Thursday, August 2, 2012

Sony Disaster Continues

So I was travelling a little bit and wandered around in a large mall nearby (living in NYC, I don't do malls that often) and took some interesting pictures.  OK,  maybe not so intesting to most of you. There is nothing new here as this is something we all know:  Apple stores are always packed and busy wherever you go and Sony stores are totally empty. 

I found it interesting that at this particular mall there was a Sony store right next to an Apple store.  I took these photos one after the other so I didn't pick and choose the timing; they were basically simultaneous.

Apple Store Packed (as usual)

Sony Store Completely Empty (as usual)

Walking around in the Sony store only seems to remind us of how lost Sony seems to be.  I walk around in there and don't know what to look at.  If you walk into an Apple store, you just naturally want to play with the iPad, iPod or a Macbook Air.  It's well lit and there is plenty of help.

When you walk into a Sony store, it's dark and gloomy with bored looking employees just walking around or talking to each other.  They don't seem very interested in the very few customers in the stores.  There is zero energy/excitement in there.  It's just creepy and you want to leave as soon as possible.  That's no good.

I know Sony stores is not a big part of Sony's business, but it does sort of illustrate what is wrong with the company.

Earnings Disaster
Sony announced earnings too which seems to be a complete disaster.  You would think that Sony is going up against easy comps as they had so much trouble last year, but it doesn't seem like things are improving there at all.

Of course, the new CEO just came on board so it may be too soon to judge the future of Sony, but I remain skeptical.  Sony seems to be in a horrible position in most segments.

Other than booking another loss this quarter, they reduced their earnings outlook for the full year ending March 2013:

They reduced their sales estimate by 8% and their operating earnings by 30% and are only expecting to earn an operating margin of 1.9%.  

It's just way too typical of Japanese companies to make tiny adjustments here and there and cutting costs marginally in response to what seems to need a dramatic overhaul.  Because of the corporate culture in Japan, I doubt that would happen (aversion to mass layoffs etc.)

The Yen
The strong yen is hurting Japanese companies for sure even though this is an issue they have been dealing with since the 1980s.  Toyota and Honda too are hurt by the strong yen, but they seem to manage these issues a bit better. 

There was an interesting article about the yen and the Japanese government's response to it in the Wall Street Journal recently.  The gist of the article was that the increasingly large retired population is an important constituent for politicians and they are the big beneficiaries of the strong yen (deflation = lower cost/expense), so politicians aren't motivated to help the large corporations and weaken the yen.

Obviously, the government with the huge debt probably also worries about inflation leading to higher debt service costs which would be disastrous in Japan with their PIIG-like government debt.

Einhorn's Yen Trade
Einhorn still has a big put position on the yen according to their 2Q earnings announcement.  I guess he is playing the cheapness of the option but I always wondered about this trade as I wonder if currency crises occur in countries with net external asset positions such as in Japan.  I actually don't have data, but I thought that currency crashes usually occurs in countries with net external debt positions.  

I always thought that if things really started to fall apart in Japan, the yen would actually go UP, probably to 50 or 60 yen/dollar at this point as Japan rushes to repatriate overseas assets. 

This may be one of those things where it may be true in the long term that if Japan can't sustain it's debt, everything will come crashing down including the yen and the JGB market, but that doesn't mean things can't happen in between.

This reminds me of what has happened in the U.S.:  with all the Fed money printing, inflation and interest rates are supposed to be going UP and yet interest rates have gone down dramatically since the crisis.  Yes, if we can't get the government budget under control, eventually, interest rates will go up.  But in the meantime, due to deflationary pressure, they continue to go down.

This is sort of how I see Japan; the yen may in fact keep going UP despite prominent people calling for the yen to fall (a best-selling author in Japan has been calling for the yen to go down for years.  I think he has a new book out still calling for a yen crash).

