Sony Remains A BUY!

Summary

• The conglomerate is firing across all fronts, especially with respect to its Gaming and Music businesses.
• Successful restructuring of its mobile business is leading to record profitability in it's Electronic Products division.
• Consolidation of the Financial and Music businesses represents excellent capital allocation decision making.

Introduction

On February 3, Sony announced financial earnings that indicated an turning point with respect to significantly increased margin leverage. Key highlights included:

• Finance - 4% increase in Revenue and 40% increase in Profit.
• Music - 15% increase in Revenue and 50% increase in Profit.
• Gaming - 41% increase in Revenue and 50% increase in Profit.
• EP&S - 1% decline in Revenue and 31% increase in Profit.
• I&SS 11% decline in Revenue and 34% decline in Profit.

The across the board increase in profit has been orchestrated by CFO turned CEO Kenichiro Yoshida who has put capital discipline and profitability as the key focus for the business.

Earnings estimates suggest full year net income of 1.1 T yen which is almost double the 490 bn yen in net income at the start of Yoshida's tenure in 2018.

Gaming - The new PS5 cycle

The launch of the PS5 is likely to dawn a new gaming cycle. The PS5 cycle is set to be Sony's most profitable as gaming software now accounts for over 60% Gaming Revenue.

The high proportion of software revenue in addition to the use of the common x86 architecture for the PS5 has led Sony to forecast an FY20 operating margin of 11.5%.

As you can see from the chart below, this puts operating margins at the start PS5 cycle close to where they were near the end of PS4 cycle which is a marked change from the PS2, PS3 and PS4 cycles which for the most part began the cycle at break-even/loss territory.

With software revenue growing at 43% yoy, it could be anticipated that Sony would be able to push gaming margins into 20%+ territory in the mid-to-late PS5 cycle.

Yoshida-San's Excellent Capital Allocation

Excellent capital allocation decisions by management has served to grow earnings substantially over the past few years.

As per the table below, the 2018 consolidation of EMI and the 2020 consolidation of Sony Financial at >10% cap rates are starting to shine through and be reflected in the earnings.

Its clear that Sony has ample opportunities for capital investment across all of its business divisions as highlighted by its recent acquisitions of Crunchyroll for $1.175 bn and Kobalt Music for $430m.

Its likely that Sony will continue to allocate the majority of its free cash flow to acquire earnings accretive businesses across Gaming, Music, Anime and Pictures where continued demand for entertainment presents secular tailwinds.

Year	Division	Deal
2018	Music	Consolidates EMI for $2.3 bn. Management forecast consolidation will increase cash flows by $275m USD. 275/2300 = 11.9% yield.
2020	Financial Services	Consolidates Sony Financial for $3.7 bn. Management forecast consolidation will increase earnings by $480 m USD. 480/3700 = 13% yield
2020	Gaming	Purchases a 5% stake in Bilibili for $680m USD.Stake is now worth $2.65bn USD.

SOTP Valuation for Sony

Segment	Revenue (TTM)	Comp Set	EV/Sales
Gaming Software	1,532,945	TTWO	6.5
Network Services	368,764	ATVI	8.38
	1,901,709	EA	6.5
		UBI	4.83
		Average EV/Sales	6.5525	Enterprise Value	$12,460
Segment	Operating Income (TTM)	Comp Set	EV/EBITDA
Music	177.5	WMG	26
		VIV	16
		Average EV/EBITDA	21	Enterprise Value	$3,727.50
Segment	Operating Income (TTM)	Comp Set	EV/EBITDA
Movies	101.9	VIAC	9.2
		FOX	7.8
		NWS	11.68
		Average EV/EBITDA	9.56	Enterprise Value	$974.16
Segment	Operating Income (TTM)	Comp Set	EV/EBITDA
EP&S	91.6	CAJ	8
Gaming Hardware	37.9	FUJIFILM	11.2
	129.5	TCL	4.5
		Average EV/EBITDA	7.9	Enterprise Value	$1,023.05
Segment	Operating Income (TTM)	Comp Set	EV/EBITDA
IS&S	159.2	CAJ	8
		ON	16.63
		II-VI	16
		AMS	11
		Average EV/EBITDA	12.9075	Enterprise Value	$2,054.87
Segment	Operating Income (TTM)	Comp Set	EV/EBITDA
Sony Financial				Enterprise Value	$1,142
				SOTP	$21,382
				Investments & Cash	8,300
				SOTP & Investments & Cash	$29,682 Trillion JPY