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Get Four
|  | OCTOBER 11, 2004
By John S. Yang Sony Gets Its Game Back Dramatic cost-cutting and two new PlayStation products mean the electronics giant could see solid revenue and improving profits Almost 18 months have passed since the so-called Sony Shock, when the outfit's (SNE; Buy; recent price: $35) share price dropped more than 25% ina week. The stock has made quite a comeback, jumping 46% from the lows hit in late April, 2003. The Street's consensus is that the upside is very limited, given what some view as the lack of an earnings driver and an ineffective cost structure. We at Standard & Poor's Equity Research believe otherwise. With an improved cost structure and new products on the way, Sony could surprise the market, in our opinion. We believe that the effect of Sony's recent restructuring has been gradually kicking in during fiscal year 2005 (ending Mar. 31). Although the company is expected to book restructuring expenses of $1.2 billion, this is projected to result in cost reductions of $800 million. This is in addition to cost reductions of $564 million and $727 million in fiscal 2003 and fiscal 2004, respectively. Therefore, by the end of March, Sony's cost structure should be improved by an estimated $2 billion. Sony is pinning its hopes on the new PlayStation2 (PS2), slimmer and lighter than the current PS2 console. The internal volume has been reduced by 75% and the weight halved. We believe that the new PS2 could ignite fresh demand among children and young adults for a few reasons. Because of its reduced price, consumers who could not formerly afford it may now decide to own one. Secondly, since it's now relatively small, families could decide to purchase extra PS2s for siblings. HOLIDAY DEBUT. Moreover, we believe the small size of the new PS2 adds portability. A user can keep the original model at home, and take the new model when traveling or visiting friends. Therefore, we believe that Sony's forecast of shipping 14 million units (both old and new models) by March, 2005, is feasible. Suggested retail prices for the new PS2 in the U.S. and Europe are $149 and 149 euros -- but actual prices will likely be less, we believe. Sony has intentionally priced it low, assuming it can still be profitable with cost reductions. The timing is also very good, since the new PS2 will make its debut on Nov. 1 in the U.S. and Europe, and two days later in Japan. We believe that a launch a month before the holiday season should be more than enough time to stir excitement in the game-console market. Another positive driver for Sony: the PlayStation Portable (PSP), which made an impressive debut at the Tokyo Game Show 2004, where users could touch and feel the handheld gaming device for the first time. After test-playing PSP, we believe that management's fiscal year 2005 domestic-shipment projection of 3 million units is conservative. Considering that the graphics and characters' movements are quite clear and well-defined for its size, we believe it's a "portable PS2" in every sense. As such, we expect Sony to ship between 3.5 and 4 million units in Japan. HEAD-TO-HEAD BATTLE. In our view, PSP will not cannibalize sales from the new PS2 because the former is entering the market for handheld game devices and the latter is leveraging the market of the old home-console model. Once PSP debuts in the U.S. -- which we expect sometime between January and March, 2005 -- we look for total shipments (including Japan) to reach between 5 million and 6 million units. By end of fiscal year 2006, we project shipments of 10 million units worldwide. Since Sony will go head-to-head with Nintendo, which priced its new handheld gaming device at $136, we do not expect PSP to be priced at more than $200. Consequently, even if Sony sells PSP at the lower end of our projection, it could produce substantial incremental revenues in the second half of the fiscal year 2006. To get a sense of how much Sony stands to gain from PSP, we estimate that revenues from PSone and PS2 for fiscal year 2004 were approximately $4 billion (Sony doesn't disclose the actual figure, but states that hardware accounts for 50% of total sales from its Games Division). Given the line of exciting software, PSP alone could generate almost half the revenue of PSone and PS2 by the end of fiscal year 2006. We expect margins for PSP to be between 6% and 8%, assuming that Sony has not mastered cost efficiency at that point in the PSP's life cycle.
BW MALL
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