Sony Research Report

Sony Analysis
Prepared by: John R. Pangere October 2011
Sony Corporation (ADR) (NYSE: SNE)

Date of Report: Current Price: 52-week range: Average Daily Volume: FY 2011 EPS (Reported): FY 2011 P/E: Dividend Yield: Index Membership: 10/1/2011 $19.00 $18.39 - $36.97 1,192,038 ($3.23) 1.6% NYSE Shares Outstanding (Millions): 1,005 Institutional Holdings: 7% Fiscal Year Ends: 31-March FY 2011 Net Income (Millions): ($3,220) Book Value, as reported (Millions): $32,922 Market Cap. (Millions): $19,812 Price/Book Value: 0.58x Industry: Electronics
Business Description: Sony Corporation is a Japan-based company mainly engaged in the manufacture and sale of electronic products. It has several business segments. The Consumer Professional Device (CPD) segment manufactures and sells televisions, cameras, audio videos, semiconductors, batteries, data recording systems and other industrial equipment. The Network Products Service (NPS) segment designs, develops, and sells game consoles, game software, personal computers (PCs), personal navigation systems and portable audio devices. The Movie segment produces movies and television programs. The Music segment produces and sells music software and animation works. The Finance segment provides life and non-life insurance services, banking services and credit finance services. The Sony Ericson segment operates a mobile phone business. The Others segment is involved in the provision of blu-ray disks, network services and advertising agency services. The company was formerly known as Tokyo Tsushin Kogyo Kabushiki Kaisha and changed its name to Sony Corporation in January 1958. Sony Corporation was founded in 1946 and is headquartered in Tokyo, Japan. *Note: The following report will be based mainly in Japanese Yen figures, with references to reconcile the difference between the yen and US dollar for comparison purposes. The US dollar/Japanese yen exchange rate may affect any actual differences between Sony as listed on the Tokyo Stock Exchange and as listed on the NYSE.
Investment Thesis With the stock currently selling at a price near its 52-week low, the company is selling at a compelling valuation. Over the past 3 fiscal years, Sony has reported net losses, which has been one cause for the price of Sonys stock to fall from 6,040/share to its current price of 1,507/share since the beginning of 2008. (The ADR in the US has fallen from $55.30/share to
Copyright 2011 by John R. Pangere. All rights reserved. Sources: Sony Company filings and presentations, ETrade Research Center, Oanda.com, Google Finance, Yahoo Finance, Finviz.com
Sony Analysis
its current $19/share). This is partially due to the struggling economy and partially due to other factors internal to Sony to be later discussed in this report. In addition, Sonys stated book value (as of FY 2011 10-k) is 2,923/share, which is approximately 1,000/share less than adjusted book value of 3,914/share (as adjusted by my estimates). The adjusted book value represents a reproduction of the assets of Sony, including selling, general and administrative costs, advertising and promotion costs, and research and development costs if a competitor were to enter Sonys market and compete on the same level as Sony. The adjustment includes a reduction for all of Sonys current outstanding debt. With the shares currently selling at 1,507/share, the company is selling at a discount of 161% below adjusted book value, or 0.39x adjusted book value. Historically, the company trades at 1.07x book value over the past 5 years, with a high of 1.89x and a low of 0.73x. The current book value compares favorably with the Consumer Goods Electronics industry average of 2.4x, and the companys top four competitors selling at a book value of 0.94x. A return to historical book value would price the shares at approximately 4,200, approximately a 179% return from current valuation, while a return to the average of Sonys four closest competitors would price the shares at 3,679, an increase of nearly 144% from Sonys current share price.
