At Sony Corporation It’s the Same Old Sony

By Damion Rallis, Senior Research Associate

As Sony Corporation (NYSE:SEN) continues its attempt to reposition itself as the leading name in global consumer electronics, its strategies have increasingly come under fire. While the company’s 2012 annual report prominently declares that “Sony will change,” shareholders and analysts are yet to be convinced. At GMI Ratings, Sony currently holds an ESG Rating of “B”; however, the uncertainty surrounding its future along with both a declining share price and overall performance are likely to drive its rating downward.

GMI Ratings’ Litigation Risk model has been flashing warning signs about Sony for some time. Having been in High Risk territory since the end of 2011, Sony currently has a 7% probability of Class Action Litigation occurring within the next 12 months. This places them in the 3rd percentile of all companies in North America, indicating higher shareholder class action litigation risk than 97% of all rated companies in this region.

While Sony’s 2000 share price peak of almost $150 is clearly out of reach at this point, it was only five years ago when prospects at Sony Corporation were strong, when the share price was over $55 at the beginning of 2008 and total revenue exceeded 8.7 trillion yen by the end of that year. Since then, however, Sony has been steadily losing its grip. Total revenue has slipped each year since 2008 with the latest figures of about 6.5 trillion yen representing nearly a 27% drop from 2008. Similarly, where net income in 2008 stood at over 369 billion yen, figures had fallen to minus 457 billion yen as of the fiscal year ending in March 2012. Consequently, the company’s share price closed at $20.77 at 2011 fiscal year end in March 2012 and has since tumbled another 42% to its current price of $11.94.

Upon closer scrutiny of Sony’s financial statements, we note that for the period ending June 30, 2012, Sony’s total revenue represented 51% of its total assets, well behind the industry average of 123%. Low asset turnover indicates potential problems in the efficiency of a company’s operations, and can adversely effect profit margins. Furthermore, for the period ending June 30, 2012, Sony’s cash and equivalents represented only 15% of its current liabilities, considerably behind the industry average of 42%. Relatively low cash ratios indicate possibly low liquidity for a company. By only including cash and equivalents, the quick ratio concentrates on the most liquid assets, with value that is fairly certain. It helps answer the question: If all sales revenues should disappear, could the business meet its current obligations with cash on hand?

Our primary concerns with Sony moving forward are not only its future strategy, but the governance personnel in place to oversee the changes. In his first letter to stakeholders, newly hired CEO Kazuo Hirai claims that Sony’s most valuable resource is “Sony’s DNA—a distinctive will and drive to generate new value—which has been cultivated since Sony’s founding and passed down from one generation of Sony employees to the next.” Unfortunately, it’s Sony’s DNA that might be the biggest threat to the company’s future and the very reason why shareholders appear to have little confidence in the company’s turnaround. Despite everything that has gone wrong, Sony refuses to broaden its gene pool.

After all, when it was finally necessary to replace former CEO Howard Stringer, the company did not seek help from outside but decided to hire from within. Mr. Hirai is a Sony veteran of nearly 30 years. And Mr. Stringer will remain with the company as the chairman of the board of directors, a considerably influential position for a man seen largely responsible for the company’s current predicament. Tadashi Saito, a former Sony chief financial officer at Sony Electronics in the United States who has been with the company since 1976 and is 92 years old, was named as the company’s chief strategy officer. CFO Masaru Kato, who has been with Sony since 1977 will oversee the Sony Group’s overall financial management, corporate and business strategies alongside Messrs. Hirai and Saito. Also, Shoji Nemoto, who has been with Sony since 1979, will oversee technology strategy and Kunimasa Suzuki, with Sony since 1984, will oversee product strategy.

