Could Sony go bankrupt?

A Credit Suisse report raises a possibility that must bring a chill to the management of the Japanese colossus.
Based on one of those leaks of confidential information that are surprisingly common in Japan, the Nikkei reported Tuesday that the Sony Corporation is on course to post up to a Ñ200 billion ($2.2 billion) operating loss in fiscal 2008 (ending March 2009), compared to a Ñ472 billion operating profit in the previous fiscal year. If the loss does prove to be correct, it would be SonyÆs first loss in 14 years. When contacted, Sony declined to comment on the report.

Not everybody will be surprised by the bad news. In December, analysts at Credit Suisse (CS) raised a major red flag about the electronics and entertainment giant in a report, arguing: ôWhile the risk of bankruptcy appears low, unless Sony can create a virtuous cycle in which swift management decision-making leads to profit opportunities in the hardware and content business, we believe it will be impossible to avoid erosion of the companyÆs intrinsic value.ö If the operating loss is confirmed, it would support the validity of those fears.

In a clear warning to the Sony management, headed by Howard Stringer, the CS report downplayed the restructuring plan made public in December. ôWe believe the business restructuring plan announced on December 9 is insufficient to guarantee a return to profit in FY2009 whatever the circumstances; we believe there is now a need for a further business restructuring plan, including some possible changes to management.ö (Italics added).

The specific reason CS raises the prospect of bankruptcy is due to SonyÆs declining quick ratio. The quick ratio is the ability of a company to quickly use its cash or near-cash instruments to pay off its current liabilities. CS points out that as of end-September 2008, the ratio for peer companies Panasonic and Sharp came to 87.6% and 62.4% respectively, while SonyÆs quick ratio was only 52.8%, or 56.1% excluding its finance subsidiary, Sony Finance. Sony has almost twice the amount of total interest-bearing debt of the other two companies, but a slightly better ratio of short-term to long-term debt.

CS adds that FY2008 will show a worsening of Sony's net debt situation and that the quick ratio could fall below 50% due to negative free cash flow amounting to Ñ400 billion. The report notes that Sony has recently expanded its syndicated loan facility from Ñ600 billion to Ñ900 billion, but still sees a threat to the company's intrinsic value. CS estimates that the company will make a net loss of Ñ150 billion in FY2008, compared to the companyÆs own projection of a Ñ150 billion profit.

In the same December report, CS also lowers its target price for Sony to a shocking Ñ1,000 a share. Again, TuesdayÆs developments bear that judgment out: following the Nikkei news article, the counter dropped Ñ195, or 8.8%, to Ñ2,000. The stockÆs 52-week high of Ñ6,062 was reached in January last year.

Of course, Sony is suffering from one of the severest global downturns in decades, as well as a strong yen, but analysts still blame the company for not properly coordinating its hardware (TVs, cameras, PCs, etc) and its software.

Unlike Apple, which produces market leading hardware (the iPod) which it then supplies with the required content (iTunes), the process at Sony has not yet gone far enough, they say. Sony products no longer crush their competitors and they are also underperforming when it comes to being combined with content.

CS provides a table for Sony which shows, for example, that only 5% of Bravia TVs are æactiveÆ, in other words, that they are being used to download Sony-controlled content. The figure for Vaio PCs is 7% and for Sony-Ericsson handsets 10%. Even the PlayStation segment shows an æactiveÆ rate of just 15%. CS believes that accelerating the content delivery while developing the necessary premium hardware should be the key growth driver.

ItÆs almost incredible that a company of such stature and prestige could be mentioned in the context of bankruptcy, and surely reflects the unprecedented stress of the world economy. It also shows that even global giants which are not being managed to extract every drop of cash flow from their operations do not have the luxury of waiting to reform.
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