You don’t hear about Sony stock nearly as often as you should.
As a global conglomerate with its hand in microchips, film production, music, and consumer electronics (via its PlayStation and TVs), Sony is a household name with a long history of success.
Its market cap of $80 billion, while impressive, is dwarfed by the likes of Walt Disney Co. (NYSE: DIS) (market cap: $265 billion) and Comcast Corp. (NASDAQ: CMCSA) (market cap: $200 billion), which owns NBCUniversal.
That’s a shame. Sony is a solid, well-run company that’s greatly undervalued right now – despite year-to-date gains of 34%.
It also has a solid Money Morning Stock VQScore™ of 3.6 out of 4.9.
In fact, there’s a lot to like about Sony stock…
Sony Is a Global Powerhouse
People the world over know the Sony brand. It’s among the top 100 brands in the world (ranked 56th by brand consultancy Interbrand).
And its diverse businesses keep revenue relatively stable.
Here’s a snapshot of Sony’s varied operations and how much each segment contributed to the top line in the 2019 fiscal year, which ended March 30:
- Game & Network Services (25.9%): Includes the PlayStation series.
- Financial Services (14.4%): Includes insurance operations, mostly in its home base of Japan.
- Home Entertainment & Sound (12.9%): Includes LCD televisions, home audio, Blu-ray players, and portable audio devices.
- Pictures (11%): Includes motion picture production, home video acquisition, and distribution and studio facilities.
- Semiconductors (9.8%): Includes the design and manufacture of various image sensor chips and other semiconductors.
- Music (9%): Includes the development, production, and marketing of recorded music as well as music publishing.
- Imaging Products and Solutions (7.5%): Includes video cameras, digital cameras, and broadcast products.
- Mobile Communications (5.6%): Includes mobile phones.
- All Other (3.9%): Includes the PC business, DVD and CD manufacturing, and a Japan-based Internet-related service business.
Three segments in particular are poised for strong growth this year. They happen to be the three biggest contributors to Sony’s bottom line: image sensors, music, and gaming. Together, these three make up 44% of Sony’s annual revenue and 70% of its operating profits.
Sensors: In its most recent quarter, Sony saw profits for its imaging sensors rocket by 59% to an all-time record. The reason behind the surge is rising demand from smartphone makers like Samsung Electronics Co. Ltd. (OTCMKTS: SSNLF), Apple Inc. (NASDAQ: AAPL), and Huawei Technologies.
In the arms race to offer fancier features in their high-end models, the smartphone makers are adding a third camera. That’s boosting Sony’s sales of sensors now. But demand will continue to rise as the triple-camera setup migrates to the mid- and low-range product lines.
The outlook for its imaging sensors is so good that in October, Sony raised its earnings forecast for FY2020 by 4%. Sony has more than half of the global image sensor market.
Gaming: Anticipation of the PlayStation 5 has hurt Sony’s gaming sales this year as customers await the new model. But Sony is set for a surge in profits after the PlayStation 5 debuts just before the December holidays in 2020. The PlayStation is the best-selling game console of all time.
Music: Sony Music revenue rose 10.5% year over year in the most recent quarter, but the key here is in the underlying trends. While physical music sales (CDs and vinyl) and downloads have mostly been flat, streaming revenue is exploding.
Streaming revenue was up 21.4% in the last quarter alone. Sony is so optimistic about growth in this segment it raised its revenue forecast for the current year by 2%.
The publishing side of Sony Music is benefiting from last year’s acquisition of EMI, which doubled that unit’s operating income. Sony expects music publishing revenue to grow at a rate of between 5% and 7% over the next three years.
And yet the market is shortchanging Sony stock right now. According to Money Morning Executive Editor William Patalon III, Sony shares are undervalued by as much as 60%.
It all has to do with how the market perceives Sony’s diversity…
Why Sony Stock Should Be Worth at Least $100
Patalon recently recommended Sony stock to readers of his daily Private Briefing column.
“Sony is getting hit with what’s known as the ‘conglomerate discount,'” Patalon said. “It’s when companies with a wide range of businesses are valued at less than the sum of their parts.”
He cited the bid by Tencent Holdings Ltd. (OTCMKTS: TCEHY) to acquire as much as 20% of the Universal Music unit of French media conglomerate Vivendi SA (OTCMKTS: VIVHY). That deal valued Universal at about $33 billion.
“If you apply that to Sony Music, the world’s No. 2 music publisher, you come up with a valuation of $23 billion – and nearly $27 billion if you add in Sony Music Japan,” Patalon said. “And if you add that to the implied value of Sony’s film and gaming units, the ‘content’ part of Sony is worth roughly the same as the company’s entire current market value of about $80 billion.”
That assigns no value at all to Sony’s semiconductor, home entertainment, and other businesses – which obviously is not true.
The Nikkei Asian Review assessed the true worth of each of Sony’s businesses by looking at them as standalone companies. It used industry averages to calculate a new valuation for each.
“They came up with an enterprise value of about $131 billion,” Patalon said. “That’s a 60% discount to the current EV of about $78 billion.”
If you remove that “discount” from the current Sony stock price of about $66, you get an implied price of $106.
And Patalon thinks some changes are in the offing that could drive Sony stock closer to that higher price…
A Blueprint to Raise the Sony Stock Price
Not surprisingly, Sony’s “conglomerate discount” has attracted the attention of an activist investor – Third Point’s Dan Loeb.
Loeb released a 104-page report in June detailing how Sony could extract value for shareholders. Third Point owns 1.5 million shares of SNE stock.
Loeb’s primary suggestion was for Sony to spin off its chip division as a separate company. He also asked the company’s board to “consider the divestiture of its public equity stakes” in Sony Financial, M3, Olympus, and Spotify.
In September, Sony’s board unanimously rejected Loeb’s proposal. Sony Chair and CEO Kenichiro Yoshida explained that the board considers the chip unit a “crucial growth driver” integral to the company’s success.
But that doesn’t mean Loeb’s suggestions won’t affect Sony’s decision-making going forward.
You see, this was Loeb’s second attempt to shake up Sony. The last was six years ago, when he tried to get the company to sell off its entertainment businesses. Sony rejected that proposal, too. But afterward, it doubled down on efforts to increase profitability not just in the Pictures division, but throughout the company.
Since Loeb made that proposal, SNE stock is up 230%.
And while Sony has again rejected Loeb’s exact remedy, it has started to make moves that echo what he suggested.
It divested its 5% stake in Olympus Corp. (OTCMKTS: OCPNY) in August. Patalon thinks more such divestitures are likely.
Sony is also shedding money-losing businesses like its live TV streaming service, PlayStation Vue, which it is shutting down in January. Instead, Sony is focusing on its content creation in movies and television. And it intends to sell that content to “all potential buyers,” according to the Hollywood Reporter.
Toward that end, Sony just announced it is buying children’s animation studio Silvergate Media. And in November, Sony became the sole owner of GSN (Game Show Network).
Such changes will start to extract Sony’s true value, boost profitability, and drive the stock price higher.
Patalon recommends investors use his “accumulate” strategy with Sony: “Buy a ‘foundational stake’ – and look to add shares on pullbacks or as you get additional cash.”
— David Zeiler
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Source: Money Morning