Video Biz Hits Sony When It's Down

On the heels of battery recalls and possible lawsuits comes the announcement that the tech giant's video game business lost big time

For months, Sony (SNE) has been dogged by dreary news about its faulty lithium-ion batteries for laptop computers. Among analysts, it was a foregone conclusion that the Japanese tech giant's global recall of nearly 10 million batteries would mean a nasty earnings haircut. Laptop sales have been disrupted for major customers Dell (DELL), Apple (AAPL), and Toshiba (TOSBF)—not to mention Sony's own PC division.

But on Oct. 19, in a startling 62% downward full-year earning revision, Sony execs revealed that its video game business was an even bigger worry. The real shocker is that Sony doubled its forecast loss on its video game business to $1.68 billion in the fiscal year through March, 2007.

The culprits: delays to the launch of the PlayStation 3 game console, production snafus, and a slowdown in sales of the PlayStation Portable, the checkbook-sized multimedia gizmo. "Besides batteries, the deterioration of Sony's other businesses exceeds expectations," Merrill Lynch analyst Hitoshi Kuriyama wrote in a report.

Still Solid Core

The announcement is yet another troubling sign that Sony's big initiatives aren't giving it the spark it had hoped for. It also raises questions about chairman Howard Stringer's ability to orchestrate a turnaround at the consumer electronics and entertainment colossus. Since Stringer took over in June, 2005, he's flattened the management structure, eliminated jobs, and tried to end the rivalries that had led to redundant product lines and bickering among divisions. But the recent spate of problems magnifies the difficulty of the task he's been given.

Sony revised its overall operating profit forecast downward from $1.09 billion to $421 million for the fiscal year through March, 2007, but left unchanged its estimates for $69.3 billion in revenues. Sony is scheduled to announce half-year results on Oct. 26. Some analysts were unfazed, since the revival of the company's core electronics business doesn't appear to have been derailed.

Sony Executive Vice-President and CFO Nobuyuki Oneda said the company was confident of delivering on its promise to have the TV unit profitable by the end of the fiscal year. In a report, Goldman Sachs analyst Yuji Fujimori kept his "neutral" rating on the company for now. Prior to Sony's announcement, the company's shares closed in Tokyo down 0.4%, slightly outperforming the Tokyo stock market's electrical machinery index, a benchmark for the electronics sector.

Blu-rays That Bloom in Spring

The problems with the PS3 first emerged in March, when Sony's games chief, Ken Kutaragi, delayed the global launch to November, from its originally scheduled spring debut (see, 3/16/06, "Sony's Delay of Game").

In September, Sony further pushed back the PS3's release in Europe until next spring, and lowered its price in Japan by 20% to entice buyers. The latest delays were caused by slow production of the blue laser diodes for the Blu-ray Disc, a next-generation DVD format that will be included in the PS3.

Oneda told journalists that the PS3's price cut in Japan and worse-than-expected yields of the console's chips would deepen the division's losses this year. But he said the console's sales target was unchanged at 6 million units and that improving chip yields would eventually contribute to lower costs.

Battery of Losses

The PSP was a different story. Oneda said the company would likely sell 9 million PSP's this fiscal year, falling short of an earlier prediction for 12 million.

(Earlier this month, rival game manufacturer Nintendo raised its target for the portable DS console to 20 million units, from 17 million, this fiscal year.)

The recall of laptop batteries will put a sizable dent in earnings as well. Sony said the global exchange program—which covers Apple, Dell and many other major PC makers, including its own Vaio laptops—would likely cost $429 million. That figure was calculated into second-quarter results.

But the cost of the recall remains preliminary. The actual figure, which won't be known for months, depends on how many of the 9.6 million batteries (8 million supplied to PC makers and 1.6 million replacement cells for laptops sold separately) are returned to PC makers, since Sony plans to pick up much of the tab for shipping, call centers, and production.

Paying the Lawyers

The company also hasn't factored in the possibility of PC manufacturers switching to rival battery makers. Sony's battery unit accounts for a fraction of total sales, but has been a reliable money maker.

Nor has the company considered the expense of a potentially messy legal standoff with Toshiba, Hitachi (HIT), and Fujitsu (FJTSY). On Oct. 16, all three said they were considering seeking damages (see, 10/16/06, ""Are Sony's Battery Woes Bound for Court?").

Sony's recent blunders put Stringer and his crew in a bind and distract the public from the progress they've made so far. This year the electronics division's operating profits would have boosted earnings by $450 million—partly thanks to favorable currency swings—had it not been for all the problems.

Stringer will have to offer solid guarantees to investors and business partners alike that the mistakes won't be repeated, or the brand could suffer. So far, no Sony exec has been dumped, and officials said no such changes were under consideration. But if things continue to worsen, it can't be ruled out.

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