S&P Cuts Sony Debt Rating

The downgrade reflects strains on the electronics giant's profitability from product and price competition

On Nov. 22, Standard & Poor's Ratings Services lowered its long-term corporate and senior unsecured bond ratings on Sony Corp. (SNE ) and its financial subsidiaries to 'A' from 'A+', and affirmed Sony's short-term rating at 'A-1'.

The ratings were removed from CreditWatch where they had been placed on Sept. 14, following the company's announcement that an investor consortium lead by Sony had reached an agreement in principle to purchase the major U.S. movie studio, Metro-Goldwyn-Mayer (MGM ) for about $5 billion. The outlook on the long-term credit rating is negative.

At the same time, Standard & Poor's affirmed its 'A+' financial strength and counterparty ratings on Sony Life Insurance Co. Ltd., and 'A-' long-term and 'A-2' short-term ratings on Sony Bank Inc. The ratings were removed from CreditWatch and the outlook on the long-term credit ratings is negative.

"The downgrade and negative outlook primarily reflect Sony's profitability, which has been strained from product and price competition, especially in its core electronics business where there is still uncertainty regarding sustainable improvement in Sony's earnings-generating ability," says Standard & Poor's credit analyst Osamu Kobayashi.

"Sony has been undergoing major restructuring efforts to reduce fixed costs and increase its overall competitiveness. However, Sony's efforts to strengthen its product portfolio, including audiovisual products -- a traditional strength for Sony -- have lagged behind in an increasingly competitive market characterized by aggressive development and marketing of new products. There is a concern over the negative impact on Sony's market position," Kobayashi says.

In the MGM acquisition, Sony will invest up to $300 million in equity. Standard & Poor's believes that Sony should benefit from access to MGM's extensive movie archives to enhance its content businesses, and the acquisition is not likely to cause major changes in Sony's overall business risk in the near term. While full-scale profit contributions and business synergies may not be expected quickly, the direct financial impact on Sony from the acquisition should be limited.

For the first six months of fiscal 2004 (ended Sept. 30), Sony's consolidated operating margin after depreciation and restructuring costs improved only slightly to 1.6% from 1.5% from a year earlier. Operating profit was supported by its motion picture business, which rebounded to a 31.5 billion yen profit from a 7.0 billion yen loss in the same period in the previous year, while operating profit at the core electronics business declined 72.9% to 15.7 billion yen, year-over-year, and home video games and music business reported operating losses.

Overall stability and resilience in earnings from its diversified business portfolio has been one of Sony's strengths, and the company maintains an adequate capital structure for its rating category. However, Sony's profit structure has increasingly become more dependent on its financial operations, and more vulnerable to the volatile performance of music and motion pictures and home video game operations, which also carry higher risks.

The rating on Sony could be lowered if the company fails to attain a sustainable improvement in profitability or if its balance sheet deteriorates significantly as a result of larger capital requirements.

The affirmation of the ratings on Sony Life and Sony Bank reflects expectations that Sony Life's stable and strong financial base will continue to underpin the credit quality of the Sony financial group overall. However, given that Sony is the parent company of Sony Financial Holdings Inc., the holding company of its financial subsidiaries, and its strong brand name is shared by the financial subsidiaries, Sony Life and Sony Bank are not insulated from impact of the downgrade of Sony. While the financial holding company plans an IPO in 2006, Sony's support for its financial subsidiaries may change in the future, but at present, Sony is expected to retain a majority stake in Sony Financial Holdings.

In its third year of operations, Sony Bank remains unprofitable, although Standard & Poor's has expected achieving profitability would take more time. Sony Bank's current performance, including an increase in both deposit and lending, is within Standard & Poor's expectations. However, housing loans, a core market for the bank, are facing intense competition from city and regional banks, and its performance in this segment will be a key issue for the bank.