So What?
So back to Sony.  I am still short this thing and it is now down to $11/share.  This is not a brilliant short at the current price as the book value of Sony as of the end of June 2012 was $24.40.  I don't think you get rich shorting stocks at 0.4x book value.

I will think about covering the short and maybe adding to some puts (I do own deep-in-the-money puts, which is a way I like to take short positions (in-the-moneyness reduces time-value/theta decay or whatever you want to call it).

Any positive development can cause a huge rally in this stock so it is definitely risky.  At 0.4x book, a double would take that up to 0.8x book.  And some conventional equity managers may see 0.8x book as cheap even though I have shown in a previous post that Sony hasn't returned much on equity over long periods of time.   But markets don't always make sense.  For much of that period, Sony has traded at a huge premium to book value. 

But on the other hand, there is so much going against Sony these days.  I think they face huge competitive pressure in just about every segment from their PC's, mobile phones, games, cameras etc.  At this point it's hard to say what their real strength is.

The macro situation doesn't seem to favor Sony either.  The very issues that yen bears talk about is very bad for companies like Sony.   Doubling the sales tax in Japan can't be good for these consumer goods companies.  The yen situation, to me, seems to be a problem that the Japanese government hasn't been able to deal with and as the WSJ reminded us, they may not even want to solve it.

The corporate culture in Japan is not favorable for turnarounds.  In the U.S., a company like this might become subject to a takeover or some sort of shareholder activism.  The Olympus situation and many others have proven to us that shareholders don't mean squat to large Japanese corporations. 

They are run for the officers and their employees (ironic, isn't it that I make such a claim when people say that about investment banks?  I defend the investment banks because they make money and have earned decent returns on equity over time despite the egregious pay.  What I look at is returns to shareholders after all that egregiousism.) 

So What's My Point?
I may be a bit late to the game here in saying this but maybe the better trade here is short select Japanese companies if not the Japanese market overall.  Maybe this is the 'easier' trade versus trying to short the JGB or the yen.

Yes, shorting stocks is a risky, dangerous business and not for everyone.  And yes, there may not be the risk/return asymmetry hedge funds look for (underpriced puts, Burry/Paulson trade-like mispricing of CDS).

But when you have declining businesses with no real prospect for a turnaround, competitive pressure coming from South Korea, China not to mention strong U.S. and other companies combined with a generally inept government and unmotivated management with stiff macro headwinds, it would seem to be a no-brainer.

I know, I am a long value investor (that does short stocks too sometimes) so the above description would seem to be an ideal place to look for values, and yes, I have been looking at Japan for years (without ever getting too excited about anything) just wanting to get into some of these big blue chips.  But everything I see and read seems to indicate more of the same: status quo.

(By the way, I am aware of some interesting smaller caps and I notice that some people have done well investing in net-nets in Japan recently.  I have generally stayed away from Japanese net-nets mostly because of Jim Grant's experience with them; he ran a Japan net-net fund for 12 years, I think it was, without making much money and he shut it down.  And smaller cap companies are hard to evaluate from afar;  some Japanese managers have done really well with Japanese small caps, but they are generally people who go and talk to management and have a good understanding of what's going on beyond what we can get in the financial statements.  I would still rather just invest in something interesting here in the U.S.).

What About Ignore Macro?
Yes, I still believe that.  When you evaluate a business, you see if it's a good business, see what it can earn normalized and then figure out what the fair value is.  You don't need macro input.  You just have to assume a more or less normal environment and then make sure that the company is well-capitalized enough to survive some bad years.

So I don't care what the economic outlook is when looking at things in general as long as the business is a good one at a great or good price. 

The Japan call is not really a macro one.  For me, it started more as a micro one.  I look at company after company and see the total incompetence of managements and the government and it makes me wonder if things will ever change in Japan.  This is not a macro call, really.  It's a call on the corporate cultures, managements etc.

When you overlay that with the macro headwinds they will be facing; declining population, unsustainable debt, competition from S. Korea, China, etc.  not to mention the ongoing problems in Europe then it turns into an untenable situation.  

