chief Executive Officer Kazuo Hirai said he hasn’t ruled out a divestiture of that business.

Sony is “focused on creating shareholder value by executing on our plan to revitalize and grow the electronics business, while further strengthening the entertainment and financial service businesses,” Ayano Iguchi, a company spokeswoman, wrote in an e-mail May 15.

A representative for Loeb declined to comment.

Market Pressure

Last week, Sony reported a 26 billion yen ($257 million) operating loss for the TV-making business in the year ended March 31, which the company said brings the unit’s total operating losses over the past decade to about 790 billion yen. It also projected a 50 billion yen companywide net loss for this year.

The stock dropped to 1,646 yen last week from 1,877 yen at the time of Loeb’s suggestion last May. Sony climbed as high as 2,295 yen in July before rejecting his proposal the next month.

Sony fell 1.2 percent to 1,627 yen at today’s close of trading in Tokyo. The American depositary receipts dropped 1.7 percent to $16.11 at 10:08 a.m. New York time today.

“Pressure is mounting,” Mike Frazier, president and CEO of Bedell Frazier, which oversees about $400 million including Sony ADRs, said in a phone interview. The market has “been frustrated for a while, but even the bull case is starting to get frustrated. For the time being, we’re staying in there but we’re contemplating our next move.”

Disparate Units

Sony’s operations sprawl from film and music studios to TV and camera products to PlayStation video games and consoles. It also offers financial services, such as life insurance.

“What does the film entertainment and the audio entertainment businesses have to do really with PlayStation or with TV sets or with camera modules? The answer is not much,” said Brian Barish, president of Denver-based Cambiar Investors LLC, which oversees about $11 billion, including Sony ADRs. “The chorus to break off the entertainment assets from the rest will grow much louder.”

A breakup would make it easier for investors to assess the disparate units, said Konstantinos of RiverFront. One way of doing that would be to put higher-growth divisions, including PlayStation and entertainment, in one business and more commoditized operations, like TV, in a “cash cow” business focused on buybacks and dividends, he said.

Conglomerate Distaste

“I tend to be one of those investors who doesn’t appreciate having to look at conglomerates,” Konstantinos said. By splitting a company into two, “not only are you allowing shareholders to choose for themselves which sort of investment style they want to pursue, you’re also freeing up management.”

Sony’s electronics business could use the extra attention, said Ernst of Hudson Square. The cost cutting and restructuring only go so far and those actions don’t solve the problem of reviving revenue, he said.

“What Sony really needs is new product momentum,” Ernst said. “Based on what we see now, I don’t see that in electronics.”

While the company projected a 28 percent jump in mobile products revenue this year and 17 percent growth for TV sales, the forecasts are too optimistic, according to Masahiko Ishino, a Tokyo-based analyst at Advanced Research Japan Co.

Trailing Smartphones

In smartphones, the company faces competition in the high- end market from South Korea’s Samsung Electronics Co. and Apple Inc., based in Cupertino, California. Sony accounted for 3.8 percent of global smartphone sales in 2013, compared with Samsung’s 31 percent and Apple’s 15 percent, according to data compiled by Bloomberg from International Data Corp.

“They’ve got competitive threats from many different angles they didn’t have in years past,” Ben Bajarin, an analyst at consulting firm Creative Strategies Inc., said by phone.

Excitement about 4K TV sets -- which Sony has touted as central to reviving that unprofitable unit -- will weaken as eventually most TVs offer that quality, said Goyal of Jefferies.

Those challenges may argue for getting rid of the electronics business altogether, he said.

Others, such as Lawrence Haverty of Gamco Investors Inc., are more bullish on the electronics business. Industrywide sales of 4K TVs are poised to leap more than 11-fold from 2013 to 2018, according to IDC.

Sony also has already taken steps to get the company on the right track, said Amir Anvarzadeh, manager of Japanese equity sales in Singapore at BGC Partners Inc., who says he had been bearish on the company for years, until recently.

Looking Better

“For the first time over the last four or five months, I am seeing real signs that the company is doing all the right things,” Anvarzadeh said by phone. “You could argue that it’s come too late, but we are where we are and the question is, ‘How would you restructure this business at this stage?’”

Severing ties between the electronics and entertainment operations now would be a mistake, he said.

“For Sony to give up its best businesses, its highest cash-flow generating businesses, when it needs it the most, doesn’t makes any sense,” Anvarzadeh said.

Even so, investors should be allowed to choose which part of the business they want to invest in, said Konstantinos of RiverFront. A breakup could be “the next logical step,” he said.

“It seems like the electronics business in general continues to just disappoint,” Konstantinos said. “After some of the bad quarters they’ve had, some people were starting to get the idea that maybe all the bad news was priced in. This was sort of a wake-up call. It’s ripe for some sort of shake-up.”

--With assistance from Aaron Clark in Tokyo and Angus Whitley in Sydney.