Sony's (SONY -0.17%) stock closed at $133.75 a share, its highest price in more than two decades, on Jan. 5. The record-setting results of the film Spider-Man: No Way Home, robust demand for the PlayStation 5, and the inflation-driven rotation toward higher-quality blue-chip stocks all drove that rally.
However, Sony's stock price subsequently retreated more than 20% after Microsoft (MSFT 0.02%) agreed to buy Activision Blizzard (ATVI). The $68.7 billion acquisition will make Microsoft the world's third-largest gaming company by revenue after Tencent and Sony, and it could potentially lock in future Activision games as Xbox and Windows exclusives.
But did investors overreact and prematurely dump a high-quality stock ahead of its third-quarter earnings report on Wednesday, Feb. 2?
What the bears will say about Sony
First and foremost, the bears will highlight the unpredictable headwinds for Sony's gaming and network services (G&NS) division, which generated 27% of its revenue in the first half of fiscal 2021.
The segment's revenue fell 14% in 2019 as consumers purchased fewer units of the aging PS4 and publishers launched fewer games. But in 2020 its revenue surged 34% as the pandemic's initial impact caused people to stay at home and play more video games.
In the first half of fiscal 2021, which started last March, Sony's G&NS revenue rose 13% year over year, even as supply chain disruptions throttled its shipments of new PS5s. For the full year, Sony expects its G&NS revenue to rise 9% against a challenging comparison to fiscal 2020.
However, the bears believe that Microsoft, which plans to close the Activision deal in fiscal 2023 (which starts this June), could migrate its library to its subscription-based Game Pass service. It might also secure upcoming entries of Activision's leading franchises, like Call of Duty, as Xbox exclusives.
Sony's financial division (17% of its first-half revenue) and image & sensing solutions (I&SS) segment (11% of its revenue) also face slower growth.
Sony's financial revenue rose 28% in 2020 as its sales of life insurance policies jumped throughout the pandemic. But in the first half of 2021, its revenue declined 4% as its life insurance sales decelerated. For the full year, Sony expects its financial revenue to decline by another 11%.
Sony's I&SS revenue surged 22% in 2019 as smartphone makers scooped up new image sensors, but it fell 5% in 2020 as that cyclical growth spurt ended. The segment's revenue dipped another 3% year over year in the first half of 2021 as the global chip shortage disrupted its recovery.
Sony expects its I&SS revenue to rise 9% for the full year as it sells more sensors for digital cameras and industrial equipment. However, that fragile recovery could still be derailed by supply chain challenges.
What the bulls will say about Sony
The bulls believe the fears about Microsoft are overblown. Sony easily beat Microsoft in previous gaming console cycles, it's already shipped 18.3 million PS5s compared with Microsoft's 12.1 million Xbox Series consoles since last November, and it still boasts a healthy lineup of exclusive games.
Moreover, Microsoft has already said that it will continue to release Activision Blizzard's games across multiple platforms -- which would generate much more revenue -- instead of locking them down as platform exclusives. Therefore, Microsoft's takeover of Activision is likely a defensive move instead of an offensive strategy that can actually hurt Sony.
Sony Pictures (10% of its first-half revenue) and Sony Music (11%) are also firing on all cylinders again.
Sony Pictures' revenue fell 25% in 2020 as the pandemic shut down theaters and postponed its production of new content. But in the first half of 2021, which didn't include the release of Spider-Man: No Way Home in December, its revenue rose 29% year over year as those headwinds waned. For the full year, Sony expects the segment's revenue to jump 57%.
Sony Music -- which includes its recorded music, streaming music, and mobile gaming divisions -- grew its revenue 11% in 2020 as it benefited from stay-at-home trends. Its revenue rose another 29% year over year in the first half of 2021 as its streaming music business continued to expand, and it expects the segment's revenue to increase 14% for the full year.
Lastly, Sony's Electronics Products & Solutions (EP&S) segment, which generated 25% of its revenue in the first half of 2021, stabilized after struggling with years of sluggish sales. EP&S revenue rose 29% year over year in the first half of 2021 as its stronger sales of mobile devices, cameras, and audio equipment offset its weaker sales of TVs. Sony expects the segment's revenue to grow 10% for the full year.
The valuations and verdict
Sony's business is complex, but its strengths are still offsetting its weaknesses. Its total revenue and operating income still rose 14% and 11% year over year, respectively, in the first half of 2021. For the full year, it expects its revenue and operating income to grow 10% and 9%, respectively -- although analysts expect tax-related charges to reduce its earnings per share by about 33%.
Those are healthy growth rates for a stock that trades at just 17 times forward earnings. That low valuation, along with the market's overreaction to Microsoft's Activision deal, suggests that Sony remains an attractive investment ahead of its third-quarter earnings report.