Goldman Says Sony Risk Jump Overdone Amid Loeb Bid: Japan Credit

Goldman Sachs Group Inc. and BNP Paribas SA recommend investors seek to profit from the jump in bond risk of Sony Corp., which is considering billionaire Daniel Loeb’s proposal to spin off its movie and music business.

The cost to protect the debt of the maker of PlayStation video-game consoles and Bravia televisions has risen 88 basis points to 228 basis points since May 13, a day before Loeb’s plan was first reported, according to data provider CMA. That’s the highest since Feb. 1. Japan’s benchmark for credit-default swaps climbed 47 basis points in the period to 121, and the gauge for the U.S. increased 19 to 92, according to CMA.

Goldman and BNP Paribas both recommend selling protection on Sony debt to profit from the excessive costs, with the French bank blaming hedging activity by equity investors for the increase. The Tokyo-based company forecast a 16 percent increase in profit for the year started April 1 after posting its first net income in four years, helped by the weaker yen, job cuts, asset sales and hit movies including “Skyfall.”

“Sony’s credit-default swaps are at pretty high levels,” Hisayoshi Nogawa, a Tokyo-based structured credit strategist at BNP Paribas, said in a telephone interview. “From a credit investors’ point of view, the levels are wider than the benchmark index by about one percentage point. That’s a good premium.”

Loeb’s Proposal

The company’s bond risk rose to a record 488 basis points on Nov. 1 as the electronics maker unexpectedly posted its seventh straight quarterly loss on falling demand, according to CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. It declined to 140 basis points May 13, the lowest since Nov. 17, 2011, before Loeb’s proposal triggered a share rally.

An initial public offering of the entertainment operations would help Sony focus on its unprofitable electronics businesses, Loeb said in the May 14 letter. Daiwa Asset Management Co. is opposed to the proposal, claiming it will drain the company of a source of profits.

The billionaire is pushing for talks with Sony directors and investment bankers advising the company on his proposal after the board agreed to consider it. Third Point LLC funds now own 70 million shares, up from 64 million in May, and it is interested in serving on Sony’s board, Loeb said in a June 17 letter to Hirai. That’s about 6.9 percent of outstanding shares.

Mami Imada, a Sony spokeswoman, declined to comment on the credit-default swap moves.

Bond Sales

Elsewhere in domestic credit markets, the Japan Student Services Organization hired banks for a 40 billion yen ($408 million) sale of two-year notes in August, according to a statement yesterday from Mitsubishi UFJ Morgan Stanley Securities Co., which is managing the deal with Daiwa Securities Group Inc. and Nomura Holdings Inc.

Japan’s benchmark 10-year bond yield rose 1 1/2 basis points, or 0.015 percentage point, to 0.875 percent as of 10:57 a.m. in Tokyo today. The securities yielded 175 basis points less than similar-maturity U.S. Treasuries, the widest spread since July 2011, according to data compiled by Bloomberg.

The yen was little changed at 97.86 per dollar as of 10:59 a.m. in Tokyo, after touching 98.70 on June 24, the weakest since June 11. It has depreciated 8.9 percent in the past six months, the most among the 10 developed-market currencies tracked by the Bloomberg Correlation Weighted Indexes. The weaker yen helps boost exporters’ overseas earnings and make their products more competitive abroad.

Hedging Positions

The cheaper currency, along with a recovering electronics business, will help lower Sony’s bond risk, BNP Paribas’ Nogawa said. The swaps may have risen in mid-May because of equity investors betting the spinoff plan will raise the stock price and buying the insurance to hedge positions, he said.

After those managers closed their positions, pushing the credit derivatives down by mid-June, the rates started climbing again as the the prospect of the U.S. Federal Reserve reducing stimulus measures roiled financial markets, Nogawa said.

Credit-default swap contracts typically rise as investor confidence deteriorates and fall as it improves, and investors use them to hedge against losses or to speculate on creditworthiness. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Entertainment Profits

Sony’s main TV business has lost 762 billion yen during nine straight annual losses. Without the contribution of profitable entertainment units and an insurance arm, Sony would have booked 130 billion yen in losses in the year ended March 31. Its net income was 43 billion yen.

The company plans to turn around the electronics segment and forecasts a 100 billion yen profit for it this fiscal year, Chief Financial Officer Masaru Kato said last month.

Operating profits and free cash flow generated in the year through March 31 “should be a tailwind to its CDS performance,” Kenneth Ho, a Hong-Kong based credit strategist at Goldman Sachs, wrote in a note dated June 18. The bank is recommending buying swaps on Mitsui O.S.K. Lines Ltd., the world’s largest merchant ship operator, at 215 basis points, while offering protection on Sony at 200.

Convertible Bonds

Goldman Sachs was one of the underwriters, along with JPMorgan Chase & Co., Nomura Holdings and SMBC Nikko Capital Markets Ltd., hired to manage last year’s 150 billion-yen sale of Sony convertible bonds.

The U.S. bank purchased the notes on the secondary market and a special vehicle was set up to hold them and sell financial products after separating the debt from the equity option, according to a Dec. 7 statement by the investment bank.

Nomura Holdings said credit-market concern that the Fed will start tapering its $85 billion in monthly bond buying may cause Sony’s bond risk to rise in the short term.

“When default swaps are likely to rise, companies with bad fundamentals are more likely to suffer,” said Toshihiro Uomoto, Tokyo-based chief credit strategist at Nomura. “I’m not positive about Sony’s recovery.”

Prime Minister Shinzo Abe’s policy to end 15 year of deflation through monetary and fiscal stimulus has helped lower the debt risk of Sony’s domestic competitors, according to Nogawa at BNP Paribas.

Sharp Corp.’s default swaps were at 812.3 basis points yesterday after soaring to a record 8,078 on Oct. 18, while Panasonic Corp. decreased to 159.3 basis points from a record 506 on Nov. 6, CMA prices show.

“You can’t win at credit investment unless you get in when the levels are high,” he said. “Timing is everything.”

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