Third Point, Sony and Abenomics

the Three Arrows” of Abenomics

Abenomics, the ambitions plan of the Liberal Democratic Party to jumpstart the Japanese economy after a quarter-century of stagnation, has three “arrows”:

–currency devaluation

–increased government deficit spending, and

–bringing an end to widespread squandering of corporate resources by complaisant and inefficient managements, either through bureaucratic/administrative pressure or by repealing laws that effectively bar bad managements from being ousted and replaced.

Arrows one and two have been fired

Arrows one and two were fired very quickly, as was expected.

Japanese export-oriented industry was in favor of the first.  And everyone likes to get a check in the mail from the government.  Neither arrow, however, will make a lasting positive impact on Japan.  Both seem to me designed to buy time for Japanese corporations to change their stripes and become more modern and more profitable.  But the moves will prove disastrous in the longer term for Japan if Arrow three doesn’t hit its mark.

Third Point and Arrow #3

Enter Daniel Loeb, whose Third Point hedge fund bought a large position in Sony and began to beat the drum for change–to wit, a partial sale on the stock market of Sony’s media subsidiary.

The proposal/demand is squarely in line with standard American financial theory:

people dislike buying bundles of disparate businesses.  Unbundle them and investors will pay higher prices for the component they prefer than for the entire package.

Sony the least difficult target

It’s important to note that in Sony Mr. Loeb picked a company that would arguably be the most open to new ideas.  Sony is not an “establishment” company in Japan.  It has no roots in the pre-WWII zaibatsu industrial conglomerates, nor in their successor keiretsu groups.   Instead, it was founded by two mavericks in 1946.  It’s free of much of the social pressure to maintain the status quo  that bears down on the keiretsu, as well as of the tangled web of affiliated company cross-shareholdings that enmeshes, say, Panasonic.

In addition, Sony’s chairman, Kazuo Hirai, has an international background.  More than that, he witnessed first-hand the destruction of Sony’s video game business at the hands of his tradition-bound predecessor there, Ken Kutaragi, through his lack of openness to new ideas.

One might have thought, too, that pressure from Mr. Loeb might serve as an excuse (gaiatsu) that Mr. Hirai could use to deflect blame from himself while still making difficult changes.

But no.

score one for the status quo

The reports I’ve read suggest that interaction between Third Point and Sony has proceeded in traditional Japanese fashion.

Mr. Loeb met with Mr. Hirai, who listened politely to his requests.  Mr. Hirai may even have made affirmative noises that avoided open disagreement, but which meant “I understand what you want,” not “I agree and will act as you suggest.”  An “independent” panel of experts, paid by Sony, was assembled to analyse the Loeb proposal.  An appropriate period of time passed.  Then Sony said thanks, but no thanks.  Case closed, without giving anyone direct offense.

only one company?

Yes, we shouldn’t rush to generalize from one instance.  On the other hand, the cards were about as stacked in favor of a shake-up of the status quo in this case as we’re ever likely to get in Japan.  Sony’s decision to remain a conglomerate is one more reason to worry that Arrow three will never leave Mr. Abe’s quiver.

That, in turn, is cause to begin to imagine what the Japanese economy will look like in the event Abenomics is unsuccessful–and to consider what the negative repercussions might be for the rest of the world if Japan collapses in a heap.

Google’s proposed new class of common stock

the C class announcement

Yesterday, in conjunction with its release of 1Q12 earnings, GOOG published a letter to shareholders on its website.  In it, Larry Page and Sergei Brin outline their plans to create a new class of stock–C shares.

On shareholders’ approval, the new C shares will be distributed as a stock dividend, on a one-for-one basis, to all holders of A and B shares.  C shares will be publicly traded on NASDAQ, using a different ticker symbol from the “GOOG” the A shares use.  As will continue to trade, though.

no voting power

The sole difference among the share classes will be in voting power.  Each A share has one vote; each B share, held by corporate insiders, has 10.   C shares will have no votes.

Since holders of B shares–principally Mssrs. Page, Brin and Eric Schmidt–wield over 70% of Google’s voting power, shareholder approval is a mere formality.

Google intends to file full details of the issue with the SEC next week.

why do this?

…to keep voting control of Google in the hands of the current B shareholders.

How could control be lost?

…through a combination of sales by B holders, issuance of new A shares through stock options or acquisitions for stock.

current shares outstanding

According to the company’s 2011 10-K filing, 67.2 million class B shares, representing 672 million votes, were outstanding on December 31st.  258 million As, representing another 258 million votes, were also out.  Employee stock options on just under 10 million new A shares had been granted and remained to be exercised.  (Notably, I think, the stock option count is growing very slowly.  Google only granted options on 718,000 new shares last year.)