The companys restructuring initiatives have helped them return to operating profitability. Since FY 2008, Sony has been transforming their business operations through a major restructuring program designed to reduce costs and increase profits. Over that time, Sony has spent 301,453 million in restructuring fees, mainly through a reduction of unprofitable business lines and total number of employees. The short-term effects of these restructuring initiatives, as well as other factors, have been one of the major causes for Sonys operating and net losses since FY 2009. During FY 2009, Sony recorded an operating loss of 227,783 million. During that year, four out of seven operating segments reported losses. In FY 2011, Sony recorded an operating profit of 199,821 million with all operating segments reporting operating profits. (See appendix for further details) Over the course of three fiscal years, Sony has become more efficient, and therefore more profitable through its restructuring initiatives. While the majority of the restructuring initiatives
Sony Analysis
have been completed, Sony anticipates further restructuring in FY 2012 of 25 billion, which may help Sony slash costs even further and increase profit margins. The companys free cash flow is sufficient to weather hard times. Over the last 3 years, Sony has averaged approximately 76,840 million in free cash flow. In FY 2011, free cash flow totaled 234,140 million, a product of reduced capital expenditures and increased operating income. As seen below, cash flow has improved significantly since FY 2009:
2011 Operating Cash Flow Capital Expenditures Free Cash Flow
*Numbers in millions
2010 423,259 338,050 85,209
2009 191,592 496,125 (304,533)
2008 842,537 474,552 367,985
2007 528,955 527,515 1,440
487,828 253,688 234,140
This free cash flow can be used in several ways, such as to increase the cash position of the balance sheet, repay debt, and continue to maintain the current 25,000 million per year dividend. The cash dividend currently provides shareholders a yield of 1.6%. The average yield of the industry is 1.0%. In addition, if one looks at free cash flow as a true measure of profitability, Sonys actual profit for FY 2011 would have been 234,140 million, or 236/share, which currently values Sony at less than 10x free cash flow
The company has a strong balance sheet. Sony has maintained a solid balance sheet for many years:
2008 1,086,431 975,586 (110,845) 3,741,938 -0.03 2009 660,789 1,208,814 548,025 3,216,602 0.15 2010 1,191,608 1,111,302 (80,306) 3,285,555 -0.03 2011 1,014,412 1,084,162 69,750 2,936,579 0.02
Cash Debt Net Debt Equity Debt/Debt+Equity
*Numbers in millions of yen, except Debt/Debt+Equity ratio
Sony Analysis
As evidenced above, Sonys net debt position, at just 2% of debt to debt-plus-equity, allows the company greater financial flexibility in order to weather an economic downturn and weakened sales figures. The company is more profitable than at first glance. During FY 2011, Sony reported a net loss of 259,585 million, which may be very bleak and dismal to the eyes of some investors, yet does not show the true picture of the companys health and profitability. Sony recorded a pretax income of 165,754 million, with income taxes totaling 425,339 million yen. The income tax figure was comprised of total current taxes of 117,918 million yen, and deferred taxes of 307,421 million yen. Had it not been for the large deferred tax figure in FY 2011, Sony would have recorded a net profit of approximately 47,836 million, a 217% increase over FY 2010.
Investment Risks Uncertainty regarding the effects of the Great East Japan earthquake. The Great East Japan earthquake in March of 2011 caused a significant amount of damage to certain of Sonys fixed assets, including buildings, machinery, equipment and inventories. The losses sustained by Sony amounted to 10,897 million, most of which has been offset by insurance recoveries to date. While insurance has covered the losses of these physical assets, there still remains uncertainty regarding business interruptions and/or lost profits over the short-term due to the effects of the earthquake. Any business interruptions and/or lost profits are not currently covered by insurance and may affect Sonys operations in the coming quarters. The ultra-competitive electronics market. Sony faces an intense amount of competition with other premium electronics makers, including Panasonic, Philips, Sharp, and Harman, as well as generic manufacturers of products Sony currently manufactures, markets, and sells. Intense competition across all of the geographic regions Sony is currently active in could adversely affect future sales and profitability. Sonys sales trends geographically (as shown below) have shown weakness in the US and European markets, and any continued weakness, if not offset by increased sales in other geographic regions, may adversely impact Sonys attempt to return to net profitability, as well as continued weak performance of Sony stock.
Sony Analysis
2009 Operating Revenue: Japan USA Europe Asia-Pacific Other Total

