2023-06-08 07:00:00 ET
Summary
- The worries about cloud gaming's threat are overblown as highlighted in a recent interview with Sony's CEO, and I concur with his views.
- As an hedge against potential disruption risks, SONY has its own cloud gaming service called PlayStation Plus.
- Sony has plans in place to spin off its financial services business, which I view to be a positive value-enhancing move from a capital allocation perspective.
- I assign a Buy rating to SONY stock, after considering cloud gaming's threat and the company's capital allocation moves to narrow its conglomerate discount.
Elevator Pitch
I award a Buy investment rating to Sony Group Corporation ( SONY ) [6758:JP] stock. There are two re-rating catalysts for SONY. The first catalyst is the completion of the spin-off of its financial services business, which should narrow the holding company discount for its shares. The second catalyst is that concerns regarding the negative impact of cloud gaming on Sony are expected to ease over time, considering the cloud gaming market's growth constraints and SONY's own cloud gaming initiatives.
Concerns About Threat Of Cloud Gaming Are Overblown
Seeking Alpha News cited The Financial Times interview with Sony's CEO, Kenichiro Yoshida, in its recent June 4, 2023 article . In this interview, the CEO of Sony noted that "technical difficulties", which The Financial Times understood as "latency" or "the fast response times demanded by gamers", are the key "challenges to cloud gaming."
I agree with Kenichiro Yoshida that fears about the negative impact of cloud gaming's rise on the console gaming industry and Sony are exaggerated to a large extent.
SONY isn't the only party that has highlighted internet access as a bottleneck for cloud gaming's future growth.
In an October 11, 2022 research report , S&P Global estimates that cloud gaming's share of the overall games market was just around 2% in 2022. More significantly, S&P Global forecasts that the cloud gaming's market share could increase to 7% by 2026. In S&P Global's October 2022 report, it is specifically mentioned that the "limited broadband infrastructure in many Latin American nations holds its (cloud gaming's) potential upside in check." Even in other geographic markets with decent internet access and coverage, it is uncertain if cloud gaming will fully meet the "latency" criterion as mentioned earlier.
In a nutshell, while cloud gaming is expected to gain share in the coming years, an estimated 7% market share in 2026 suggests the death of console gaming or PC gaming is not coming anytime soon.
Separately, Take-Two Interactive Software's ( TTWO ) CEO Strauss Zelnick stressed at the company's Q3 FY 2023 earnings briefing that he has "never felt like cloud gaming would represent a seismic change", and he emphasized that cloud gaming is a "distribution technology" rather than a "business model." Strauss Zelnick's views are similar to that that of another Sony executive. Hiroki Totoki, who was promoted to President and COO of SONY in February 2023, mentioned at Sony's Q4 2022 earnings call that "in any case, some kind of a client (gaming hardware) would be necessary to enjoy different games" as long as "the evolution of technologies and the hardware that matches the times" and "creates value."
In other words, it is likely that both console gaming and cloud gaming will continue to be part of the broader games industry for the foreseeable future. In his book titled "One Up: Creativity, Competition, and the Global Business of Video Games", author Joost van Dreunen used the music industry "where people still buy CDs, listen to the radio, and pay a monthly fee for a music streaming service" as an example of how different forms of gaming can co-exist.
In summary, cloud gaming might not grow as fast as one would expect in the near future, considering "latency" issues as highlighted by Sony's CEO and S&P Global research. Furthermore, the rise of cloud gaming doesn't necessarily translate into the demise of other gaming categories, assuming the games industry players learn to adapt to changes. In the next section, I touch on how Sony has been preparing itself for potential changes in the gaming space.
Sony Has Hedged Its Bets
SONY is a company which is cognizant of potential disruption threats and has hedged its bets accordingly.
As detailed in The Financial Times interview piece referred to in the preceding section, Sony was one of the early adopters of cloud gaming, considering that it introduced its own cloud gaming service known as PlayStation Now in 2014. PlayStation Now was subsequently rebranded as PlayStation Plus in March 2022 , which is now estimated to have around 47 million subscribers as per data from Statista . Also, Sony reiterated at the company's FY 2023 corporate strategy meeting on May 18, 2023 that it is "prepared for the possibility (of a faster-than-expected pace of growth in cloud gaming) as we already offer a cloud gaming service (PlayStation Plus)."
At its 2023 Business Segment Meeting (event transcript sourced from S&P Capital IQ ) held on May 24 this year, SONY also revealed that it has "some fairly interesting and quite aggressive plans to accelerate our initiatives in the space of the cloud" in the months ahead. While the details of such plans are unknown at this point in time, it is clear that Sony is more than ready to deal with the potential rise of cloud gaming. As indicated in its 2023 Business Segment Meeting presentation, SONY's PlayStation Plus cloud gaming subscription service already offers 800 titles and over a billion hours of gameplay in its current form.
I highlight a key re-rating catalyst for Sony in the subsequent section.
SONY Is A Conglomerate With Value Unlocking Potential
Sony is probably best known for its PlayStation consoles, but the company is actually a conglomerate with multiple businesses as noted in the table presented below.
SONY's Financial Performance By Business Segment For The Most Recent Fiscal Year
Sony's FY 2022 Results Presentation
The most obvious catalyst for Sony is any action or initiative to narrow the conglomerate discount assigned to its shares. Examples include having some of its businesses separately listed, and diverting capital to businesses with good growth potential.
An earlier May 18, 2023 Seeking Alpha News article mentioned that SONY "is considering partially spinning off its financial services unit, Sony Financial Group, as a separately traded entity." At FY 2023 corporate strategy meeting on May 18 this year, Sony explained that the planned spin-off was proposed on the basis that its "image sensor and entertainment businesses will require investments on an entirely different scale than what they have before." In other words, proceeds generated from Sony Financial Group's spin-off will help to fund SONY's other businesses, while Sony Financial Group will be less reliant on the parent for financing after it becomes a listed company.
Simply put, SONY is allocating capital from slower-growth businesses to higher-growth ones with its proposed spin-off of the company's financial services business, while allowing its Sony Financial Group to obtain an independent valuation from the market as a listed entity. In my opinion, these wise capital allocation moves will drive a positive re-rating of Sony's share price and valuations.
Closing Thoughts
In my view, Sony's shares have the potential to trade higher, which warrants a Buy rating. Sony's stock has suffered from a valuation discount relating to the risk of cloud gaming's rise and the company's holding company structure, which I think will narrow in time to come. I think that the threat of cloud gaming is not as significant as feared; and the company also has spin-off plans in place for its financial services business.
For further details see:
Sony: Don't Worry About Cloud Gaming Threat