Therefore, assuming all stock options grants are exercised, A shares represent 28.5% of the total vote.  Bs represent 71.5%.

implications of the Cs

control structure frozen

The most obvious is that the new class will provide a way for the company to issue potentially large amounts of new shares without altering the current control structure of the company.  Google has already said future employee stock option grants will be for Cs.  Bs continue to rule.

price of the Cs vs. Bs

It’s not clear that the Cs will trade at the same price as the Bs.  Arguably, voting power should be worth something.  But in this case, as the company is currently constituted, the Bs’ votes basically have no value.  So you’d think the two prices should at least be pretty close.

stock options

Stock options don’t seem to me to be a big deal–or any deal at all.  Here’s what I mean:

If we assume all outstanding stock options are exercised, the company currently has a total of 940 million votes.  Bs have 672 million, with 268 million more for the As.

For the moment, let’s ignore the possibility that insiders sell a significant number of Bs to get walking-around money.  Yes, company rules require that Bs be converted into As before being sold, so no outsiders can end up with the super-vote shares.  Bs, therefore, can–and in the past have–disappeared.  And, yes, Mssrs. Page and Brin are halfway through a modest (for them) sell program that goes into 2015.  But put these thoughts to the side.

As things stand now, A shares can only achieve a voting majority if over 672 million are outstanding.  That’s an extra 404 million shares.  At the 2011 stock option issuance rate, the As take over in the year 2575, or 563 years from now.  At the 2010 issuance rate of 1.7 million, the As grab the reins in a mere 238 years, in 2250.

Suppose B holders sell 10% of their stock–because they need a loose $4.4 billion.  That would imply that the Bs outstanding shrink to roughly 6 million and As expand to 275 million.  In this case, the As still need 325 million more shares to take over.  That would happen, at the earliest, toward the end of the next century.

Even for long-term thinkers like Google, dealing with stock options worries can’t be a pressing issue.

stock-based acquisitions

This is the only reason I can see for the C share move.

True, Google has $44 billion+ in cash; operations generated $14 billion+ last year.  But a seller may well prefer stock to cash.  And, of course, a potential acquisition could be very large.  It could also be very large and very sick, needing a big infusion of cash after the purchase.

Yes, the founders’ letter says  “we don’t have an unusually big acquisition planned, in case you were wondering.”  I’m sure that’s true.  But I’d emphasize the word “planned.”  It seems to me that Google may well have decided it needs to make an acquisition of a certain type over the next couple of years and have developed a list of possible candidates. The next step is figuring out how to pay for it–which is what I think Google is doing now.

Who know what such an acquisition might be?  I wouldn’t care to bet on anything.  But I do have a guess, however   …somebody like Sony.  But that company has been such a train wreck for such a long time that I don’t see any percentage in speculating that Google would rescue them.  There are also severe legal obstacles that Tokyo has erected to deter foreign takeovers of its domestic firms.  On the other hand, Sony is a post-WWII upstart, not part of the establishment.  And the company does have TV technology, cellphones, tablets/PCs and the Playstation in tens of millions of homes around the world.





consumer electronics: a new front on the online/bricks-and-mortar battlefield

I’d been planning to write this post before the announcement yesterday that the CEO of Best Buy is resigning.  Maybe it’s a bit more topical today.

trying to end discounts on consumer electronics

Early in the month, Korean and Japanese consumer electronics firms–among them, Samsung, LG, Sony and Panasonic–announced new rules for sales of their high-end products in the US.

Previously, the device manufacturers had at least threatened to, and perhaps actually withheld sales incentive payments to retailers who aggressively discounted the recommended selling prices set by the brands.  That didn’t stop internet retailers from undercutting their bricks-and-mortar rivals, however.  The manufacturers are now taking a new tack.

From April 1st, the consumer electronics companies say they won’t just not pay marketing money to discounters.  They won’t ship “hot” products to them at all.  To get the latest and greatest, buyers will have to go to full-price outlets.

Sounds crazy. 

Why would they do this?

Two reasons occur to me:

1.  The manufacturers want to preserve the bricks-and-mortar distribution channel.  In particular, they want to preserve the big-box strip mall retailers like Best Buy.

This would be somewhat like what the book publishers did a year ago, when they forced Amazon–by withholding newly-published “best seller” e-books from the internet retailer–to charge higher prices.  That provided a pricing umbrella under which independent bookstores could a least continue to limp along and under which Barnes and Noble could complete development of its own e-reader, the Nook.

2.  As far as I’m aware, the consumer electronics companies aren’t going to raise wholesale prices.  So they won’t initially make more money.  They may think, however, that if all retailers become more profitable, then they’ll be less likely to resist future increases in wholesale quotes–or future reductions in sales incentives.

the new plan won’t work

My guess is that this new plan will do more harm than good.  Four reasons:

1.  When prices go up, consumers buy less.  If the price of, say, high-end HDTVs rises by the $800 a unit that some are suggesting, sales volumes will doubtless contract.  Pre-Great Recession, a customer might think of a new HDTV as being like a new car–and finance it.  Not today.  Absent easy availability of cheap credit–and customer willingness to use it–the falloff in unit volume that higher prices brings might be surprisingly large.  And not every manufacturer is in rude financial health, so profit contraction could be painful.

