It took many years, but Sony Group’s long-running diversification strategy into content finally seems to be paying off amid shifting technology and consumer habits, enough that Morningstar analyst Kazunori Ito on Friday upgraded the company’s moat and raised his fair-value estimate of the company by 9 to 12.5 percent, depending on the currency.
“Over the past decade, Sony has shifted to an asset-light business model, focusing on content acquisition, and developing recurring revenue businesses that enable long-term monetization from customers,” Ito wrote. “As a result, while Sony’s return on invested capital track record is poor, we believe the company’s current business portfolio is much stronger than before and can generate ROIC above the weighted average cost of capital over the long term.”
Crucially, Ito also upgraded Sony’s “moat” rating – a measure of the uniqueness and value of a company’s products – from “None” to “Wide.” Ito credits the company’s massive investments in Sony Music and in the PlayStation and related game operations.
Sony founders Akio Morita and Masaru Ibuka created the company in 1946, amid Japan’s post-WWII devastation, as a maker and seller of consumer electronics, famously beginning its international distribution with a handheld transistor radio.
These days, Sony still makes plenty of consumer electronics, from well-regarded televisions to smartphones, speakers to headphones, and much else, but competes with Korean powerhouses Samsung and LG, and a seemingly endless armada of low-cost Chinese, Turkish and other competitors. It also has been a pioneer in optical sensors, from high-end broadcast video equipment to its market-leading Alpha “mirrorless” interchangeable-lens cameras for consumers.
But that traditional hardware focus left the company “highly dependent on consumer electronics (with) a very fragile and volatile earnings structure in the face of economic fluctuations,” Ito wrote.
Over the past three decades, the company acquired a string of content-creation companies across games, music, and film/TV. Those ventures have had their own ups and downs in the cycles and shifts of each industry, but Ito suggested the company is now seeing the benefits of digital distribution that are providing it with far more durable revenue streams.
“Sony’s profitability has become much higher and less volatile than before, because 1) the internet has increased the revenue and profitability of the game console business and the music business and both have become the largest contributors to operating profit; 2) Sony has become the leading brand in interchangeable lens cameras; and 3) the company has implemented a significant business model transformation in consumer electronics to become less vulnerable to economic fluctuations, such as the restructuring and reorganization of production facilities for TVs and smartphones, and the divestment of PCs,” Ito wrote.
He credited the long-time management team led by CEO Kenichiro Yoshida and COO/CFO Hiroki Totoki for transforming the company in recent years into “a more disciplined company that does not pursue market share in its hardware business, but invests effectively to expand its user base and maximize revenue per user in its content business.”
Sony’s most notable diversification venture may be the PlayStation game consoles, the first of which debuted 30 years ago. The consoles have been at the center of a huge ecosystem of game developers and gear that has continued to expand as the entire game industry has exploded in size.
Analyst estimates put global game revenues at around $180 billion annually, with potential for a huge additional leap thanks to new experiences and revenue models driven by blockchain, immersive headsets, and artificial intelligence.
The investment in games has paid off as the business has shifted to internet-driven distribution, marketing and gameplay, Ito wrote. Of particular note is the rise of PlayStation+, the three-tiered online game subscription service that provides access to online play and hundreds of new and older games.
Sony’s 1988 acquisition of CBS Records weathered a collapse in the music business in the early 2000s amid the shift to digital distribution dominated by Spotify, Apple Music and other purveyors. In the past two years, music industry revenues finally passed pre-collapse figures as millions of fans have come to rely on subscription services for their tunes.
Sony also has seen its investments in film and TV (Columbia Pictures and related operations) undergo a rugged transition into the digital era, though crucially, Sony Pictures Entertainment resisted the temptation to launch its own subscription streaming service to compete against Netflix and those of its Hollywood competitors.
Instead, SPE became an “arms dealer,” selling off its own small Crackle service and focusing on profitably producing and selling features and series through traditional film and TV outlets and to the other streaming services. That strategy likely spared Sony a share of the billions of dollars in losses that have hamstrung competing studios other than profitable Netflix.
Thanks to the company’s ability to evolve with dramatic changes in its original business and all the content plays it has made since, Ito raised the company’s “fair value estimate” substantially, from 16,000 yen to 18,000 yen, or 12.5 percent, and for American Depositary Shares, from $103 to $112, or 9 percent.
Sony Group’s ADR shares on the NYSE closed the week at $86.82, up $1.17. The ADRs are down for the year so far by 7 percent.