Don't forget that a company like Sony was barely able to register an ROE in the double digits in the best of times back in 2006/2007.  And this was before the iPhone, iPad, etc.

Again, it may not be too smart to stay short a stock at 0.4x book even if they can't earn much return on that book (in Japan with low interest rates, people may gladly pay book value for a 4% ROE company; who knows.  Sony has been valued much higher in the past so it can happen again).

But I will still maintain this short and a short on Japan in general via the EWJ (I have shorted this off and on over the years).

The risks are obvious; collapsing yen, strong recovery in global economy, new hit product from Sony (maybe the next generation Playstation) etc.

And yes, I know, I am really at risk here of putting in a low in Japan.   When someone is so convinced of something, well, we have to assume that the rest of the world has already come to that conclusion too. 

Oh, and I finally started reading this book which has been sitting in one of the many stacks of books I have around here and it's a fascinating read.  It's an old book from 2007 or 2008, but it's about how Samsung came to dominate while Sony dropped the ball in the digital age.

The general story of Sony is really simple.  Their franchise value was in their manufacturing expertise (miniaturization/microelectronics) but when the world went digital, their moat was gone.  They tried to defend their business which made them late into the game when the world went digital etc...  and gave companies like Apple and Samsung time to take what might have been Sony's businesses.

But there is much more to it than that.  One interesting thing was how Sony was broken up by segment / product line.  They wanted each unit to have their own p/l and operate like independent companies.  This sounds reasonable in a company where much of the middle management didn't think about costs/expenses.  But this backfired as it 'silo-ed' the various businesses so there was lack of cooperation, reduced R&D spending, turf wars etc.   This contributed to their losing out in TV's (as they wanted to extend the life of the factories they built (for CRT TV's); this made them late when LCD's started selling), and everywhere else.

It is certainly an interesting read.  Here's a link:

Sony Versus Samsung


  1. Hi

    thanks again for your very interesting post!

    "I look at company after company and see the total incompetence of managements and the government and it makes me wonder if things will ever change in Japan. This is not a macro call, really. It's a call on the corporate cultures, managements etc."

    I just wanted to add a Japanese company,which I personally think is really well managed. Fast Retailing with its brand Uniqlo is in my opinion very well managed, also when I go into the stores in Europe or Japan. Although too expensive at the moment.

    best and thanks again for your posts!

    1. Hi, thanks for the post. Yes, Uniqlo is one of those Japanese companies that are not like Japanese companies. They have done really, really well over the years. These companies do exist in Japan (look at the financials of Yahoo Japan, for example, and there is another rare high return on equity, high margin, well-managed company which is rare in Japan).

      But unfortunately, Fast Retailing has never really been that 'cheap'. I looked at it over the years and love to follow it but never pulled the trigger. That guy Yanai stepped down from the CEO position and it didn't really work out and he had to come back. That's a concern; is it a one man show?

      Also, he has made very ambitious comments about wanting to get sales by a certain date (it was a huge increase in sales, the figure escapes me at the moment), so the concern for shareholders is that he may make a huge overseas acquisition.

      We have seen their inconistency internationally (unlike, say, H&M that seems to do well consistently everywhere) so that is a big worry for me. If they do a major acquisition, will they be able to handle it? I am skeptical about that a little. It may work, but it's a big risk.

      But anyway, yes, it's a great company for sure that has done really, really well, but I don't own it (I don't own H&M either, but again, it's a price issue)

    2. I just saw last Saturday the uniqlo store in France next to the Opera and it was really packed, so I'm a bit positively biased ;), but definitely not long the stock also out of price issue. very good points with the inconistency internationally, with the concern relating to the one man show and capital allocation. Peronally, I think also the goals are too aggressive. But maybe when they really disappoint the expecations of the market, the stock could become cheap...who knows.

  2. Another brilliant post!

    Btw, kk, I'd like to ask a favor from you.

