Sony Undergoes Californication As Profits Surge

| About: Sony Corporation (SNE)
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Summary

Sony setting up "Sony Interactive Entertainment" division in California.

PS4 and Movies divisions the highlights in last quarter.

Diversification and standalone unit profitability strategy paying off.

In my January article on Sony (NYSE:SNE), I pointed out that the company was well-placed to profit in 2016 and 2017 on the back of its well-diversified product strategy. Its latest results for Q3 2015 and comments at its analyst call very much reinforce this. Setting up a new "Sony Interactive Entertainment" division in San Mateo, California, on 1st April this year can be seen as a declaration by the company that it's back to creativity and being at the forefront of the kind of technological change for which it used to be famous.

Results.

The highlights from Q3 2015 are as follows:

  • Revenue +0.5% to 2,580.8 billion Japanese yen (US$21.5 billion). Analysts had predicted JPY2,523 billion.
  • Operating Income +11% to JPY202.1 billion (US$1.685 billion).
  • Net income attributable to shareholders JPY120.1 billion (US$983 million).
  • Net income per diluted share +21.3% to JPY93.33 (US$0.78). Analysts had predicted JPY73.69.

The beating of analyst forecasts gave the share price on the NYSE an immediate overnight rise of over 17%. Sony is a strong buy at this point, and long term, there is no reason why its share price should be falling because the price of oil is falling.

The price later fell back on general market trends but not on Sony specifics. It is widely anticipated that the company will continue to increase its dividend payout based on the improved results and generally optimistic outlook.

The strong results were driven by the performance of the Game and Network division (headlined by PS4), the Pictures division and the Music division.

As usual, the often overlooked Financial Services was a strong and steady contributor to the bottom line. Indeed, for the period Q1 to Q3, it was the best performing division. Operating income totaled JPY52.2 billion (US$427 million) and for the first three quarters was at JPY139.4 billion (US$1.14 billion).

The phone business continued to be troubled and the previously high-flying image sensor division had a disappointing quarter. The latter was a sign that the world mobile phone market is indeed in a downturn but also was affected by capacity constraints.

For 2015 as a whole, the company has targeted full-year revenue of JPY 7,900 billion, slightly below analyst expectations of JPY 8,122 billion. The company forecast is unchanged from that made at the Q2 results briefing.

However, the mixed bag between the different divisions is a sign of strength, not of weakness. It shows the strategy of independent profit center divisions within a well-diversified company is paying off.

On the analyst call, CFO Kenichiro Yoshida got to the heart of the matter:

"We achieved the highest level of third quarter consolidated operating income and net income since Q3 2008. This was primarily due to the significant cost reductions we undertook... and due to our strategy of not chasing share, we like to emphasize profitability."

PlayStation Comes to California.

PS4 is at the center of the resurgent company and is its fastest-growing business. The figures show this.

In Q3, revenue was JPY587.1 billion (US$4.8 billion) and operating income JPY40.2 billion (US$329 million). For the first three quarters of the year, the figures were JPY 1,236.4 billion (US$10.1 billion) and JPY 83.5 billion (US$684 million).

In Q3 2015, the company sold 8.4 million units, up from 6.4 million in the same quarter last year. PS software sales also were up sharply. This illustrates it is not just about consoles but covers hardware, software, content and network business opportunities.

Sony Interactive Entertainment (SIE) will be the result of merging Sony Computer Entertainment with Sony Network Entertainment. As my previous article pointed out in some detail, PS4 has been substantially the market leader over rival Xbox from Microsoft (NASDAQ:MSFT). It has sold approximately double the figure of Xbox consoles over the lifetime of the product. As for traditional rival Nintendo (OTCPK:NTDOY), it just published its results for the October to December period. These illustrated how Nintendo is indeed a profitable business, but with very little growth. PS4 has sold approximately three times what the Wii U has been able to achieve.

However, now PS4 is not just competing against Xbox and Wii U consoles. It is fast becoming a full-service offering rather than purely a games console.

As such, PS4 incorporates many things:

  • PlayStation Vue is a challenge to the cable TV companies at an opportune moment as cord-cutting catches on.
  • PlayStation Store offers video rental, competing with the iTunes offering from Apple (NASDAQ:AAPL).
  • PlayStation VR will later this year put Sony strongly into the virtual reality market which is forecast to take off in coming years. This will see a face-off with the likes of Facebook (NASDAQ:FB) and Samsung (OTC:SSNLF) and perhaps Apple.
  • PlayStation Now is set to offer a cloud gaming platform for the whole PlayStation brand.