*Numbers in millions of yen
2010 2,099,297 1,595,016 1,644,698 1,193,573 681,414 7,213,998
2011 2,152,552 1,443,693 1,539,432 1,288,412 757,184 7,181,273
1,873,219 1,827,812 1,987,692 1,285,551 755,719 7,729,993
Continued weakness in the global economy. A weak global economy may adversely impact Sonys bottom line. During recessionary times, consumer cyclical companies such as Sony may see declined sales of their products due to consumers seeing many of Sonys products as discretionary purchases and not necessities. With economies struggling across the globe, including the US and Europe, sales of Sonys products may continue to be depressed in these locations. In addition, with the Japanese yen strengthening against other major currencies, such as the US dollar, the Euro, and the British pound, it may prove difficult for Sony to increase sales to other regions of the world due to the current exchange rates. Current exchange rates are as follows:
Currency Pair USD/JPY EUR/JPY GBP/JPY September 2011 77/dollar 104/euro 120/pound September 2007 115/dollar 163/euro 233/pound % Change -33% -36% -48%
*Data obtained from Oanda.com as of September 30, 2011
Since the bulk of Sonys sales are earned mainly through exporting its goods to other regions of the world, the continued strength of the Japanese yen may prove to be a formidable obstacle in trying to increase sales across the globe. (See appendix below for trends in geographical sales.)
Potential Catalysts: 1. Continued efficiency and greater profitability due to restructuring initiatives: As shown below in the appendix, Sonys continued restructuring initiatives have helped the company to return all of their business segments to operating profitability. For FY 2012,
Sony Analysis
Sony will continue its restructuring program, albeit on a much smaller scale than in previous fiscal years, to the tune of approximately 25 billion. A breakdown of restructuring charges since FY 2009 by business segment is as follows:
2009 53,732 2010 68,640 2011 38,018
Consumer, Professional & Devices (CPD) Networked Products & Services (NPS) Pictures Music Financial Services All other and corporate Total net charges
3,062 4,908 6,337 789 6,562 75,390
3,682 5,605 5,225 5,078 28,242 116,472
7,021 2,722 2,662 5,010 6,885 62,318
According to the footnotes section of the FY 2011 Annual Report, the bulk of incurred restructuring charges occurred due to employee termination benefits. Segments such as the CPD and Networked Products divisions, which operated at a large loss during fiscal years 2009 and 2010, showed operating profits of 2,898 million and 35,569 million in FY 2011, resulting in a 105% improvement for the CPD segment over FY 2010 and a 143% improvement for the Networked Products segment over FY 2010. Sonys ability to more efficiently produce its products with fewer employees and continually improve its operating margins in each segment due in part to these restructuring intiatives may continue to help it maintain operating profits across all business segments, and/or even further improve these profits in the coming quarters and years. 2. A return to a reported net profit: Sony reported substantial net losses in the fiscal years ended 2010 and 2011 of 40,802 million and 259,585 million, respectively. While the FY 2010 net reported loss was largely due to operating and other losses, the FY 2011 net reported loss was largely due to a deferred taxes (as previously discussed). The breakdown of taxes incurred by Sony are as follows (see appendix for effective tax rates):
Sony Analysis
Income Taxes Current: Japan Foreign Total Income Taxes Deferred: Japan Foreign Total Total Income Tax Expense (benefit)
2009 34,631 45,890 80,521
2010 42,723 5,975 48,698
2011 60,514 57,404 117,918
(105,211) (48,051) (153,262) (72,741)
(25,589) (9,151) (34,740) 13,958
365,665 (58,244) 307,421 425,339
With such a large net deferred tax figure of 307,421 million, Sonys book profits may have looked abysmal to many investors, which may be a cause for its continued weakness in the stock market. If Sony is able to report a net profit in the coming quarters and fiscal years, it may help boost the confidence of investors. 3. Expansion of new and profitable business segments: While Sony has been known as a premier maker of consumer and other electronics, Sony also operates a banking and insurance business in Japan. This expansion has proven to be very lucrative to Sony, as shown below. In fact, after incurring an operating loss in FY 2009, Sonys Financial Services segment has been its most profitable business line as shown below:
