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Sony's Big Activist Investor Flips Its Prior Thesis Upside Down

By Leo Sun - Jun 19, 2019 at 7:30PM

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Third Point now wants Sony to sell its chipmaking division to fund the expansion of its film and gaming units.

Dan Loeb's Third Point recently revealed that it had accumulated a $1.5 billion stake in Sony (SONY 3.71%), and advocated a spin-off of its semiconductor business to finance a more aggressive expansion of its film and gaming businesses.

Third Point's stake in Sony wasn't surprising, since it has already invested in the Japanese conglomerate before. However, its proposal stunned many investors since it marked a complete reversal from its prior suggestions for Sony.

A man stops a row of dominos from falling with his hand.

Image source: Getty Images.

Back in 2013 Third Point accumulated a 7% stake in Sony and pushed the company to spin off its movie business. Sony rejected the idea, but cut costs to improve its profitability. Third Point sold its stake in Sony the following year, and Sony Pictures subsequently struggled with data breaches and box office flops.

Third Point started building a new position in Sony earlier this year. At the time, Reuters reported that the fund wanted Sony to consider selling its film unit and evaluate the importance of its insurance and semiconductor units. However, Third Point's recent announcement flipped that thesis upside down.

Should Sony sell its semiconductor business?

Sony's semiconductors unit mainly makes image sensors for cameras and mobile devices. It provides image sensors for about half the smartphone market, and its top customers include Apple, Samsung, and Huawei.

This unit enables Sony to profit from the growth of the smartphone market without owning a market-leading brand. Its own Xperia brand, which was marginalized by Samsung and other Android device makers, controls less than 1% of the market.

Global smartphone shipments fell 4% in 2018 according to IDC. Smartphone makers sold less units, but they still bought more of Sony's image sensors for their multi-camera devices.

Higher sales of those mobile sensors offset lower sales of its sensors for traditional cameras, and Sony's semiconductor revenue grew 3% annually and accounted for 10% of its top line. It expects that figure to rise another 13% this year as it sells more image sensors and 3D sensors for multi-camera phones.

A woman takes a picture with an Xperia phone.

Image source: Sony.

The semiconductor unit's revenue growth looks healthy, but its operating income, which accounted for 16% of Sony's total operating profits, fell 12%. That decline was attributed to higher R&D expenses and a tough comparison to its results in 2017, which included one-time gains from divestments and earthquake-related insurance payments.

Yet Sony expects the unit's operating profit to stay flat this year, which indicates that it isn't a dead weight like Sony's unprofitable mobile business. Loeb believes that the chipmaking unit could fetch up to $39 billion in a sale, but several analysts scoffed at that valuation. Macquarie Group analysts Damian Thong and Hiroshi Taguchi, for example, value the unit at just $11 billion.

Should Sony pump more cash into its entertainment units?

The gaming unit, Sony's core growth engine in recent years, is running out of room to grow as its PS4 hardware sales wane. The unit is offsetting its weaker hardware sales with higher software sales, but that strategy will lose steam as gamers postpone their purchases and wait for the PS5's arrival next year.

Pumping more cash into the gaming unit's R&D and marketing efforts could give it a much-needed boost as it faces off against Microsoft's (MSFT 2.26%) next-gen Xbox. It could also help the gaming unit land more exclusive titles, expand its PS Plus ecosystem, and strengthen its PS Now cloud gaming platform.

The film unit, however, is a mixed bag. The expansion of its Spider-Man universe with Venom and Spider-Man: Into the Spider-Verse was well-received, but it clearly lacks the theatrical firepower to go toe-to-toe against Disney. Sony's film revenue fell 2% last year, and recent films like Men in Black International have generated disappointing returns.

Pumping more cash into movies is tremendously risky, and massive budgets don't guarantee big box office returns. Therefore I'm not convinced that selling the stable semiconductor unit to fund more films is the right move.

Sony probably won't listen to Loeb

Loeb's $1.5 billion stake represents just over 2% of Sony's enterprise value. Sony didn't listen to Loeb when he held a 7% stake in 2013, so it's doubtful that they'll listen now. Loeb also sold his original position in 2014, yet the stock more than tripled over the past five years on the strength of its gaming unit. Given that track record, I'm not sure why Sony, investors, or analysts should care about Loeb's new thesis. 

I personally think Sony should keep its semiconductor business. If it wants to sell something, it should consider dumping its money-burning mobile division instead.

 

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