Not only does the board consist of Chairman Stringer, CEO Hirai, CFO Kato, and another Sony executive who joined the company in 1977, but of the remaining ten independent directors, only one board member, an accountant named Takaaki Nimura, is new to the board. The nine other independent directors joined between the years of 2005 and 2010 and certainly offer little in the way of new vision. Furthermore, of the ten non-executive board members, only three offer any relevant experience whatsoever to Sony’s main business enterprises and only one independent director, Yukako Uchinaga, has relevant industry experience. However, while Ms. Uchinaga formerly served as Technical Advisor at IBM Japan, it is a position that she no longer holds. Not only does the board consist of individuals with virtually zero relevant industry experience, but they are over-committed as well. Seven of the ten independent directors serve on at least three other boards, calling into question the time they have available to devote to Sony board duties.

Clearly, Sony shareholders have taken notice. At the company’s 2012 annual meeting held in June, several directors lost support from voters as all ten directors up for election both in 2011 and 2012 received significantly more votes against in 2012. Most notably, Chairman Stringer received only 66% votes of approval. On top of that, eight other directors received more than 10% votes against, led by Vice Chairman Ryoji Chubachi, who received 19% votes against. Overall, shareholder dissatisfaction is clear.

Not only are question marks hovering over the personnel tasked to oversee the company’s future, but the investment world has also raised eyebrows over Sony’s strategies to right its ship. In his letter to stakeholders, the CEO blamed a poor operating year on the 2011 earthquake and resulting tsunami as well as the floods in Thailand and on a “persistently strong yen.” He then outlined five key initiatives which included strengthening its core businesses, turning around its beleaguered TV business, optimizing resources, as well as creating new businesses and accelerating innovation. It sounds a bit like a company that is stuck in the past with an unsure foot in the future. Unfortunately, “optimizing resources” is code for layoffs as Sony revealed that it intends to reduce headcount by approximately 10,000 across the entire group in 2012. And as for strengthening its core business (like gaming), Sony stated in August that first quarter sales for their PlayStation gaming consoles and handheld Vita and PSP units were down from the same period last year. Furthermore, sales forecasts for the handheld units were revised downward for rest of the fiscal year, from 16 million to 12 million. Similarly, TV sales for the first quarter fell to 3.6 million compared to 4.9 million for the same period last year, forcing Sony to revise downward its annual TV sales targets from 17.5 million to 15 million.

As Sony begins to search for new revenue streams, investors must question whether their decisions are articulated from a clear strategy or a product of desperation. Sony made news recently when it announced an alliance with camera-maker Olympus Corp. Three days before the Sony and Olympus partnership was announced, three former Olympus executives pled guilty over charges related to a $1.7 billion accounting cover-up. It would appear that from a public relations standpoint, Sony picked an inopportune time to partner with Olympus. Moreover, is Olympus the right kind of company for Sony to be partnering with? Sony will spend 50 billion yen for an 11 percent stake in Olympus and the two companies said they will set up a new medical equipment company together later this year, 51 percent owned by Sony. Clearly, it is a risky venture to partner with a company that is not only fresh on the heels of one of Japan’s biggest corporate scandals, but, like Sony, has also seen a loss of revenue of almost 25% from 2008.

In September, Sony also agreed to pay about 60 billion yen to acquire all outstanding shares of its subsidiary So-net Entertainment Company, a medical information website operator. This comes about a month after Sony agreed to pay $380 million for cloud-gaming service Gaikai. In light of these acquisitions, Standard & Poor’s downgraded Sony’s long-term corporate credit rating and stated that Sony’s “outlook is negative, reflecting our expectation that we could lower the ratings further if Sony fails to demonstrate solid signs of recovery in weakened measures of its credit quality within the next 12 months.”

It would appear that at this point that CEO Hirai is still throwing darts, desperately hoping that he will eventually strike gold. None of these initiatives have impressed shareholders. Given the continual spate of poor financial results, it’s hard to blame investors in their inability to trust Sony going forward. In an interview with Bloomberg Businessweek, Mr. Hirai said that in order for Sony to change it must “focus on [its] core” and “execute with a lot faster speed, which means faster decision-making, faster execution.” At this point, it all adds up to a bunch of business speak from the same old group of graying Sony executives, a formula unlikely to entice shareholders unless positive results are actually achieved.

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