16 January 2007

Sony (SNE) - The Case Against

When I did my usual digging around Google Images for a visual accompanyment for this post, I found the above photo of Michele Wie struggling at the recent Sony Open.

I know, I know. Wrong Wii.

This is the only Wie struggling with Sony.

Enough with the homonyms. Here's how I'm structuring this lengthy post: First, present a link to each recent news story, magazine article, or research piece I'm using to justify my conclusions on how to trade Sony; and second, outline the major points with my sparklingly irreverent commentary. At the bottom of the post, I'll leave you with my current strategic plan on how I'm going to invest in SNE.

Wired Magazine offers up a broad hit piece.
- Sony introduced the PS3 at E3, the Electronic Entertainment Expo in 2005...and again in 2006. The revolutionary new bit of information released in '06 was the staggeringly outsized price of $600.
- Rootkit software embedded on CDs that prompted recalls and plaintiffs attorneys to crap out some class action lawsuits.
- Sony is making attempt number 42 at a proprietary format: "[Sony's]become oddly fixated on imposing its own standards – Betamax for VCRs, the Mini-Disc for digital music players, the Universal Media Disc for PlayStation Portable, the Memory Stick for anything you can think of – despite the world's unwavering rejection of those standards."
- Is Sony too far ahead the consumer taste and demands with its expensive, yet technologically advanced microchip and Blu-ray combo? "[T]he Cell [processor at the heart of the PS3] has caused a lot of headaches for developers. Tim Sweeney, cofounder of the North Carolina-based developer Epic Games, figures it will take at least twice the effort to fully exploit the PS3's potential as to take the Xbox 360 to the max. Until that happens, it's unlikely there'll be much discernable difference between games on the two platforms. "The Cell has more theoretical computing power," says Sweeney, "but it might be years before we see that reflected in actual performance. So it's a fundamental question whether the long-term direction in computing is with architectures like the Cell.""
- "Blu-ray is equally fraught. For starters, the whole business of high-definition disc drives seems designed to invite cynicism. With DVD players now in 85 percent of US homes, sales fell in 2005 for the first time – so some manufacturers may need a next-gen disc player, but it's not clear consumers do."
- Wii, with its flailable wiimote, is fun. Xbox has Xbox Live's online gaming community. What is PS3's winning angle?
- An argument in Sony's favor: the corporate suits are sweating the (up until very recently) crap performance of SNE shares: "A couple of months ago, Howard Stringer and Ryoji Chubashi, Sony's president, reported to a luxury hotel in Tokyo's Shinagawa district to face 7,200 shareholders at Sony's annual meeting. It was not an enviable assignment. With the company in the red yet again in its most recent quarter, Japanese investors were in an unhappy mood. "I bought shares in mighty Sony," cried a woman whose holdings had lost nearly two-thirds of their value. "What are you going to do about this?""

Zacks Investment Research issued a recent negative report on Sony.
- Zacks named SNE Bear of the Day for 1/12/07. Investors apparently didn't notice this as SNE jumped $2.03 (4.45%) to $47.68.
- Zacks has a Sell rating and a $35 price target on the stock.
- Sony's LCD business is facing competitive pressures and lowering prices.
- Sony's brand image hurt by the global recall of notebook computer batteries.
- PS3's hefty price tag and launch delays, especially the failure to launch in Europe during the '06 holiday season.
- Rich valuation: "In spite of its difficulties, Sony is currently trading at a rich 68.3x extimated fiscal 2007 ending March 31, 2007 EPADR, a significant premium to its peer group." Even the six-month price target of $35 represents a robust P/E multiple of 52.2x of estimated 2007 EPADR of $0.67.

Fark.com linked to this, which used this post as its source:

"The MD of US development studio Valve Corporation has labelled Sony's PlayStation 3 "a total disaster" and predicted that Nintendo's Wii will win the next-gen console battle."

Why is this guy pissed? I think this issue is developing games for PS3:

Just say, 'This was a horrible disaster and we're sorry and we're going to stop selling this and stop trying to convince people to develop for it.'