Revenues Operating Profit Operating Margin
2009 538,206 (31,157) (5.8)%
2010 851,396 162,492 19.1%
2011 806,526 118,818 14.7%
While the Financial Services segment, which comprises of life and non-life insurance operations, and banking operations through a Japanese Internet-based banking subsidiary, currently only operates throughout Japan, continued expansion of this segment in Japan, as well as internationally, may boost Sonys profitability and cash generating capacity even further, if they are able to maintain operating margins close to those reported over the last two fiscal years.
Sony Analysis
Taken together with Sonys continued restructuring efforts, the company may be able to unlock larger profits and reduced expenses with an expansion of the Financial Services segment, while continuing to maintain a position as an innovator of electronic products in the ultra-competitive consumer electronics industry. 4. A weaker Japanese yen: With the Japanese yen at all-time highs versus other major currencies, such as the US dollar, the Euro and the British Pound, Sonys exports and sales internationally have suffered. If the yen were to reverse course versus these other currencies over the next several years, international sales could be positively impacted since it would be much less costly for importers of Sonys products to purchase those products and earn a profit in their place of operation. For instance, if the yen were to return to its levels in 2007 and 2008, Sonys sales may once again reach FY 2008s levels of 8,433,956 million yen, a year in which Sony reported a net profit of 369,435 million. While macro-economics is beyond the scope of this report, the performance of the yen must be considered as it could have a major impact on the performance of Sonys business, and therefore its performance in the stock market.
Recommendation: Upon my review of Sonys corporate filings, I believe Sonys stock as listed on both the Tokyo Stock Exchange as well as the NYSE is heavily undervalued. It is true that there is uncertainty regarding the worldwide economy as well as the effects from the Great East Japan Earthquake, but given that Sony has been able to weather the storm of the past few years without compromising its balance sheet, as well as continuing to produce a positive free cash flow, I feel the depression of the companys stock will not continue for much longer. My main concern is not the profitability of Sonys operating segments, but its ability to cope with the strength of the Japanese Yen, which has been a boon to sales outside of Japan. While Sony has no control over the performance of the Yen, the question remains as to how Sony (as well as other Japanese companies) will respond to the Yens continued climb. Regardless, with Sony selling at a stated book value of 0.58x, at a Price-to-Sales ratio of 0.22x, and at less than 10x free cash flow, I believe Sony is worthy of investment at this time as its current price provides a significant margin of safety. Based off of my calculations and assumptions, I believe that Sony is worth 4,000 per share ($53 per share on the NYSE), more than 265% above the closing price as of Friday September
Sony Analysis
30th, 2011. I feel that the stock is safe to buy up to 2,100 per share ($26 per share on the NYSE). I will continue to monitor Sony as an investment until I believe my thesis no longer holds true. In addition, while it cannot be quantifiably measured, my opinion is that Sony brings with it a reputation as an innovator of electronic products that is hardly matched by many of its competitors. Ask yourself, if all else was equal, would you rather buy a Sony made product or a generic product? The point is, while there is no way to quantify the value of Sonys brand, the price of that brand may be worth more than an investment in Sony currently costs. Note: As there is risk in buying foreign securities (i.e. buying Sonys stock as listed on the Tokyo Stock Exchange and denominated in yen) due to the uncertainty of exchange rates, I would further recommend domestic investors purchase Sonys ADR as listed on the NYSE in order to avoid any potential losses should the yen depreciate versus the US dollar.
Sony Analysis
Appendix: Operating Income (Loss) by Operating Segment

