sne thesis

8/12/2019 SNE Thesis

1/16

Why the Emperor (Japan) still has no clotheseven as the weavers (Thirdpoint and Abe) furiously try to

convince the market the Emperors clothes are real

Authored by: Daniel Russell5/30/2013


2/16

Global Deficits, GDP Growth and Labor Force in the past decade

Global deficits (in red) seem to be in apermanent new normal trend, global

GDP growth is in a severe downtrend

----

US GDP + Germany GDP + Japan GDP + France GDP Dollarized YOY % ChangeWorld Deficit as % of GDPUS YOY GDP GrowthChina YOY GDP Growth (not dollarized)

5 Largest Economies Dollarized GDP Growth YOY versusWorld Deficits as a percent of GDP

5 Largest Economies Employment to Population Ratio (ex China)

Over the past decade global deficitshave increased global growth proxied bythe 5 largest economies has downshifted

Eventually the demographics will

compound on the already bad decisionsbeing made to create a debt crisis.

The population to employment ratio inthe US (blue) peaked after the dot combubble burst,

Japans Population to EmploymentRatio peaked in the early 90s

France looks like it peaked in the 80s.

A lower number of employed funding alarger number of unemployed workerscreates social, political, and financialconsequences


3/16

JapanThe Emperor

JapanA Developed Country with hugedebt load

The nominal debt dipped during 2008 because the debt wasrefinanced at a lower rate. Since 2008, the debt has againaccumulated at a rather quick pace.

Nominal Gross Debt shown in blue and estimated GrossDebt shown in Red.

.and whose answer to low GDP growth

seems to be just expand the balance sheet

of the BOJ

Nominal GDP in (shown in blue), the only answerfor a massive drop in GDP seems to be the BOJs

Balance Sheet (shown in red) Notice the exponential nature of the increase in the

BOJs balance sheet since Abe has entered office


4/16

Possible ways to clothe the Emperor

Traditionally there are three ways to solvedebt problems:

I. Grow

II. InflateIII. Default

Which one will Japan choose? 58%20%

20%

-2%

Japan GDP by Expenditure FY 2012

Consumption Investment Government X-M

Growing consumption?Growing Investment?

New orders are picking up of a much lower base post 2008.

The flow of fixed capital being utilized is in a massive downtrend, less capital means the expectation s for using capital for creatingnew businesses is very low


5/16

Industrial production has dropped off a cliff Inventories look to be in a downward spiral (reduction in inventory due to lack of demand)

Possible ways to clothe the Emperor

Current account should go full negative 3Q4Q 2013 The massive move in the JPY could help trade bounce back but global growth doesnt seem to be picking up

Without increases in investment or consumption, growth seems out of reach, to further compound thedilemma, Japan will hit a full negative current account for the first time in years


6/16

Structural Changes in Energy will compound the weakness in the Balance of Payments

02468

10

1214161820

0

5,000

10,00015,000

20,000

25,000

30,000

35,000

40,000

Japan Abandons Nuclear post 2011

Energy

Number of Plants December 2012 Poll - ASAHI SHIMBUN

Trade is deteriorating and with no natural resources and no nuclear production, Japan must import almost all of its

energy. To add fuel to the fire, Japans politics have shifted post Fukushima to not favor any nuclear power.


7/16

Adding debt to the most indebted nation on earth

The debt non-linearity is shown by theexponential growth in the interest cost eventhough the cost of borrowing is at an all timelow

Adding more debt will just add more interestexpense to the budget

When you spend 25% of your budget onyour debt, adding debt is not really asolution

Current Accounts and Fiscal Deficits arehighly correlated. A current account deficitwill mean a increase in the fiscal deficit for

Japan.

Japan cant grow, and Abe wants to inflate,

but when you try and inflate with your debtspring-loaded like Japans you have a debt

crisis.

I believe Japan will try and inflate and then

default on its sovereign debt in the next 5years.


8/16

So how would you trade on Japans coming fiscal crises?

Characteristics I want in a company to play theeroding of Japans Fiscal situation:

Highly levered to debt Credit risk includes the Sovereign risk of the home

country High rate of production in Japan

Inputs with a higher yen will be more expensive Poor positioning within the industry Poor product mix Revenue mostly from Japan

Higher inflation should mean lower purchasingpower and combined with poor market position

should spell real trouble with the firm High pension costs

-45.0%

-40.0%

-35.0%

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

-400,000

-350,000

-300,000

-250,000

-200,000

-150,000

-100,000

-50,000

0

Fundedamountas%ofPBO

Underfundedamount(Millions

of)

Sony Pension Underfunded Status

Underfunded

Funded as %of PBO

Scale inverted

Product mixBubble size is the amount of segment Revenue Largest business lines have low or negative margins, major warning sign Revenue growth is low for the most profitable Segments Goal is to be in the top Right (Large operating margin large revenue growth)

