How to Play the Turnaround At Sony (NYSE: SNE)

by David Eller, Investment U Research
Tuesday, January 29, 2013

Sony (NYSE: SNE) may be the Rodney Dangerfield of the consumer electronics industry. It gets no respect…

But that may be changing.

Despite making one of the best TVs, one of the best gaming consoles, one of the coolest-looking laptops, high-quality phones and decent A/V receivers… The share price has been on a multi-year downward escalator, from $40 in 2010 to below $10 in 2012.

Competition in consumer electronics has always been a bare-knuckle brawl. But Sony has had to contend with incredibly bad luck, as well.

The Japanese tsunami was followed by a warehouse fire in London, which lasted for days and wreaked havoc on the company’s DVD business. If that wasn’t enough, Sony was fined $400,000 last week for losing customer information in a 2011 database hacking attack. The amount of bad luck is biblical. Could a plague of locusts be next?

Sony, to some extent, has also been a victim of its cultural heritage. The company consists of a large number of separate businesses, all operating as individual units. However, a new leader may be changing that.

Starting a Turnaround

Kazuo Hirai took the reins as CEO in April 2012. Hirai was actively involved in the launch of the original PlayStation. He also led the company to new heights by introducing the Network Adapter, which brought Sony into online gaming.

The first step for a turnaround is making the TV business profitable. Hirai believes he can do this in under two years, by aggressively reducing the costs of components and logistics. For instance, by ending an agreement with Samsung, Sony can now go out and bid for the lowest-priced LCD displays. Even though this is a multi-year goal, progress toward it will likely be rewarded ahead of profitability.

Sony has been trying to increase its focus on core businesses and shed non-core. Last year, Sony sold its chemical division for $700 million. And last Friday, there were rumors in the Japanese media that Sony is looking to offload its lithium ion battery business. This boosted the shares by 7% in overseas trading.

In addition to selling off non-core assets, Hirai has also been breaking down barriers between complementary businesses. Sony’s waterproof Xperia Z smartphone received good – if not great – reviews at CES. But more importantly, it received high-profile product placement in the most recent James Bond movie, Skyfall, which was distributed by Sony pictures. Leveraging synergies between related businesses can unlock value for Sony shareholders. But the company isn’t just selling off non-core business assets…

It’s also selling real estate.

Sony announced that it would sell its New York headquarters for $1.1 billion. This announcement, coinciding with the end of CES, sparked the recent run in the stock price from $11 to $15.

Playing the Rebound With Options

Even with the recent 25% move, the stock is cheap at just 0.6 times price-to-book, and offers a 2% dividend.

Rather than chasing the stock right after a dramatic run, we would suggest selling July out of the money puts. The July 2013, $14 puts are selling for $1.20 per contract. We like the July expiration because it includes the E3 conference, which begins on June 11 this year. If the stock is put to you, it will be at a price of $12.80. And if the option expires worthless, you make 9% on committed capital.

French developer Quantic Dream recently registered the domain, SingularityPS4.com. It’s sparked rumors that the PS4 is forthcoming. If so, E3 might be the forum to make the announcement.

It’s clear that the new leader is willing to make structural and cultural changes at Sony. Even if the company doesn’t find the next “Walkman” right away, with a share price well below book value, there are enough gains to be found through streamlining to drive the stock above $20.

Good Investing,

David Eller

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