Sony (SNE) provided a great boost to our investment thesis with the company’s 3Q20 earnings results.  Earnings easily beat Wall Street estimates with strength in almost all segments.  Gaming and Image Sensors led the way.  Gaming got a boost from the rollout of the PS5 console, popular new games, and continuing subscription growth.  Image Sensors saw big gains from sales to Apple for the iPhone12 family and a return of shipments to Huawei.  Beyond the strength in Games and Image Sensors, better sales of Electronics Products (TVs, cameras), Music, and Pictures (film and TV production) also contributed.  Even more important than the earnings results, Sony raised operating income guidance for its fiscal year ending on 3/31/21 by 34%. 

Our initial investment thesis for Sony revolved primarily around the idea that the stock trades at a modest EBITDA multiple of less than 10X after backing out the value of 100% owned Sony Financial and a large portfolio of investments.  This is the case even though peer pure play competitors in video games, music, semiconductors, and film and TV trade for 15-20X EBITDA. 

Sony is a complicated Japanese conglomerate.  Complex conglomerates generally trade at a discount to the sum of the parts.  In the case of Sony, we think the discount is way too high, especially considering the company has no debt, substantial cash reserves, and is operated conservatively consistent with Japanese culture.  Furthermore, over the past ten years, Sony has dramatically narrowed its focus to the current set of mostly above average growth businesses and improved capital allocation in favor of shareholders.

The current CEO was elevated last year from the CFO position where he played a huge role in the company’s transformation.  Along with the 3Q20 release, management hinted at future growth plans that focus on better coordination across the business segments, particularly when it comes to synergy in content between video games, film and TV production, and music.  Sony is nearing the end of its latest three-year plan and is due to provide new targets in the spring.  We expect heavy reinvestment of the company’s substantial and growing cash flows in these businesses.  We also expect expanded capacity for semiconductors given Sony’s leadership position in camera technology utilized in high end smart phones and automated vehicles.

Sony’s 3Q20 results provide support for a higher multiple for the shares against material increases to earnings estimates following the 3Q20 report.  This explains the 10% pop in the shares the day after the report.  Due to the strong quarter and management comments, we are raising our multiple target from 13X to 14X on newly increased EBITDA estimates.  We also add the value of Sony’s large investment portfolio including stakes in Tokyo-listed M3, and U.S.-listed Spotify, Bilibili, and Tencent Music.  Finally, we also include for Sony’s wholly owned subsidiary Sony Financial that is excluded from EBITDA estimates.  Putting it all together, our target for Sony increases to $145 from $125 at the time of our purchase just two weeks ago. 

Sony is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.