Sony’s (SNE) share price went up 9% after news reports that Third Point is building a stake between $500 million and $1 billion in the company. If accurate, this would be Third Point’s second attempt to take a position in Sony. In 2013, it proposed that Sony dismantle the entertainment business as well as Sony Financials so it could focus on electronics.
Given the price reaction, the stock has clearly already priced in Third Point’s intent. But we think major changes to the corporate structure are unlikely, and thus, investors should stay focused on the fundamentals. Key upcoming events to look out for include the 4Q18 results on 26 April and the IR day on 21 May, where each division will present its medium and long-term goals.
But even following the Third Point-driven "premium", Sony stock has underperformed since late last year.
(Source: Yahoo Finance)
Google’s introduction of game streaming services, unfavorable FX movements, and consistent mobile losses, among other factors, have presumably weighed on the stock.
On the one hand, nearly 80% of operating profit is stagnating. Games, Insurance, HE&S (includes TVs) and Imaging (includes cameras) divisions are slowing down, leaving Music, Movies and CMOS to drive growth.
On the other hand, Sony's earnings quality is much better than it used to be, and it should continue to generate healthy, stable cash flows.
We think that more important than spinning off businesses or exiting the smartphone division, Sony should transition to a more shareholder-friendly policy, returning more cash to investors and thus spurring interest in a new class of stockholders.
With a current dividend yield of 0.6%, Sony may not seem attractive to income investors, but the prospect of a rising dividend and a 100 billion yen buyback program may entice a yield-seeking investor base.
While we do think Sony is attractive from a valuation standpoint and offers potential capital return upside, we think it more prudent to fade the Third Point-driven rally. As we saw in 2013, such rallies tend to fade as investors focus on fundamentals eventually. Thus, we favor waiting for a more opportunistic entry point ahead.
Furthermore, we think there is risk Sony could be heading into some turbulence, especially considering Dan Loeb's tendency for "hard" activism, which has historically led to lose-lose situations in corporate Japan. Potential activist-driven dips could present more attractive entry points.
Third Point …again?
According to a Reuters report on April 8, Third Point, a US activist fund is building a stake in Sony with intentions to draw a proposal for a revamp.
Both parties have a history. In 2013, Third Point acquired a stake in Sony and proposed spinning off the entertainment business. At the time, Sony rejected the proposal, advocating the need to keep a 100% stake in the business to ensure it contributes to overall earnings.
Nevertheless, the incident led Sony to improve disclosure to help investors monitor the business. Like the recent rally, the share price went up 10% on the news back then but faded when Third Point exited Sony before October the following year.
What’s changed since then?
The values of Music and Games &Network Services have grown since 2013, while the value of electronics has decreased due to the overall cooling of consumer electronics demand, including Semiconductor. Given that the remaining electronics business faces strong competition in a muted industry outlook, we believe spinning off the entertainment business may not create additional value to Sony. That’s why it remains unclear how Third Point (or other activists) can unlock the value of Sony’s different business units.
Sony currently positions entertainment as a core business and the company is strengthening ties with content creators and artists while leveraging hardware technologies. Even if Sony receives outside proposals similar to those last time, we doubt it will spin off the entertainment business.
We think it’s much more likely that Sony considers strategic partnerships to leverage its gaming platforms and content while at the same time creating greater synergies within Sony.
Lessons from Apple Inc.
Although we believe the stock is trading at attractive levels, the slowdown in growth decreases the stock's appeal to growth-oriented investors.
This happened to Apple a few years ago. From Sep ’12 to Apr’ 13, Apple stock fell 44%. The fact that it was cheap and had 20% of its market cap in cash wasn’t enough to limit downside.
It bottomed only after Apple more than the doubled capital return program and increased its appeal to income-oriented investors.
At the time Apple was in a strong position in the smartphone market, with a fortress balance sheet. The only thing that changed was earnings growth expectations that started to fall.
As growth investors exited to find new opportunities, the company shifted gears toward a massive capital return program to attract a more income-oriented investor base.
A lesson for Sony we think - give back more to shareholders.
We think there is every chance Sony does an Apple and shifts gears toward a more proactive capital return policy to attract an income-oriented investor base as growth slows. Thus, we think Sony is worth a look for yield-seeking investors as Sony is capable of raising the dividend, in addition to its ¥100B buyback program, given its financial capacity.
But Sony tends to be reluctant to make drastic changes such as exiting key business segments (case in point - the smartphone division, which continues to generate losses) so we don’t expect much different this time around. If Third Point has learned its lesson and adopts a softer engagement style, we think they will have better results, but given Dan Loeb's record, we think there could be turbulence ahead in the Sony story.
Instead, we favor a wait-and-watch stance as we think any activist-driven dips could spell opportunity.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.