The idea of spinning out Sony Corp’s entertainment assets isn’t a new one. It’s been in the air at 550 Madison Avenue for several years, as the once-proud electronics giant lost market and mind share in the consumer electronics market to Samsung, LG and Apple.
In fact, Sony Entertainment insiders said in private conversations that despite CEO Kazuo Hirai’s protestations, they’re expecting some kind of entertainment spinout to happen within the next 12-18 months. Or, as one insider told me this morning, “They swore they weren’t selling the building [550 Madison] and they did. Need I say more?”
A former Sony senior management veteran described some sort of spinout of the entertainment assets as “inevitable.” (Sony Entertainment, led by Michael Lynton, includes Sony Music Entertainment, Sony Music, a 50 percent stake the number-one music publisher Sony/ATV, and the Hollywood studio Sony Pictures Entertainment.)
Even though Sony returned to a small profit in the fiscal year to March 31, the outlook remains bleak -- especially for the electronics units, which account for the bulk of its business.
This is where Dan Loeb of hedge fund Third Point comes in. Loeb, whose firm manages some $13 billion in assets, has had recent success in shaking up Yahoo's board last year after he built up a sizable stake in the Internet business. He's also credited with helping to recruit CEO Marissa Mayer from Google. Yahoo shares have risen 70 percent since she took the role.
Loeb has quietly amassed around 6.5% of the Tokyo electronics giant and has written a letter to the Sony board asking for several moves to revitalize the sleeping giant. At the top of his list is for Sony to place a 15-20% stake in Sony Entertainment on the public markets, leaving Sony in full control while generating cash from the public offering -- cash that could be very useful in helping to boost the struggling electronics business.
It’s worth noting that Sony’s entertainment assets are a relatively small part of a business that generated $72.3 billion in revenue last fiscal year. Sony’s combined music assets generated $4.7 billion in revenue in the year to March 31st and posted an operating income of $396 million, or operating margins of 8.4%. Sony Pictures brought in $7.8 billion with an operating income of just $509 million, or operating margins of 6.5%.
"Margins at studios like Fox are double what Sony's studios do because there's too much fat,” a source said.
The key here for the entertainment business is the margins, said one former insider. As Loeb points out, Sony’s entertainment assets are simply underperforming and would be forced to perform much better under the harsh lights of public markets.
“To give a glimpse of the hidden value attainable, if Sony Entertainment simply achieved peer group margins, EBITDA would increase by as much as 50%,” writes Loeb in the letter to the board. “In our view, such an increase, at a modest valuation of 9x EBITDA, would contribute an incremental ¥625 billion in market valuation or ¥540 per Sony share.”
But a person with knowledge of the business’s finances pointed out the margins were weakest at Sony Pictures, which has had few movie hits in recent years and relies on its TV syndication business for a good proportion of its profits. While Sony’s music business still has several highly paid executives, its recent successes with the likes of Adele and One Direction have helped improve the picture.
Sony's leadership under Hirai is very much on the path to change. Dan Loeb might just have put them on the fast track.