    I'm currently a long-only investor. I wanted to expand my tool set to include shorting. But for a small retail investor, maintaining a short account is expensive. I've been thinking of using puts. But options introduce 2 additional variables (maturity and strike price) in the decision making process. I still haven't come up with a framework to think about it or value options from the perspective of an value investor. (Apparently, Ben Graham's Security Analysis, one of the primary source of my investing knowledge, is of no help.)

    Would you be able to point me to some right readings/resources?

    1. Hi,
      Off the top of my head, I can think of McMillan's "Options as a Strategic Investment" (or something like that) and Natenburg's "Option Volatility and Pricing". They explain the basics pretty well.

      There are a lot of 'spread' strategies explained in the book, calendar spreads, put spread, call spread, straddles, strangles, butterflies and whatnot, but I personally don't have any interest in those spread trades.

      Anyway, to bet against a stock, shorting is still the best way even if expensive. If you think shorting is expensive, option premiums can really cost you a ton of money over time too. Most of the time you are paying a premium (like insurance) and the market will go against you so it's good to only put a small amount into options overall.

      I bet most people who play options lose money on them over time, so it's not such a great idea.

      Time is probably way better spent just reading company filings and learning about business and practicing to value companies etc.

    2. Thanks kk.

      I take it that your suggestion is to focus on fundamental analysis and forget about synthetic trading strategies.

    3. Yes, that's what I would suggest. I don't know if you read "You Can Be a Stock Market Genius" by Greenblatt and Seth Klarman's "Margin of Safety", but if you haven't, I would highly recommend it. These guys have put up really good performance figures over the years without options trading or shorting (other than arb-type trades). There is a section in the Genius book where Greenblatt talks about using LEAPs, and that's one thing I do too; buy LEAPs (again, within strict limits) on stocks I think are highly undervalued.

      There are experts that trade options exclusively, but I don't know that equity managers' performance is ever enhanced by options trading. We know how Buffett has done with no options, Klarman, Greenblatt, Ackman and many others and we know the approach they take.

      On the other hand, I have never seen a track record of anyone that follows the options trading methods of, say, McMillan (Options as a Strategic Investment). I have never seen a really long term, audited track record of these guys.

      Oh yeah, and Benjamin Graham too has a nice long track record so we know his method works and has worked over time.

      So if you look at the evidence, I think it's pretty clear what a good path to take is.

      Of course, some will argue that since we are not as talented as Greenblatt or Buffett, that we can't do what they do. Well, even if that's true it's even less likely that we'd be able to put up a long term track record trading options!

      Anyway, that's something to think about.

    4. Yes, I read both Greenblat and Klarman. In actual fact, when I asked about option "trading", I had Greenblat's use of LEAPs in mind. This leads back to my original question: if I buy LEAPs instead of the common stocks, apart from the unit price, there are two additional variables I need to consider: maturity and strike price. This is the bit I don't have a good handle on.

      I'm definitely not interested in McMillan's trading strategies.

    5. Oh, OK. You can check out my BAC LEAP post too which is similar to what Greenblatt wrote about WFC.

      The key is to value the LEAPs based on your own assumptions and not on some option model. For example, I looked at the BAC LEAP as a binary sort of trade even though it's not really a binary event. You can look at whatever stock and make your own assumptions about where something might be trading in 18 months or so and see what the LEAP would be worth and put some odds on it.

      The difference between this LEAP trading and regular option trading is that it is based on a longer term view, so in that sense is less speculative (even though it's still speculative as time works against you).

      The other way to use LEAPs is to gain leverage; you can buy in-the-money LEAPs, for example, a levered way to gain exposure to a stock. The math here is simple too; your cost / risk (compared to owning the stock) is going to be the premium you pay over instrinsic value of the LEAP (current stock price minus strike price is the instrinsic value of the LEAP; this excludes the value of the optionality).

      Maybe I will make a post about this in the future...


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