The news that Sony is at least considering Third Point founder and CEO Daniel Loeb’s proposal to partially spin off the company’s entertainment assets seems to have unleashed a bevy of what-ifs: Among them, could such a move result in more transparency and more discipline? And is there a better chance that, after a generation’s worth of predictions that the Japanese giant would unload its showbiz properties, such a scenario could be a step closer to coming true?
A publicly traded Sony Entertainment, including the film and TV studio as well as the music division, might indeed flourish with the veil of the parent company lifted. The value of such things as Sony’s many international cable channels would become more apparent, or the profitability of its TV division more starkly realized (the arm accounts for 60% of profits at Sony Pictures Entertainment, according to sources).
Yet many analysts, and certainly a few on the Sony lot, keyed in on what else Loeb said about the entertainment properties in delivering his letter personally to Sony CEO Kazuo Hirai. “Profit margins fall short when benchmarked versus their U.S.-listed competitors despite superior scale and leading market positions,” Loeb wrote. “We believe the underperformance would be remedied by a more disciplined management approach to Sony Entertainment.”
In other words, as much as Sony Entertainment, led by Michael Lynton, is helping to prop up the beleaguered electronics giant, and is even ripe for its own independent day in the sun, management still has some work to do.
Just exactly what a spinoff would mean for movies, TV and music is speculative, but analysts quite naturally focus on the fi lm studio. According to a source close to both companies, Third Point (a minority stakeholder in Variety Media, along with majority owner Penske Media Corporation) believes that a separate listing would allow for a Sony Entertainment board of directors, give management more flexiblity and provide more capital, inasmuch as it would keep money generated by entertainment operations from going to shore up the parent company.
The studio has been cutting costs; increased market scrutiny could mean additional cost pressures. Loeb’s letter estimates that if Sony Entertainment “simply achieved peer group margins,” its EBITDA would increase by as much as 50%.
For the fi scal year ended March 31, Sony Pictures Entertainment reported operating income of $509 million, up 40% from a year earlier, on revenue of $7.8 billion, which rose 11%. Sales in music were flat, at $4.6 billion, along with operating profi t at $396 million.
“I don’t think anyone can fault (Sony Entertainment management) for anything they have done,” said Hal Vogel, a longtime industry analyst and president of Vogel Capital Management. “They have done a good job. However, the world changes, and there is probably going to be a different attitude when and if this goes public as a separate entity.”
A leaner, more nimble Sony Entertainment — one that would surely give investors a better idea of profitability — would still largely be owned by the parent company. Loeb’s proposal calls for an IPO of 15% to 20% of the company, backstopped by Third Point.
But just the fact that Sony admitted it was considering the offer was taken as something of an unusual step for the Japanese giant. The spectacle of corporate raiders, hedge fund managers and private equity players exerting shareholder influence on companies is still not regarded as a routine part of the Japanese business culture, so the company’s willingness to listen is taken as a sign new dynamics may be taking root.
“In the old days of Sony, this would have been rapidly dismissed,” said George Geis, adjunct professor at the UCLA Anderson School of Management. A prospective entertainment spinoff would face many challenges.
Film
“Skyfall” and “The Amazing Spider-Man” helped propel the movie studio to a stellar year in box office market share, grabbing pole position with a gross of $4.4 billion. But just how profi table is the theatrical side?
Execs at Sony bristle at the suggestion they’re spending lavishly while their rivals reduce their number of releases and focus on a strategy of tentpoles and branded franchises, doing more with less. The theory is that such a plan involves less capital and more upside for profits.
A March report from Nomura Securities’ Michael Nathanson found some stability in the film business overall, in part due to a leveling off of home entertainment returns and an expansion of the international box office. But his report showed Sony’s total number of releases in 2012, at 35, to be far more than any major studio; Warner Bros. and Universal each distribbed 24 fi lms (U’s included Focus Features) , and Disney had just 13. The Sony figure, however, includes Sony Classics. Without those specialty pics, along with re-releases, the studio had just 19 films on its schedule.
The point Sony execs have made is that they, like other studios, are also trending toward fewer releases, even if the slate is markedly more diverse than those of their competitors, relying on what has been described as an approach more vested in hitting doubles and triples than home runs, in the words of one analyst.
One of the questions is whether a publicly traded company will put even more pressure on Sony to invest less in movies, focusing to an even greater degree on a small number of action films, superhero franchises and animated titles, and less on comedies and dramas.
Brian Wieser, senior research analyst at Pivotal Research Group, said such an outcome is not necessarily a given. “Some of this comes down to management preferences in how best to run the business,” he said.
When it comes to profitability, there’s also the matter of accounting and how much overhead the parent company is assigning to entertainment properties.
What it does mean is that Third Point’s offer has raised the stakes for Sony’s summer slate, starting with the May 31 bow of Will Smith starrer “After Earth,” directed by M. Night Shyamalan.
The source close to the companies said Third Point believes that a separate Sony Entertainment would enhance the film studio’s ventures with its sibling TV and music divisions, and would enable greater pursuit of ancillary markets and merchandising.
TV
The assumption is that the TV division is the most profitable part of Sony’s entertainment biz. Wieser calls it the most lucrative — the problem being that the international cable channels that help drive such profi tability don’t command a great deal of attention. “No one is even aware of (that business) because it doesn’t have a presence in the United States,” Wieser noted.
Sony pointed out in its annual results the higher subscription revenue from international channels, and Lynton has been increasing investment overseas, including boosting its interest in Multi Screen Media, which operates TV networks in India.
Sony also has been successful in building up its TV production division, dismantled a decade ago, with expectations among analysts that the revived operation will prove lucrative as digital licensing activity grows.
Music
The flat revenue on the music side is in part due to the continued decline in the sale of CDs. But there is growth in digital revenue, and Sony could be well positioned in that sphere. With One Direction and Justin Timberlake, it has star acts that still generate healthy returns, and Sony/ATV Music Publishing, co-owned by the estate of Michael Jackson, is the world’s largest music publisher, with some 2 million songs, including the Beatles catalog. “These are very healthy units, and I think they will continue to be healthy if they are spun off,” said Mark Young, professor at USC’s Marshall School of Business.
Nevertheless, Young doesn’t think a spino is a good idea for the parent company, even if one of the rationales is to provide a cash infusion to help revive the electronics division. “Is this infusion really going to solve the problem, or is it a management issue?” Young asks.
There’s also the possibility that, were the Sony board to seriously take up the Third Point proposal, it will only open the door to further suitors in the hedge fund world or from a competitor seeking to buy the entertainment properties outright. Wieser floated CBS Corp. as a suitor in a January research report, noting the synergies.
And if the Sony board decides to keep the company in one piece?
It’ll be a statement about the future, but certainly not an end to speculation.
