Sony: Staying Neutral With In-Line Results And Mixed Developments

seekingalpha05-14

Sony's actual FY 2023 operating profit was pretty close to the company's management guidance and the sell-side analysts' forecasts.The appointment of new co-CEOs for Sony Interactive Entertainment and...

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Sundry Photography/iStock Editorial via Getty Images Elevator Pitch Sony Group Corporation (OTCPK:SNEJF) (NYSE:SONY) [6758:JP] is awarded a Hold investment rating. My prior update published on January 10, 2024 was focused on the \"partial sale of its Payment Services business\" and a decrease in the \"number of live service games\" targeted for launch by fiscal 2025 (April 1, 2025 to March 31, 2026). The current write-up assesses Sony's recently announced financial results for FY 2023 (YE March 31, 2024) and its latest corporate developments. The company's operating income for fiscal 2023 was consistent with the sell side's projections and its own guidance to a large extent. Recent developments are mixed, considering the appointment of new co-CEOs for Sony Interactive Entertainment and the potential acquisition of a movie studio as reported in the media. I am staying Neutral on Sony after reviewing its financial performance and assessing its recent moves. FY 2023 Operating Profit Met Expectations Sony disclosed the company's full-year FY 2023 financial performance on May 14. The company delivered a normalized operating profit of JPY1,208.8 billion in the most recent fiscal year, as indicated in its results presentation slides. This was largely consistent (marginal +0.7% beat) with the market's consensus operating income forecast of JPY1,200.9 billion (source: S&P Capital IQ). Sony's actual operating earnings for the latest fiscal year were also slightly better (+2.4%) than its earlier JPY1,180 billion guidance. Sony's operating income was aligned with the analysts' expectations, although that still represented a -7.2% decline as compared to the prior fiscal year. Operating profit for the Game & Network Services (G&NS) and Music segments rose by +16.1% and +14.7% to JPY290.2 billion and JPY301.7 billion, respectively on YoY terms in FY 2023. But this was more than offset by a -45.4% YoY operating earnings contraction for the Financial Services segment to JPY173.6 billion for the recent fiscal year. In its results announcement, Sony explained that the Financial Services segment faced an unfavorable comparison in FY 2023, considering relatively higher \"net gains related to market fluctuations for variable life insurance\" and a one-off \"gain from the sale of real estate\" for FY 2022. At its FY 2023 results briefing, the company also noted that \"increased streaming sales\" and \"increased third-party software sales\" boosted the results of its Music and G&NS segments, respectively, in the latest fiscal year. In summary, Sony's recent financial performance didn't throw up any major surprises, as evidenced by its in-line operating earnings for fiscal 2023. Overhang Regarding Leadership Transition At Sony Interactive Entertainment Has Been Removed With my earlier September 29, 2023 article, I highlighted that \"Jim Ryan is retiring\" in March 2024 which creates \"uncertainty over Sony Interactive Entertainment's (or SIE's) future leadership.\" On May 14, 2024, Sony published a media release revealing new management appointments at SIE. Specifically, \"Hideaki Nishino will be appointed CEO of SIE's Platform Business Group, and Hermen Hulst will be appointed CEO of SIE's Studio Business Group\" as indicated in the company's latest press release. The company mentioned at its FY 2023 earnings briefing that the appointment of new co-CEOs is done to ensure that \"our decisions (at SIE) are made in a timely manner and a really granular manner.\" I view this latest development for SIE in a positive light. Firstly, there is finally clarity over who will lead SIE following the retirement of Jim Ryan. SIE's interim CEO, Hiroki Totoki, is also Sony's Chief Operating Officer and Chief Financial Officer, so he won't have the time and energy to take charge of SIE if this interim CEO arrangement had continued. As such, it comes as a relief that Sony has made the decision regarding permanent CEO appointments for SIE. Secondly, my opinion is that it is the right decision to have two co-CEOs for SIE, rather than continuing with the previous arrangement of having a single CEO. As per the May 14 announcement, the Platform Business Group and the Studio Business Group are in charge for \"the experiences and technology within PlayStation products and services\" and \"bringing video game IP to new mediums such as film and television\", respectively. It is clear that these two businesses within SIE are different, which implies it is appropriate to have two CEOs lead the two divisions separately. Potential Mega Deal Is A Concern A recent May 2, 2024 Associated Press article indicated that \"Sony Pictures and the private equity firm Apollo Global Management (APO) have expressed interest in buying Paramount Global (PARAA) for $26 billion.\" At the company's recent fiscal year earnings call, Sony indicated that it had \"not made any announcement\" on the reported Paramount deal. But the company also stressed at the latest briefing that \"we consider possibilities\" assuming that \"there is any good opportunity.\" This suggests that there is a good chance that the media report is true. There are good reasons to be worried about Sony being engaged in such a large M&A transaction. One reason is that there is evidence indicating that big M&A deals typically fail to create value for shareholders. A June 2022 research paper on the topic of M&A made reference to past studies highlighting that \"more than 60% of mega-deals result in shareholder loss\" and that \"mega-deals above $1 billion destroy twice the shareholder value as small deals.\" Another reason to be wary of this new potential transaction is Sony Pictures' prior major deal quite a while ago. Sony Pictures previously acquired Columbia Pictures in 1989 for a consideration of $4.8 billion, and subsequently took a $2.7 billion impairment in 1994. If history is any guide, the purchase of other film businesses hasn't worked well for Sony's movie division. Final Thoughts A look at Sony's recent results and corporate moves implies the risk-reward for the stock remains balanced. There were no surprises with Sony's FY 2023 operating profit. At the same time, I have a mixed view of the company's latest developments pertaining to SIE and the Pictures segment (movie business). Also, I think that Sony's shares are trading at a fair valuation that justifies a Hold rating. My target P/B multiple for Sony is 1.9 times. This is based on the Gordon Growth Model that arrives at a P/B metric by dividing [ROE - Perpetuity Growth Rate] by [Cost of Equity - Perpetuity Growth Rate]. My assumptions for ROE, Perpetuity Growth Rate, and Cost of Equity are 12.3% (FY 2024 consensus ROE estimate as per S&P Capital IQ data), +3%, and 8%, respectively. As a comparison, Sony's current P/B ratio is 2.0 times (source: S&P Capital IQ) or close to my target.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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