2009 Operating Income (Loss): CPD Networked Products Pictures Music Financial Services Equity in net income (loss) of Sony Ericsson All Other Total Corporate and Elimination Consolidated operating income (loss) Other Income Other expenses Consolidated income (loss) before taxes
2010
2011
(115,571) (87,428) 29,916 27,843 (31,157) (30,255) 3,105 (203,547) (24,236) (227,783)
(53,174) (83,265) 42,814 36,513 162,492 (34,514) (4,976) 65,890 (34,118) 31,772
2,898 35,569 38,669 38,927 118,818 4,155 8,554 247,590 (47,769) 199,821
98,825 (45,997) (174,955)
43,834 (48,694) 26,912
44,966 (39,774) 205,013
Statutory versus Effective Tax Rates

Statutory Rate Effective rate 2009 (41.0)% (41.6)% 2010 41.0% 51.9% 2011 41.0% 207.5%
Sony Analysis
Comparison of Sony and 4 largest competitors:

Company Sony Panasonic Philips Sharp Harman Current Price 19.00 9.52 17.94 8.33 28.58 Avg. of 4 competitors P/E 15.07 Price-to-Book 0.58 0.61 1.00 0.73 1.40 0.935 EV/EBITDA 2.78 4.02 4.06 4.19 4.66 4.23
Sony Sales by Geographic Region

Japan United States Europe China Asia-Pacific Other Areas Total FY 2010 2,099,297 1,595,016 1,644,698 FY 2009 1,873,219 1,827,812 1,987,692 Q1 2011 486,013 274,398 266,842 114,166 176,045 177,457 1,494,921 Q1 2010 456,097 360,039 330,632 143,453 188,998 181,830 1,661,049
1,874,987 7,219,998
2,041,270 7,729,993
*Numbers in millions of yen *China and Asia-Pacific were included in Other Areas during FY 2010 and 2009. For comparison, Other Areas (including China and AsiaPacific) for Q1 2010 was 514,281 million and Q1 2011 was 467,668 million yen

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Sony Analysis

Prepared by: John R. Pangere October 2011

Sony Corporation (ADR) (NYSE: SNE)

2010 423,259 338,050 85,209

2009 191,592 496,125 (304,533)

2008 842,537 474,552 367,985

2007 528,955 527,515 1,440

487,828 253,688 234,140

Cash Debt Net Debt Equity Debt/Debt+Equity

*Numbers in millions of yen, except Debt/Debt+Equity ratio

2009 Operating Revenue: Japan USA Europe Asia-Pacific Other Total

2010 2,099,297 1,595,016 1,644,698 1,193,573 681,414 7,213,998

2011 2,152,552 1,443,693 1,539,432 1,288,412 757,184 7,181,273

1,873,219 1,827,812 1,987,692 1,285,551 755,719 7,729,993

*Data obtained from Oanda.com as of September 30, 2011

3,062 4,908 6,337 789 6,562 75,390

3,682 5,605 5,225 5,078 28,242 116,472

7,021 2,722 2,662 5,010 6,885 62,318

2009 34,631 45,890 80,521

2010 42,723 5,975 48,698

2011 60,514 57,404 117,918

(105,211) (48,051) (153,262) (72,741)

(25,589) (9,151) (34,740) 13,958

365,665 (58,244) 307,421 425,339

2009 538,206 (31,157) (5.8)%

2010 851,396 162,492 19.1%

2011 806,526 118,818 14.7%

Appendix: Operating Income (Loss) by Operating Segment

98,825 (45,997) (174,955)

43,834 (48,694) 26,912

44,966 (39,774) 205,013

Statutory versus Effective Tax Rates

Comparison of Sony and 4 largest competitors:

Sony Sales by Geographic Region

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