Sony gets a 3-star rating from Morningstar, and a fair value estimate of $50 per share.

Morningstar analyst Rod Bare's report dated 12/7/06 is oddly dissonant in its use of positive adjectives like "leading" "robust" and "intriguing" to describe Sony's fortunes:

Sony's Bravia line of flat-panel televisions is a growing success. Sony Ericsson phones have leading market share among profitable high-end customer segments, and Walkman phones are showing real promise. Sales of the PlayStation Portable video game player are robust, and the PlayStation 3 is selling well, when it's available. More importantly, these investments have partners with skin in the game. They represent an intriguing consortium of tech-savvy allies with a very Sony-friendly set of incentives.

Newer reports say the PS3 isn't selling well and has plenty of availability. Dunno about you, but all I've read and heard on the phone front is the promise of the Apple I-Phone and Motorola's Razr/Krazr glut. I have read nothing about Walkman phones or Sony Ericsson phones. Either Bare's analyst report is stale (after only a month and change) or it's off-the-mark.

Jim Cramer, on the 1/11 edition of Mad Money, pushed Sony as a value play, hated by Wall Street. How did he equate SNE with value? By comparing it to the current beauty queen of the market, Apple. Apple commands a market premium because investors love the Apple story and its innovative products. Unlike Sony, Apple has had tremendous success with foisting its proprietary music format on consumers via I-Tunes.

Cramer then bizarrely talked about the value of Sony broken up into its indvidual businesses and valued the entire package in a wide range between $61 and $72.

If Howard Stringer announces that he's going to spin off valuable parts of the Sony conglomerate, then yes, Cramer's value thesis would take purchase on the Pig, but until that happens, I think the Sony-as-an-investing-alternative-to-Apple thesis is a stretch.

I am in complete agreement with Jonathan Last, and his argument against Sony at Galley Slaves.

JVL says to short Sony for two huge reasons: PS3 sales are severly lagging expectations, and Blu-ray purchasers will be unable to go on Rome adventures with Barbara Dare.

Here is the first site cited by JVL, plus a related post at The Guardian.

Sony doesn't want porn produced on Blu-Ray discs. Apparently Sony made this same mistake with Betamax. Porn helped VHS win the videotape format war. Didn't Blockbuster's policy of no porn/no NC-17 videos save the mom-and-pop video store from oblivion by leaving a tremendous revenue source in the marketplace? Is Sony doing the same thing here? Or is Sony worried that it currently cannot manufacture enough Blu-Ray discs and doesn't want the market dominated by Digital Playground and Vivid titles? This is negative for Sony's bottom line, either way.

Here is the second site mentioned by JVL.

Sony has sold only 687,000 PS3 units, whereas Nintendo sold 1.1 million Wiis and Microsoft sold 4.5 million Xbox 360's. 'Nuff said.

Finally, a brilliant commentator kicked Sony around in November 2005 over its penchant for awful DRM software. He also didn't care for the stock's fundamentals either. Of course, SNE stock shot up from $32 to $50 soon after this post.

Which makes a perfect segue for some second-guessing:

- A hot must-have game for PS3 could generate considerable interest and demand, much like what Halo did for Xbox.

- What is the forecast for the yen versus the dollar? Last week's weaker yen drove up Japanese stocks, including Sony.

I'm not going to make this post any longer by recapping the cons (and pros) for Sony. The case against Sony is wholly convincing.

What am I looking at investment-wise? Puts that are barely out-of-the-money. As I write this, SNE is trading at around $46.90. The April $45 puts are $1.45/1.55 bid/ask. The July $45 puts are $2.15/2.25. The January '08 $45 puts are $3.10/3.20. If Sony rises a bit, then I'll also consider the $50 puts.

Before I pull the trigger on any of these, I'm going to do three things: 1. Look up the yen/dollar exchange rate and yen forecasts; 2. Check for any new Sony news reports, especially on PS3; and 3. Make sure it's a bullish day for Sony and Wall Street.

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