Japan 2020: Sony struggling to adapt; moving to Conviction Sell Equity Research Structural hardware business decay a dilemma for Sony In our view, Japan’s once iconic electronics name Sony is struggling to adapt to the reality of structural decay in its traditional entertainment hardware business. We believe Sony faces a dilemma. On one hand, if it maintains its current course, we think legacy products (particularly TVs) will erode Sony’s enterprise value as they continue to make heavy losses. But on the other, restructuring your way to prosperity is rarely successful in volume-sensitive businesses. We calculate the market is ascribing a value to Sony’s hardware business (excluding semiconductors) of ¥400 bn, whereas we believe it represents a negative value of ¥427 bn. Silo structure is hindering Sony in the cloud age Moreover, as we enter the era of the cloud—with integrated platforms such as smartphones delivering multiple entertainment categories—we think Sony’s current network devices and content services are commoditized. The chief problem we see for Sony in distinguishing itself in the key platform market is its silo structure for traditional hardware products. We believe this is delaying withdrawal from commodity products, undermining R&D efficiency by misallocating resources, and hindering development in new-generation products such as smartphones or tablets. In our view, this handicap will only increase as network products become the mainstream. Caught in a vice; downgrade to Sell, Conviction list Caught in this vice and with the market in our view being over generous on Sony’s proposed rescue plan, we downgrade the stock to Sell (Conviction list), from Neutral. We revise our 12-month target price to ¥1,000 (now based on SOTP) from ¥1,300. We revise our FY3/13-FY3/14 operating profit estimates by -14% to -12% on lower sales and higher restructuring costs. Two scenarios – Base case and radical revival In our base case scenario, we see Sony coming to recognize its rescue plan is not working, and then embarking on a major and costly hardware business overhaul in FY3/15-FY3/16. We think Sony can minimize TV losses, but this process would cost ¥590 bn over two years, and we see little chance of revitalizing the business’s fortunes. We also lay out a radical scenario to revamp Sony— divest legacy hardware, devices, and financial businesses; acquire extra music content; and develop a smartphone-based platform — which we estimate could boost valuation to ¥4,200 by 2020, although there is execution risk, that we don’t factor in.