2.  There’s no reason to think that loss in unit volume will be distributed equally across all competitors.  In an environment of smaller price differentials, competition won’t disappear.  It will just take a new form.  My candidate is perceived product quality.  If so, I think this means the market will gravitate toward Samsung and away from Sony.   In any event, market share losers would be under enormous pressure to go back to the old system, before the new competitive game causes irreparable damage to their businesses.

3.  The umbrella of higher prices will potentially allow competitors who don’t adopt the new system–or new market entrants, for that matter–to compete successfully by discounting aggressively.

4.  The move won’t fix what ails Best Buy, in my opinion.

Thirty years ago, suburban big box retailers were an evolutionary advance over urban department stores and local mom and pop shops.  They still are, but the latter, like the dodo, aren’t the competition anymore (actually, the dodo never were).

Today’s competition takes two forms:

–internet retailers, and

–Wal-Mart/Target/Costco, the discount retailers who are the modern successors to the department store.

Compared with the latter group, Best Buy stores are too big and too seasonal (think:  Toys R Us). Best Buy has to lease, light, heat/cool and staff its retail space for the full twelve months of the year, even though 60% of its profits come from sales that happen between the year-end holidays and the Super Bowl.  The others just expand and contract their seasonal departments, depending on the time of year.

Tilting the playing field away from internet retailers and to the benefit of bricks-and-mortar will, it seems to me, just intensify the battle between Best Buy and Wal-Mart et al.  I think we all know who’s going to win that struggle.

there is a better solution for consumer electronics

By the way, this all shows how prescient Apple was in opening its Apple Stores.

what the big Sony writeoff means

Sony’s fiscal 2010 results

Sony reported its fiscal year 2010 earnings (the company’s fiscal year ends, as is customary with Japanese companies, on March 31st) in Japan overnight.  Tokyo Stock Exchange requires that all listed firms both make an official estimate of anticipated results.  The TSE also requires companies to publish a revision–prior to releasing the actuals–as/when it realizes the actual results will differ from the official estimate by more than 30%.  In line with this requirement, Sony announced a downward revision to earnings last Monday.

the writeoff

The issue is deferred taxes in Japan.  Sony wrote off US$4.3 billion.

The company points out that:

–the writeoff is a non-cash charge,meaning no money has been lost,

–this doesn’t preclude use of  tax-loss carryforwards in the future, and

–the charge “does not reflect a change in Sony’s view of its long-term corporate strategy.”

what this means

Unlike most Japanese firms, Sony keeps its official financial reporting books according to US Generally Accepted Accounting Principles.  GAAP uses deferred taxes.

Let’s say a company loses money this year–thereby establishing a tax-loss carryforward that can be used to offset taxes on future income.  GAAP tells the company that it should record a credit for this possible future tax benefit in this year’s financials.  In other words, if you have a loss of $100 this year, but anticipate that you will have enough profit, say, five years from now to employ this loss to offset $30 in income tax that would otherwise be payable, you should take the $30 gain in the current year.  You record a loss of $100 on your income statement plus a deferred tax benefit of $30.  The net loss you report to shareholders is $70, not the full $100 amount.

One proviso, though.  You have to have a reasonable basis for thinking that you’ll have enough future profit to use the potential tax benefit that today’s loss represents.  And your auditor has to agree with you.

Sony has been in loss in Japan for three years now.  The writeoff means that Sony’s accountants no longer think the company will be able to generate enough taxable income to use $4.3 billion of future tax credits it had previously expected to enjoy.

my thoughts

Sony cites the March earthquake/tsunamis as a reason for this re-evaluation.  But at the same time it notes that the damage to its businesses in Japan haven’t been that great, are mostly covered by insurance, and that it’s confident it will collect on its policies.

The benign reading of the big writeoff would be that Sony’s overall internal profit projections haven’t changed much and the important thing to note is the “in Japan” part of the company statement.  It could be the writeoff means that Sony is going to make a major shift of production away from Japan.  It will continue to make the same profits, just not in its home country.

In my experience, though, events rarely follow the benign path.  I don’t know today’s Sony well enough to judge in this case, but typically a firm’s accountants notice business deterioration and propose a writeoff–and management reluctantly (sometimes, very reluctantly) falls in line.  It may be that the operative word in Sony’s statement of confidence in its prospects is “long term.”

SNE as a stock

I don’t know the company well enough to have an opinion.  I know what I’d look for, though.

Sony has two main businesses:  consumer electronics and video games.  The company has lost ground in the first to Samsung and Apple.  In the current generation of game consoles, Sony has regained past form after turning first-mover advantage over to X-Box, allowing MSFT to gain a market share I don’t think it could otherwise have achieved.  But rival Nintendo is already talking about a new game console.  And the game business is morphing into one favoring simple games played on a cellphone or through a social network.  What are Sony’s plans?

Ideally, one would like to see both main businesses in sync and operating profitably–not strength in one being offset by weakness in the other.