30% underfunded pension as a percent of PBO As of 2012, the asset class breakdown is 23% Equity and 45% Fixed income,

of which ~65% is invested within Japan

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

-20% -10% 0% 10% 20%

RevenueCAGR

FY09 - FY12

Operating Margin

Sony Segment Mix Imaging Products &Solutions

Game

Mobile Products &Communications

Home Entertainment &Sound

Devices

Pictures

Music

Financial Services

Japan,32.41%

United States,18.66%

Europe ,19.53%

China, 7.62%

Asia-Pacific,9.80%

Other Areas,11.96%

Net Sales by Region as % of TotalSales


9/16

Sonys Fundamentals

Sony has decreased its CCC by increasing its days payables

Sony was downgraded to Baa3(negative outlook) in 4Q2012 Because of this downgrade I dont believe the CCC can

improve by dragging out payables much longer

Sonys Long Term Debt/Equity Ratio continues to rise, making the

firm more levered Leverage can hurt the firm if conditions externally andinternally continue to weaken

Managements use of assets has become more and moreinefficient as shown by the Asset Turnover Ratio

Both of these metrics show that management hasnt effectively

controlled the Balance Sheet

0%

10%

20%

30%

40%50%

60%

70%

0.00

1.00

2.00

3.00

4.00

5.00

6.00

Long Term Debt and Asset Efficency

FinancialLeverage

AssetTurnover

0.00

20.00

40.00

60.00

80.00

100.00

Sony Cash Conversion Cycle

Days Paybles

Days Inventory

DaysReceivables

CCC

67.00%

68.00%

69.00%

70.00%

71.00%

72.00%

73.00%

74.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

Age and Depreciation of Assets

CAPEX as % Rev

R&D Exp as % ofRev

Depreciation/Amorization over Capex as% of Rev

Avg Age in %

Sony allowed its assets to age without any plan to replace agingassets

For the past 5 years, Depreciation/Amortization has outpacedCAPEX spending, this mathematically cannot continue intoperpetuity unless all assets are expensed


10/16

The Weavers (Thirdpoint) proposal and why Sony shouldnt agree

*Third Points Steps taken directly from the letter to Sony posted on businessinsider.com

Step 1: Take Public a 15--20% Stakein Sony Entertainment, Allowing It toThrive Independently with the Supportof the Sony Parent Company WhileIncreasing Capital to Revitalize SonyElectronics

Sony entertainment is an industryleader in the entertainment industry

Sony Electronics doesnt just needmore capital it needs better products Sony laptops batteries exploded in2006

Sony didnt introduce a tablet until2011

Sony needs to trim its failingElectronics segment to only includethe most profitable and best units

Point Counter-Point

17%

32%

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

0%

5%

10%

15%

20%

25%

30%

35%

Sony Entertainment Box Office and Music Sales andMarket Share

Gross FilmRevenue MMUSD

Gross MusicRevenue MMUSD

Film MarketShare

Music MarketShare

Step 2: Focus on Industry-Leading

Businesses to Bring Growth to SonyElectronics

Sony should center on narrowing their

focus and eliminating any segmentsthat are outside of their circle ofcompetence

Sony Entertainment and Gaming canbe leveraged to the existing productportfolio to add value and cash flow tofund the trim electronics division Why cant you buy movies and musicon your Sony phone?

80% of smartphone users shop ontheir phone (1)

Point Counter-Point

1. http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/ *Music data only goes back to 2008:*Music Market Share sourceNielsen Company & Billboards Yearly Music Industry Report *Film Market Share sourceBoxofficeMojo.com
http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/http://techcrunch.com/2012/09/19/comscore-4-out-of-5-smartphone-owners-use-device-to-shop-amazon-most-popular-mobile-retailer/


11/16

ChairmanFormer CEO - Sir Howard

StringerFormer Head of Sony EntertainmentDivision

Current President & CEO - Kazuo Hirai

Started at Sony Music Entertainment(Japan)

Member of Sony BoardRoland A.HernandezEx-CEO of Telemundo

Does Sonys Board Composition make Thirdpointsproposal less likely to be adopted?

Sir HowardStringer -Chairman

Ryoji ChubachiVice

Chairman

Masaru Kato

TakaakiNimura

Tsun-YanHsieh

KanemitsuAnraku

Kazuo Hirai

Yorihiko Kojima

YukakoUchinaga

Ryuji Yasuda

Peter Bonfield

Roland A.Hernandez

OsamuNagayama

MitsuakiYahagi

Current Sony Board

Chairman, President & CEO both started in theSony Entertainment Division

Another member of the board ran a largeentertainment division

Does Thirdpoint think the board will admit ithas mismanaged the entertainment divisionand agree to a spinoff?

Does Thirdpoint also think the insiders thatstarted in that division wont think they know

what is best for Sony Entertainment? I dont think the spinoff is likely to

happen

Key Board Insiders

For Thirdpointsproposal to be successful theboard must be convinced that it is in Sonys

best interest to spinoff the Entertainment

division.


