As I have previously explained, I think that Sony Corp. (NYSE:SNE) is right in its decision not to give in to demands by activist investor Third Point LLC to break the company apart. I believe that the company will be stronger in the long run if it keeps most of its different businesses under one roof. There is, however, one part of Third Point’s assessment I agree with. I, too, believe that Sony should divest its 65.06 percent stake in Sony Financial Holdings Inc. (OTCPK:SYFHF; OTCPK:SNYFY). Previously, I only alluded to this rather briefly. I have decided to explain my rationale in more depth in this article.
Substantial Value
Based on Sony Financial Holdings’ current share price, the parent’s stake in the company currently has a value of around $5.9 billion. It accounts for roughly a fifth of Sony’s operating income (as of Q3). So, it does represent a substantial value. The company is growing steadily, albeit slower than other divisions.
Third Point suggests that Sony should monetize its stake in Sony Financial Holdings in order to use proceeds to foster the growth of remaining divisions or “for shareholder returns” (in other words buybacks and/or dividends). This would indeed be one way that could unlock considerable value for shareholders. On the other hand, I personally believe that, alternatively, it may also be an idea worth entertaining to spin the company off via a distribution of shares in Sony Financial Holdings to the owners of the parent company. This way, investors would have maximum flexibility with regard to the decision which businesses to retain in their respective portfolios.
Financial Services Are Not A Good Fit With Sony’s Other Divisions
As Third Point rightfully points out, the financial services division has a high capital intensity compared with the other businesses. This comes as no surprise, given the importance of the life insurance business which accounts for more than 80 percent of revenue.
Also, while the other divisions are operating globally, Sony Financial Holdings is solely focused on the domestic market. And this is not an easy market. The semiconductor business is a market leader for sensor solutions. The entertainment divisions (music, motion pictures and gaming) are also among the leaders in their respective global markets. When it comes to insurance and banking services, however, the Japanese market is rather fragmented.
There are no apparent synergies between Sony Financial Holdings and the various technology and/or entertainment divisions either.
Sony Brand
Sony itself refers to the importance of the Sony brand for the insurance and financial services business.
SFH’s financial services businesses have delivered a high level of customer satisfaction over a long period of time, and those businesses share a high affinity with the Sony brand which customers associate with safety and reliability.
– Letter from CEO Kenichiro Yoshida to shareholders, p. 5
I do not deny that the Sony brand name is an important asset. And yet, I do not believe that this is a valid argument for keeping the company in house. It would not be too hard, I imagine, to retain the brand name. There is no overlap between the banking and insurance products and the mother company’s other businesses. Thus, a conflict is more than unlikely.
I doubt that the shareholder structure matters much to consumers. I am not even sure whether many of the insurance customers even know that the financial services division is not a full subsidiary of Sony as it is.
Cyclicality
Admittedly, Sony Financial Holdings business is less cyclical than the other divisions. Regardless, I think it would be better to be focusing on the technology and entertainment businesses. While this would leave a company that would be more cyclical overall, it would be advantageous for investors to be able to decide for themselves whether they prefer to only own the more dynamic technology and entertainment business or also a stake in the more stable yet slower growing financial services division as well (which they could easily, given Sony Financial Holdings is publicly listed). Shareholders would also be free in their decision on how to allocate capital between the two companies instead of being tied to a fixed share in the financial services being held through their Sony stocks. Of course, investors could also choose to add other defensive names to their respective portfolio instead of Sony Financial Holdings. So, all in all, I do not believe that Sony becoming more cyclical overall is necessarily problematic from investors’ point of view.
Conclusion
I agree with Daniel Loeb and Third Point that Sony Financial Holdings should be separated from the parent company. The reason is not that Sony Financial Holdings is a bad business. It rather lies within the fact that it is not a good fit with Sony’s remaining semiconductor, electronics, and entertainment divisions. Thus, I think it would be better for Sony to focus on its core businesses while Sony Financial Holdings continues as an independent company. It could (and probably should) retain the Sony brand, but that does not mean it should remain part of Sony itself.
I would be supportive in this regard of Third Point’s proposal to sell the stake and reinvest proceeds, yet I am also open to alternative ways such as a spin-off to Sony’s shareholders. Shareholders in Sony would profit either way.
If the stake is sold, the profits will either benefit them directly through buybacks and/or dividends. And if the proceeds are used in order to further strengthen the remaining businesses of the parent, this would increase the value of their investment.
If, on the other hand, shares of Sony Financial Holdings were to be distributed to Sony shareholders, they would gain flexibility with regard to their portfolio structure. They could either decide to monetize their shares or hold on to them. On top of that, markets usually tend to prefer specialized companies over conglomerates. Thus, the separation alone might already increase the value of both stocks, Sony and Sony Financial Holdings.
For those reasons, I am convinced that Sony should spin off its stake in Sony Financial Holdings.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: All research contained in this article was done with utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his or her own due diligence and research.
