This Company Faces a Tough Road Ahead

Sony faces the threat of dying business segments.

Feb 5, 2014 at 11:45PM

Sony (NYSE:SNE) investors should not only have been disappointed, but also worried, after credit rating agency Moody's downgraded the company's credit rating to junk. The company has been downgraded by other agencies as well, which has strongly put forth the lack of sustainability in its core business segments. The electronics giant is facing a rough patch due to increasing obsolescence of televisions and fierce competition from the likes of Samsung and Apple (NASDAQ:AAPL) in the smartphone and tablet markets.

Can PlayStation turn around Sony's fortunes?
Last year, Sony reached the pinnacle of success with the launch of its much-awaited gaming console, PlayStation 4, which sold nearly 4.2 million units, ahead of its arch-rival Microsoft's Xbox One. Though sales figures remained short of management's expectation of 5 million units, they definitely set the ball rolling for the company to enhance the features on the gaming console and leverage initial sales.

There isn't a need to elaborate further on the glaring success of PS4, and as leading experts in the gaming industry have proclaimed, Sony's gaming console will conveniently beat Xbox One to become the gaming system of this generation . However, for Sony investors, it's important to understand the impact of PS4's success on the financial health of the company. Even though the giant has established dominance in the gaming arena, troubles in its televisions and smart devices segments are far from over.

Apple is a fierce competitor
In the smart devices sphere, Apple is proving to be a magnanimous challenge for Sony, as the company is badly struggling to maintain its market share. The successful launch of iPhone 5s and 5c put Apple back in the game and ended speculation related to a slow down in innovation. Additionally, the launches of the Retina iPad Mini and iPad Air are garnering good reception after some initial criticism.

The recently announced results for the first quarter clearly highlighted Apple's explosive quarter in terms of iPhone, iPad, and Mac sales. Revenue surged 6% to $57.6 billion in the quarter, with a commendable gross margin of 37.9% and diluted EPS of $14.50 per share. The focus of the earnings call was management's outlook on the big partnership with China Mobile because of the massive size of the Chinese markets.

It is prudent for investors to watch out for the development of Apple's share in China, especially after Google announced the sale of Motorola's mobility division to Lenovo (NASDAQOTH:LNVGY). This deal can prove to be a major threat to Apple in the Chinese markets, as Lenovo has a better position there . Thus, the onus will be on Apple to maintain its innovation streak and develop a robust way to capture the Asian markets amid competition from low-priced devices from Lenovo and Samsung.

Lenovo's acquisition spree
Lenovo has a robust repute of growing inorganically, as testified by it's ascent to World's Largest PC maker after acquisition of IBM's PC unit in 2005. Though the move was claimed to be risky then, Lenovo turned the deal around and left many colossal enterprises behind. The company can now have access to North American markets that have been captured by Apple and Samsung with its acquisition of the distant third player, Motorola.

Bleak business prospects
If we were to simply view Sony's operations based on the industry analysis model designed by Michael Porter, it is clear that the consumer electronics favorite is now facing a threat of substitute products as well as competitive rivalry within the smart devices industry. While it is true that Sony is a clear winner in gaming consoles, and its latest innovation, PlayStation Now, should keep gamers connected to Sony for a longer time , the company's struggling earning potential is represented by its core electronic products.

Sony is poised to announce its quarterly earnings on Feb. 6, which will be of extreme significance for investors as the announcement comes after a series of downgrades by leading rating agencies. The company has tried to enter the smart devices markets, but has failed to capture the taste of consumers.

Final words
Recently, there have been reports regarding a potential alliance between Sony and Lenovo, with the latter taking over Sony's Vaio PC business overseas. Though nothing has been confirmed yet, it is a clear indication that Sony's management does not see considerable potential in the PC business and offloading it could prove better for the giant.

Sony is an age old company, but the revolutionary shift in consumer preferences and industry norms are taking a toll on its financial health. Hence, it is prudent to hold off putting money in this giant until there are some conclusive signs of momentum in its dying business segments.

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Mihir Mehta has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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