When Sony reported 3Q20 results three months ago, the company sharply raised guidance for the fiscal year that ended in March.  4Q20 results met or slightly exceeded the new higher guidance.  In conjunction with the latest report, Sony established a new three-year financial and strategic plan including guidance for the current quarter and fiscal year.  The new plan is heavy on investment in operating expense, capital spending, and possible M&A.  These investments lead to modest near-term pressure on estimates and perhaps a slower growth rate in EBITDA over the next three years.  However, the plans should lead to more sustainable long-term growth and higher growth looking beyond the three-year time horizon.  Given that Northlake’s investment thesis for Sony is built on a materially discounted valuation, we like the plan to invest in growth as it supports an expansion in the stock’s valuation multiple toward its peers in music, video games, entertainment, and semiconductors.  The modest pullback in the shares in response to earnings is of little concern to us and we reiterate our target of $145, nearly 40% above current trading levels.

As a blue-chip Japanese company, it is no surprise that Sony thinks long-term and usually guides conservatively.  Even so, there has been a big change at the company in the past ten years that crystalized during the just completed three-year plan.  In the earnings presentation, Sony noted, “In previous Mid-Range Plans, we have prioritized improvement and enhancement of the profitability of each business, but in the Fourth Mid-Range Plan, we aim to grow both sales and profit.”  The company is indicating that the restructuring of its asset base, including asset sales, cost savings, and productivity enhancements is complete and the time to invest for growth is at hand.

This does not mean that Sony will forego continued M&A or stop trying to improve margins.  Rather, the current business segments of Music, Video Games, Entertainment, Imaging Sensors, Electronics, and Financial Services have been restructured with growth opportunities identified.  Music and Video Games should receive the most investment through both acquisitions and capital spending to build the businesses.  Entertainment is sitting out the streaming wars beyond its dominant position in anime, and instead will seek to create content and exploit it in the best distribution channel whether that be theaters or selling it to the highest and best entertainment company that is looking to pivot from linear to streaming.  Imaging Sensors offers both further restructuring as it recovers from the loss of Huawei as a customers and growth given increasing use of cameras in premium smartphones and new areas such as automated vehicles.  Electronics remains a restructuring story but also has opportunities for growth as the mix of TVs and video production equipment improves.  Financial Services serves as a supplier of excess capital and offers modest growth. 

The financial forecasts in the new three-year plan will probably be conservative if recent history is a guide.  Northlake expects higher results to be achieved but it may not be evident until the transition from the pandemic economy to whatever the new normal economy looks like is complete.  We believe that the shift in behaviors that has benefitted the company’s music and video games business will contain a significant element of permanence.  Not only is the increased digitization of life beneficial to consumers but management has smartly focused its business mix to take advantage of the post-pandemic economy.

An indication of the payoff from both past actions and the new plan is the announcement of a new 200 Trillion yen buyback program.  The company did not buy back any stock in the past year.  This buyback is just a taste of what is to come and we have seen the results of growth company buybacks at Apple and more recently Alphabet.

Recently, Sony shares have been caught up in the rotation trade between growth and value.  Many growth stocks have moved sideways for months after huge runs in 2019 and 2020.  We are not sure when the shares will make their next move higher but we remain confident and patient.  The company’s financial strength, improved asset mix and performance, and general conservatism provide protection while we wait for multiple to expand from the current 11X EBITDA to more closely match its peers that trade at 15-20X EBITDA.

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.