Third Point LLC, Asset Under Management (as of 17/05/13): $12.9bn
Sony Corporation (SNE), Market Capitalization (as of 17/05/13): $20.37bn
Deal type: Spin-off Proposal via IPO
Mr. Daniel Seth Loeb, manager and founder of the NY based hedge fund Third Point LLC, has recently turned his attention toward Japan and Sony in particular. Mr. Loeb’s view on Japan is positively affected by the new “three arrows” plan of the PM Shinzo Abe, which relies on aggressive monetary easing, stimulus government spending and promotion of foreign private investments.
On May 14, Mr. Loeb sent a letter to the CEO of Sony Corporation Mr. Hirai, providing suggestions on how to improve the company. The core of the issue is: “For Sony to Change, Sony Must Focus”.
In the letter, Mr. Loeb declares to be the largest owner of Sony with approximately 64mln shares (6.5% of the company) valued above $1.1bn (more precisely $0.70bn of direct ownership and $0.44bn of cash-settled swaps). Moreover, the activist investor announces to have already made an HSR filing with the US Federal Trade Commission, thus holding the rights to increase its direct ownership.
Mr. Loeb’s proposal to Sony is grounded on the observation that while Sony core business is electronics, much of the current value of the enterprise derives from a “hidden gem”, i.e. Sony’s Entertainment division. The activist’s idea is to take public a 15-to-20% stake of Sony Entertainment to trade independently from Sony Electronics, thus benefiting both of them.
For the existing shareholders to preserve their economic interests and benefit from the division’s concealed value, Mr. Loeb proposed a non-standard spin off of the Sony Entertainment unit, based on the offering of subscription rights to current shareholders. Third Point LLC also offered to backstop the IPO up to $1.5-2bn in order to ensure the success of the operation.
According to Loeb, the Entertainment division would benefit from a more disciplined management approach, reaching the margins of listed competitors. The Entertainment businesses account for over 40% of Sony’s enterprise value and are important contributors to Sony’s growth: Sony’s motion unit represented 26% of the company’s operating income in the year ended March 31, while the music division 20% (according to Bloomberg’s data). However, some changes are needed since the Entertainment sector is becoming more and more competitive and Sony’s entertainment unit’s EBITDA is valued at about 8 times, much below the 10-11 times EBITDA at large media companies including Disney, News Corp. (NWSA), CBS, Viacom Inc. (VIAB) and Time Warner Inc. (TWX).
After the IPO, Sony would still retain the control of the entertainment assets. The company, indeed, already concluded a similar deal before: in 2007 it spun-off its financial services in an IPO raising 320bn JPY and still owning 60% of the banking and insurance business, Sony Financial Holdings Inc. In addition, the parent company would receive useful liquidity to reduce the high leverage of the newborn Sony Entertainment and to inject in Sony Electronics, investing in the launch of new products and restructuring the management in order to provide a more appealing remuneration system, increasing their interest to improve their performances.
Mr. Loeb appears to be optimistic about the future of Sony, which notwithstanding the unsatisfying results of the last decade is still regarded as “a source of considerable and underappreciated value”. The stock has underperformed for a long time, in fact earnings yield (inverse of the P/E ratio) has never been more than 5% and for the fiscal year 2012 it had a loss of 520bn JPY, the worst in its history.
However, if we consider EV/EBITDA, Sony is in line with its competitors Samsung and LG Display Co., Ltd (Sony: 3.89, Samsung: 3.39, LG: 2.18), while Philips is over-performing with an EV/EBITDA equal to 7.39. Moreover, Sony’s Price to book value ratio is slightly under its competitors, with a value of 0.73 (according to Yahoo Finance data).The underperformance of the last years can be attributed to the financial crisis, increasing competition for PlayStation, the Japanese earthquake as well as its stagnancy and the fading brand. Sony should focus more on its core business in order to strengthen its brand awareness; it has to go at the same speed of the technological change, launching original and innovative products.
Markets have positively reacted to the news as Sony shares rose 10% on May 15th and rocketed to the level of 2,082 JPY the day after, gaining an additional 0.5%. The stock closed at only 1,877 JPY on May 14th before Loeb’s letter was disclosed. Moreover, many commentators have been positively impressed by Mr. Loeb’s proposal. The Macquarie Group Ltd.’s analyst Damian Thong suggested that the spin off might increase the company’s market value up to 30%, though not confirming the activist’s 60% forecast. Joshua Strauss, co-manager of the Appleseed Fund at Pekin Singer Strauss Asset Management Inc., asserted – “When you do that sort of thing, the sum of the parts is greater than the whole”.
Concerning Sony’s reaction, the CEO Hirai said, “The entertainment businesses are important contributors to Sony’s growth and are not for sale”. Hence, despite these favorable views of commentators, Mr. Loeb might have hard times in pursuing his strategy in a country traditionally hostile to activist investors, where even small shareholders would typically side with managers in a hostile takeover, perceiving that those investors only go after easy money rather than company’s interests. As a matter of fact, activist investors have never been successful in Japan since it’s really hard to change the way the Japanese operate and they want to pursue their strategy.