The company blames its woes on the strong yen, but some analysts are not convinced. How long can the CEO hang on?
Sony yesterday announced an operating loss of ¥18 billion ($197 million) for the crucial Christmas quarter of fiscal 2008 (ending March 2009), compared to a gain of ¥236.2 billion for the same October-December period in 2007.
Operating profit is supposed to reflect the company's actual operations, and does not include tax or "other income." Net income, which does include tax and "other income" (from interest, dividends, net gains on securities investment and gains on changes in interest in subsidiaries and equity investees), amounted to ¥10 billion thanks to a remarkable ¥79 billion foreign exchange gain, which offset losses at the operating level. Net income was nevertheless down 95% on the same period last year.
The Q3 FX gain is somewhat ironic, because the company was at pains on Thursday to blame the ever-strengthening yen for the company's losses. Regarding the operating income of the electronics division, for example, the company blamed the ¥16 billion operating loss mainly on a huge negative ¥94.2 billion charge as a result of the strengthening yen. The effect on the games division was even more striking, with operating income in local currency (non-yen income) up a remarkable 156%, but down 97% in yen terms. Several other divisions told the same story — positive local currency sales, but negative yen sales.
The yen would indeed be the obvious culprit for a Japanese exporter's woes, but less so when you consider that the same company has also benefited from a very weak yen in the past. CEO Howard Stringer joined Sony in June 2005 when the yen was at 105 to the US dollar. It weakened to 123 in June 2007, before beginning the strengthening trend which is still in play today. The earlier weakening (against the euro as well) naturally boosted Sony's overseas sales, while the recent strengthening is having the opposite effect. Sony appears to be unusually sensitive to FX fluctuations for two reasons, say analysts: compared to rivals such as Matsushita, Nintendo and Sharp its operating margins are too narrow; and its exports are also the most heavily dependent on the U.S. and the E.U., with 74% of sales revenue coming from those markets.
And if you delve deeper into the figures, it does not seem possible that currency shifts were the principal cause of the company's losses. Sony's initial guidance for FY08 was ¥450 billion in operating profit, based on an exchange rate of ¥100 to the dollar. According to brokerage CLSA, yen appreciation would have had an impact of around ¥100 billion, meaning a profit of ¥350 billion. Instead, the company is now forecasting an operating loss of ¥260 billion, or a swing of ¥610 billion on top of the currency losses.
The current full-year forecast was announced at a press conference in Tokyo last week that was hosted by CEO Howard Stringer. The company also forecast a full-year net loss of ¥150 billion and said the projections were sharply down on earlier profit forecasts due to ¥60 billion in foreign exchange-related losses and another ¥65 billion in losses related to the stockmarket decline.
Stringer understood the problems facing Sony early on, and he has announced cost cuts of ¥250 billion for FY09 (although at a one-off cost of ¥170 billion), and a policy of integrating software and hardware. Unfortunately, Sony appears to be falling between two stools: it has not managed to imitate the Apple strategy and its elite hardware engineers are demoralised — since Stringer's whole strategy is predicated on knocking them from their high status and forcing them to cooperate with content providers like the movie division and the games software division.
Demoralised and departing hardware engineers may be why Sony is not making money on so much of its hardware: games, TVs and mobile phones in particular are all loss making and are no longer automatically considered "best in class," despite the premium price tags.
Some analysts believe that what Sony is now confronted with is a management failure, and that it won't be long before talk of Stringer's departure becomes more urgent.
However, it's difficult to see where opposition to Stringer might become concentrated. A look at the Sony board (which has the right to dismiss the CEO) shows that it is dominated, as required by Japanese company law, by non-Sony people. Of the 15 members of the board, only three are from Sony (Stringer, Chubachi and Ihara) while the remaining 12 are "outside directors," in the Japanese terminology. They include executives from Berlitz International, McKinsey, Telemundo, Sumitomo Mitsui Financial Group, Fuji Xerox and elsewhere. It's very difficult seeing these executives being able to come up with a detailed rescue plan for Sony. (At Sony, members of the board of directors are put up for election or dismissal by a "nominating committee" which consists of at least five people, of which two must be Sony executives and the majority outside directors.)
A shareholders' revolt could be a possibility at first glance, given that 14.8% of outstanding shares are held by Moxley and Co. and 10.7% by the Japan Trustee Service. However, both are nominees, holding the shares or ADRs on behalf of other companies. The other shareholdings are highly fragmented.
One analyst says that any successor to Stringer should "get rid of the semiconductor business (loss making), the components business (loss making), batteries (loss making), Sony Pictures (loss making), Sony Music (loss making), Sony Ericsson (loss making), games (loss making) and Sony Financial Services (which have no synergies whatsoever with the rest of the company.) The only segment where Sony has a No. 1 position is the video camera business and which earns a profit....Sony could possibly capitalize its strong brand in TVs and digital still cameras (despite neither of these businesses being profitable), add them to the video camera business and shed everything else."
A second analyst believes Stringer's fate will be decided within the next six months — based on evidence that progress is being made towards the ¥250 billion in cost cuts, and that the TV business is returning to profitability.
One name being mooted as a possible successor is Miles Flint, the former head of mobile phone division Sony Ericsson. Flint did extremely well at Sony Ericsson but left the company 15 months ago to join Silver Lake, a private equity company. It's not clear why he left, but given the dire state of the private equity business, he might be interested in returning — or perhaps that would be a case of "out of the frying pan into the fire."
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