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Hot Stocks: The Three Roadblocks to Sony's Turnaround

By , Money Morning •

Sony Corp. (NYSE ADR: SNE) is facing the first consecutive annual loss of its 63-year history.

The Tokyo-based company lost $1.1 billion (98.9 billion yen) last year, and it expects to lose another $1.4 billion (120 billion yen) in its fiscal year ending March 31. That would be Sony's first back-to-back annual loss since the company went public in 1958.

And despite renewed optimism within its ranks, Sony still faces a plethora of challenges, including a questionable direction, cost-conscious consumers and a strengthening yen.

The onetime bellwether of the electronics industry has seen its market share crumble in almost every category: Nintendo Co. Ltd.'s (OTC ADR: NTDOY) Wii game console has supplanted Sony's PlayStation brand, Sony has given up its lead in portable media players to Apple Inc.'s (Nasdaq: AAPL) iPod, and Samsung Electronics Co. Ltd. is now the world's largest seller of televisions.

Hoping to turn the tide, Sony earlier this year underwent a major restructuring with the goal of unifying its hardware, software and entertainment businesses. The idea is to leverage its growing catalog of networked products with the software and services its sells, such as Internet-enabled televisions that enable consumers to watch Sony movies through an online connection.

"Consumers want products that are networked, multi-functional and service-enhanced utilizing open technologies, and user experiences that are rich, shared and, increasingly, green," said Sony Chief Executive Officer Howard Stringer. "[The restructuring] will now make it possible for all of Sony's parts to work together to assume a position of worldwide leadership and, together, achieve great things."

Doubts Cast Shadow Over Efforts

While analysts agree with Sony's loss estimate for this year, some doubt its restructuring efforts - which included thousands of layoffs and a streamlining of manufacturing in the - will truly pay off.

"They were hit fairly early by the downturn and have moved quicker than some competitors to restructure, but it remains to be seen if those moves will pay off," Hideyuki Ookoshi, who helps oversee $365 million at Chiba-Gin Asset Management in Tokyo, told Bloomberg News. "The problem with Sony is it doesn't know what it wants to be: Is it a game company, a consumer-electronics maker, a financial-services provider? There's no direction."

Operating income at Sony's financial services division was propelled more than 57% by a boost in its life insurance revenue in the company's fiscal first quarter ended June 30. But this non-core business won't be the catalyst that brings Sony out of the red, according to Makoto Haga, president of Tokyo-based hedge fund Wing Asset Management Co.

"Profit at the financial unit helped Sony narrow a loss, but investors don't appreciate that," Haga told Bloomberg. "I can't see any engine that drives its recovery and the company's prospects are dim."

As it stands now, CEO Stringer's cost-cutting efforts have only gone so far, and investors like Yasuhiko Hirakawa want the British-born executive to prove he can boost Sony's sales, which are expected to be 6% lower than last year.

"Cost cutting and reshuffling of management may help mend unprofitable businesses but they won't make Sony competitive against Samsung and other rivals," said Hirakawa, a fund manager at DIAM Co., which oversees $80 billion in assets including Sony shares. "The brand is still highly regarded but that won't last forever."

Premium Without the Value in Tough Times

While all electronics manufacturers have suffered during the worst economic crisis since World War II, premium-branded Sony has been hit especially hard. The economy has brought out the practical side of consumers, who flocked to cheaper television sets from makers like Vizio Inc., which is No. 2 in North America behind Samsung.

It's the "intensification of price competition" that contributed to Sony's $1.7 billion operating loss in its electronics segment last year, the company said. Comparable televisions from Samsung are often hundreds of dollars less than a Sony, without a significant sacrifice in tangible quality.

"I don't think you can say a Samsung TV has a better picture than Sony TV," Richard Doherty, co-founder of industry researcher Envisioneering Group told the San Diego Union-Tribune. "But (the difference) has narrowed, and that's one of the problems."

Indeed, while TVs from Sony may have technically superior features such as 240mhz refresh rates, it usually won't make a difference to the mass market. The benefit of such a feature is "difficult to discern," writes CNET, a leading Web site from CBS Interactive Inc.

Televisions are just one area where Sony is struggling with its value proposition. Until recently, Sony faced mounting pressure from video game executives and analysts to cut the price of its $400 PlayStation 3 (PS3) console.

"They have to cut the price, because if they don't, the attach rates [the ratio of games purchased to a console] are likely to slow. If we are being realistic, we might have to stop supporting Sony," Bobby Kotick, chief executive officer and president of Activision Blizzard Inc. (Nasdaq: ATVI) said in a June interview with Times Online.

After months of lowering manufacturing costs on PS3, Sony finally dropped the price of the console to $300 in the United States and launched an ad campaign touting "It only does everything," a reference to PS3's ability to play games, Blu-ray movies and browse the Internet.

The result was Sony selling more than 1 million PS3s in the first three weeks of September, almost the same amount it sold in the entire second quarter. A similar price drop in Japan led to PS3 outselling Nintendo's Wii last month, a first since the console was released in Nov. 2006.

Sony's Walkman, which first revolutionized portable audio 30 years ago, now comes in the form of a touchscreen digital media player, but has failed to put a dent in Apple's ubiquitous iPod, which also has a touchscreen model. Sony's 32-gigabyte Walkman sells for $400. But while it gives users some limited Internet options, Apple's comparable iPod Touch sells for $100 less and has access to thousands of applications - many of them free - in its vaunted App Store.

Without any tangible features to discern it from the competition, it's no wonder Sony expects to sell just 6.7 million Walkmans this year, while Apple sold 10 million iPods in its third quarter alone.

Currency Crisis

Sony, like its Japanese counterpart Panasonic Corp. (NYSE ADR: PC), is inherently at a disadvantage to Korean competitors like Samsung and LG Electronics Inc. due to the yen's strengthening position against the won and U.S. dollar. The yen's gain has enabled the Korean manufacturers to sell its products at a discount of as much as a 10% without taking a hit on margin.

"We don't have a moment to breathe," Sony Vice Chairman Ryoji Chubachi said of the strengthening Japanese currency in a Bloomberg interview on Tuesday. "It is a tough environment."

The yen has gained about 15% versus the Korean won and 14% against the dollar in the 12 months ended Sept. 30, according to Bloomberg data. The dollar is at its weakest levels against the yen since February, trading at as low as 88.86 yen on Tuesday. The yen has been the third-best performer among G-10 members in the past 12 months.

For Sony and other Japanese companies, a rising yen is "like a death warrant as things stand now and if this continues, they will have a very difficult time," said Chu Moon Sung, a Seoul-based fund manager at Shinhan BNP Paribas Asset Management Co., which manages the equivalent of $26 billion in assets. "For Korean companies, it's a favorable environment and the currency has been the biggest factor for their good performance."

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