12/16

Valuation Output

FCFF 2013 3,461,033.4

FCFE 2013 1,452,062.4

FCFE/Sh 1,356.1

Share Price in $ $13.96

Valuation and Sensitivity

4.50% 3.50% 2.50% 1.50% 0.50%

Share Price in $ $34.3 $22.2 $14.6 $9.2 $5.3

$0.0

$10.0

$20.0

$30.0

$40.0

Growth Sensitity on SNE Share Price

Share Price in $

Key Assumptions

Growth 2.5%

WACC 8.24%

Cost of EquityAdjusted withCDS Premiums

11.77%

One stage FCFE model was used becauseSony is a mature company with estimatedguidance issued by the company

My target price based on intrinsic value is$14.55 which is a 30% drop from itscurrent price

The twelve month target pricealso fits with the technical levelson the chart

1 2 3 4 5 6

Japan CDS 0.78% 1.78% 2.78% 3.78% 4.78% 5.78%WACC 8.23% 9.38% 10.52% 11.66% 12.80% 13.95%

Share Price $13.97 $8.44 $4.49 $1.53 $0.00 $0.00

$0.00$2.00$4.00$6.00$8.00$10.00$12.00$14.00$16.00

0.00%2.00%4.00%6.00%8.00%

10.00%12.00%14.00%16.00%

Japan CDS Sensitivity Share Price

Japan CDS

WACC

Share Price


13/16

Why I could be wrong

Thirdpoints

Reputation

Thirdpoint has anexcellent track record

being an activist

Thirdpoint has broughta deal that is relatively

small and not very

intrusive to the board

Sony is readyto turnaroundits business

Shareholders might beready for change

Institutional ownershipis at a 5 year low, so

entrenchedshareholders shouldnt

be a problem

OverallEnvironment

With Abe doingwhatever it takes

Sony could findrenewed vigor for

change

Kazuo Hirai has placedan emphasis on theturnaround and not

status quo

Sony has lagged the major indices over the past two years The JPY weakening hasnt helped Sonys stock much


14/16

SonyDetails of the Trade

Long TermTarget 14.06

Stop at 22.63

Entry after thegap is filled at

19.01


15/16

USDJPY Paired with SNE

Why pair Short Sony withUSDJPY Long?

Sony could possibly benefit inthe very short term from aweaker yen if they decide totake off their hedges

When CA goes negative theYen will have to weaken orforeign investors will have toinvest in Japan

With the lowest yieldsin the world I dont

see foreign investors

jumping to Japan

Levels A small contract, long at the

current spot (101.000) with a stopat 98.475 and a target of 105.

The 61.8 Fibonacci levelwas previously rejectedthis should be set as the

stop level

Structure of Trade: Short SNE at 19.01 Buy the spot USDJPY

(utilizing the standard leverage

for spot currency contracts)

Long TermTarget 105

Stop at the61.8 Fib Level

(98.475)

Entry atthe

confluenceof 101.00


16/16

Scenario Analysis and Risks of Trade

$14.06 $15.56 $17.06 $19.01 $19.63 $21.13

98.475 11.36% 11.36% -2.92% -12.20% -15.16% -22.29%

99.475 16.26% 16.26% 1.98% -7.30% -10.25% -17.39%

100.475 21.07% 21.07% 6.79% -2.49% -5.44% -12.58%

101.475 25.79% 25.79% 11.51% 2.23% -0.72% -7.86%

102.475 30.41% 30.41% 16.13% 6.85% 3.90% -3.24%

103.475 34.94% 34.94% 20.67% 11.38% 8.43% 1.29%

105 41.69% 41.69% 27.41% 18.13% 15.18% 8.04%

Sony Stock Price

USD/JPYSpot

Scenario AnalysisShort SNE & Long USD/JPY

Risks to this trade: Events in Europe cause a flight to safety in

USD/JPY Sony takes off some currency hedges and

reports an upside EPS surprise due to FXTranslation

BOJ gets skittish when inflation occurs andtalks down further easing

Sony starts an early marketing campaign forthe PS3 (expected Holiday of 2013) and themarket bids up SNE

Macro concerns ease as global centralbanks continue to ease Monetary Policy

Sonys 5 step turnaround plan succeeds

Namely, TV turnaround andRealignment of business portfolio

and optimizing resources Sony decides to spinoff Sony Entertainment,

this would result in a price spike

Tailwinds to this trade: Asian trade relations worsen Global Macro data worsens BOJ doubles down on asset purchases and

further weakening of the yen in an effort toboost the Current Account

Japan 2QGDP misses expectations andcauses the BOJ and Abe to institute furtherinflation expectations

Sony hedges incorrectly causing theheadline EPS to miss by more than expecteddue to FX translation

Risk Reward Ratios

USDJPY 1.58

SNE 1.37

Total Trade 1.87

**Gross of trading costs

sne thesis

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