PS4 has a raft of promising products for the coming year:

  • "Unchartered 4: a Thief's End" due in April, reportedly with very strong pre-orders on Amazon.
  • "No Man's Sky" due in June.
  • "Horizon Zero Dawn" with strong pre-orders reported.

The move from Japan to the US for this division is a reflection of the success of PS4 in North America. Additionally, it is an indication that Sony aims to be at the forefront of technological and fashion trends in an industry which in many ways is better geared to Western trends than to those in Japan. Its key partners are in the US and major shifts in digital content tend to happen in the US.

As CFO Yoshida said at the analyst call:

"Locating the headquarters there will allow us to quickly respond to the rapidly changing business environment and continue to expand and strengthen the PlayStation business."

The company is targeting JPY 1.6 trillion in revenues for the year ending March 2018.

Image Sensor Division.

Sony is the world leader in this business. It is understood to be the almost exclusive supplier to Apple iPhones and a major supplier to Samsung. Sony is generally regarded as being the highest quality manufacturer of sensors for mobile phones as particularly evidenced by the Sony Z5 model and also the Samsung S6.

It has recently bought an Israeli company, Altair Semiconductor, for US$212 million to strengthen its hand further in new technology in this field. This company specializes in 4G LTE modem chips and RF modules. Its products are primarily used for upgrading from 2G to 4G and will enable Sony to combine Altair chips with its own Global Navigation Satellite System products.

This is very key to the company's future. It is part of Sony's drive to connect products such as wearables, smart appliances, cars and drones.

The Altair deal explains why Sony has decided to keep its mobile phone business as a strategic asset and part of an "Internet of Things" strategy. Other new products under development by Sony in this field include smartwatches, smart glasses and fitness trackers. 4G modem chips will help Sony tie all these elements together.

Seeking Alpha contributor Jimmy Lamz in the comments on his recent article stated that "they need to dump the phones." With respect, I believe he is very much mistaken there and this most definitely will not happen. The phones are regarded by management as strategic to the company's future direction.

Image sensors have been very profitable for Sony and the company has a great market position for the long term. However, this division (which also includes batteries and camera modules) declined 12.6% in the quarter just gone on the back of the worldwide slowdown in mobile phone sales. On the results briefing, the company also explained that it turned down several phone manufacturers last year as the company was supply-constrained at the time.

One might speculate on a likely rise in sales again in Sony's fiscal 2017 with the advent of the reported iPhone 6C and iPhone 7. The division also should be boosted by the launch of their new dual lens-dual camera platform this year.

Pictures Division

This ended 2015 very strongly and has a promising raft of new pictures planned for 2016 and 2017. These include "The Angry Birds" and "Ghostbusters" and what are seen as new potential franchises with the "Jumanji" and "Barbie" brands. Big name stars include Sacha Baron Cohen, George Clooney, Denzel Washington, Kate Beckinsale, Tom Hanks and Jennifer Lawrence. Further films under the "Spider-Man" franchise are expected for 2017 and 2018.

Revenue for the quarter was up 26.9% on the back of the latest James Bond franchise "Spectre" and the success of "Hotel Translyvania 2." After some hiccups in the past, Sony seems to have this division primed for a strong and profitable market position. Increased management time in sorting out the division can perhaps also be seen as a further "Californication" of the company.

Music Division

This continues to be a sound profit-maker for the company and definitely integral to its future strategic direction. It is also at the heart of the soul of the company since the time the company effectively invented mobile music.

The division produced JPY27.4 billion (US$228 million) in operating income in the most recent quarter. For the first three quarters of the year, it contributed JPY73.7 billion (US$604 million), the third highest division contribution behind Financial Services and the PlayStation business. New music by Adele and One Direction gave the division an extra boost. Sony upped its forecast for a strong increase in revenue for the coming year on the back of increased sales of recorded music, of visual media and growth in the music streaming sector.

Conclusion.

In "Californication," the Red Hot Chili Peppers sang of how the sun may rise in the East but that it settles in the final location of California. Sony seems to be heeding this and reinventing itself as a creative entity in a world where California is seen as the seed-bed of business creativity in the high tech field.

Sony has product and geographical diversification on the back of successful rationalization. Its technological prowess in new growth areas means that its glory days, so long behind it from the days of the Sony "Walkman," could see a brave new world for it in the years to come.

Disclosure: I am/we are long AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.