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It’s been more than a year since I initiated a buy rating on Sony Group Corporation (NYSE:SONY). That seems a good amount of time to follow up on that initial piece, especially given the significant depreciation in the Yen that took place since then.
The Original Sony Thesis
The argument I made last year was that Sony’s sum of the parts should be 50% more than its market cap of $100 billion based on the multiple assigned to its peers.
Sony is a leading company in gaming, music, scripted content, consumer electronics, and semiconductors. Yet despite that, it has a market cap of $104 billion, much smaller than companies like Costco Wholesale Corporation (COST), The Walt Disney Company (DIS), and Salesforce Inc. (CRM). Sony generated more operating income in 2021 than all those three companies combined.
The analysis used a price to operating income multiple to compare Sony’s various business units to pure play peers trading on the market. It concluded that the company should have a market cap at $150 billion given the multiple awarded to its competitors.
Some risks to the thesis were a decline in the general prices of stocks that would affect Sony’s stock price, inflation that would see Sony increase its capex, and weakening global demand.
Where Does Sony Stock Stand Now?
Sony’s stock is down a little more than 1% since the publication of the first article, compared with a 15.68% gain for the S&P 500.
Gaming
Sony’s gaming business recorded revenue of $26.9 billion in 2022, up more than 10% compared to 2021. Operating income fell sharply however to $1.8 billion, from approximately $3 billion in 2021. Meanwhile, Activision Blizzard (the comp I use to price the gaming unit) saw its operating income for the same period fall to about $2 billion, giving the company a multiple of 37.8x its operating income.
Applying Activision’s multiple to Sony’s would give the unit a price of $68 billion. This is roughly 15% below the price I reached in last year’s article.
Last year I argued that Sony’s gaming business deserves a multiple at least on par with Activision Blizzard given the Japanese company’s status in gaming as the maker of PlayStation. That competitive strength still holds today despite Microsoft’s acquisition of Activision Blizzard.
One limitation of this method applied to the gaming unit is that Activision’s price didn’t change given it agreed to be acquired by Microsoft, and that it would have likely declined had it been an independent company. On the other hand, there is enough conservatism built in the gaming unit’s price, given that it sells below Activision based on my calculation. It should be clear that a company that has a dominant position in the distribution of games should sell for more than a company that develops games.
Music
Sony Music is one of the largest businesses of its kind in the world. In fiscal year 2022, the business unit generated revenues of $10.2 billion. That’s essentially flat YoY in dollar terms. Operating income was $1.9 billion, the same as it did the previous year.
Warner Music Group generated $695 million in operating income during the same period. It trades at 23.2 x the operating income of the 12 months ending March 2023 (the same period of Sony’s fiscal year). That’s two turns more than the multiple it traded for in the first article. Universal Music Group generated operating income of $1.6 billion during the same period. It trades for 29.2x the period’s operating income.
Pricing Sony Music’s business unit based on the average of Warner Music Group and Universal Music Group’s multiple would lead to a valuation of (1.9 * 26.2) of almost $50 billion. That’s an appreciation of 8.7% compared to the pricing derived in the first article.
This pricing seems conservative given it’s at a discount to Universal Music Group even though Sony’s business unit has higher operating income and margins.
Pictures
Sony’s movie and TV business struggled a little in 2022, mostly as a result of strong comps compared to 2021. There was no Spiderman movie or Seinfeld licensing deal in 2022 like there was in 2021. The result was revenue that came in at $10.1 billion, down from the $11 billion generated in 2021. Incidentally, the most notable observation about the revenue result is that Sony Music has surpassed the Pictures business unit after the former generated $10.2 billion in 2022. Sony’s music business unit is also likely to have less lumpy revenues compared to the pictures business unit, with the latter subject to fluctuations on the theatrical releases side.
I am making a slight tweak to the pricing of this business unit in this article. I will use the adjusted OIBDA number provided by Sony management, rather than the operating income number. I think this will give a cleaner comparison to Warner Bros. Discovery than it did last year. Sony’s adjusted OIBDA number was $1.2 billion.
In the 12 months ending March 2023, Warner Bros. Discovery generated GAAP operating income of $-3.1 billion, according to Seeking Alpha’s financials tab. Using the same adjustments made by Sony (adding back depreciation, amortization, non-recurring profit/loss), WBD’s equivalent adjusted OIBDA was $8.6 billion for the period. With a market cap of $26.1 billion, WBD is trading at 3x that period’s OIBDA. This would give Sony’s pictures unit a price of (3 * 1.2) of $3.6 billion. That’s almost half the price I assigned the unit last year, and is a result of both multiple contraction and lower profits.
Note that using operating income for Sony instead of adjusted OIBDA would have improved the unit’s price a bit, but it would have been still drastically below last year’s pricing. That’s because operating income in declined 45% YoY.
Consumer electronics, semis, computer vision system
These business also struggled in dollar terms in 2022. The imaging and sensors business unit however was a bright spot for the company during the year. It benefited primarily from foreign exchange, but also from demand for imaging sensors for mobile products.
Those business units generated a combined revenue of $28.6 billion. Revenue was down 6.7% in US Dollar terms. Their combined Operating income was $2.9 billion, down 12% as the decrease in TV unit sales has a big impact on profitability, with operating income for the consumer electronics business turning negative in Q4 of the fiscal year.
I chose Samsung as the comp for those business units, given the similarity they share with the Korean giant. Samsung currently sells at 14.7x its operating income for the 12-month period ending in March 2023, as the stock is actually up since the first article even though its operating income more than halved.
Assigning the multiple to Sony’s business unit would give them a price of (14.7 * 2.9) of $42.6 billion. That’s almost double its pricing from last year as Sony’s income didn’t fall much thanks to its imaging and sensors unit.
Bringing it all together
Adding the price of all business units together would give Sony a price of (68+50+3.6+42.6) of $164.2 billion ($133 a share). That’s a potential upside of 59%.
Risks
The risks I mentioned last year remain:
Further declines in the general prices of stocks would likely bring down the multiples of Sony’s comparable stocks. The valuation provided in the article did lean towards conservatism whenever the option existed, providing some margin of safety against any potential declines. Inflation could see Sony increase its capex, potentially lowering the quality of the company’s operating income. A deterioration in economic conditions could see the company struggle to replicate its 2021 performance for some time, which would require lowering the stock’s valuation.
I’d add to it 2 new risks. The first is that Sony’s stock price is probably now much more influenced by Q1 results and the guidance for the rest of the year, rather than 2022 results. That’s probably cushioned by the fact that this applies to Sony’s comps as well, and they are all in similar business lines. This brings me to the second new risk, which is that even though they are similar business lines, they are not exact. For example Sony doesn’t have a semiconductor fab business like Samsung, and the latter doesn’t have anything akin to hawk-eye. Furthermore, WBD has a very high exposure to US cable, unlike Sony. And as pointed out earlier in the article, Sony’s gaming centers around consoles while Activision doesn’t.
Conclusion
Sony continues to present a compelling investment opportunity in my opinion. The spread with the comps I selected last year has actually grown to a potential upside of 59%, and I expect that gap to close at some point (though it could be by having the stock prices of the other companies come down). And while there are differences between Sony’s business units and the comps I selected, it’s hard to argue that those differences are so severe as to invalidate the thesis.
Sony enjoys strong competitive advantage in virtually all its business units, and I expect patient investors to be rewarded for holding the stock.
