Sony: Fire Sale?

Just when things start looking up for Japanese electronics powerhouse Sony, the company takes another punch to the gut. Consider these Friday the 13th developments. On that day, Sony unveiled a new Walkman digital music player that it hopes will rival Apple's ubiquitous iPod. On the very same day, however, electronics makers Sharp and Fujitsu announced recalls for tens of thousands of Sony batteries used in their laptops. This follows massive recalls by Apple, Dell and Toshiba and brings the total number of retrieved Sony batteries to more than 7.7 million.

Recalls happen, but these are more serious. The defective batteries can short-circuit and cause some laptops to overheat. In the most extreme cases, the laptops burst into flames. Morgan Stanley analyst Masahiro Ono expects the battery exchanges to cost Sony 55 billion yen ($460 million). On the bright side, the Sony's recall effort "was voluntary and demonstrates good faith," he says, and the company has "very sound" manufacturing controls to monitor battery quality.

Ono upgraded Sony stock on October 13 from "equal-weight" to "outperform" because he thinks the selling of Sony shares has been overdone. Sony's American depositary receipts (symbol SNE) gained 4% on the news, to $40.68. The stock is off 22% since late April is and nowhere near its record high of $157, set in 2000.

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The battery debacle has sapped some momentum from the restructuring initiated by Howard Stringer, Sony's first non-Japanese chief executive. Stringer, hired in June 2005, has committed to slashing costs by 200 billion yen ($1.7 billion) through plant closings, job cuts and the sale of unprofitable businesses. He also wants to revive Sony's dominance in electronics, which it has ceded to competitors such as Apple and Samsung.

The launch of PlayStation 3, due in Japan on November 11 and in the U.S. six days later, will be Sony's next chance at redemption. Sony has cut prices on the basic model in Japan to boost the odds that the console will be a hit there (it trimmed the suggested retail price of the basic PS3 to 47,600 yen, or $410, from an originally planned 59,800 yen, or $515). But Sony has yet to announce price cuts for the U.S. market, where two models of the PS3 are slated to retail for $499 and $599. That concerns Value Line Investment Survey analyst Eric Kolb, who says those prices may be too stiff. Game consoles from Microsoft and Nintendo sell for $200 to $250 less, Kolb notes.

Sony had to cut PlayStation prices in Japan to remain competitive, Ono says, but that will ding revenues. The price cuts, coupled with the cost of the battery recalls, may cause Sony to reduce its earnings forecast for the March 2007 fiscal year, Ono warns. Such a move would likely hurt the stock, at least temporarily.

The stock trades at 35 times the average analyst earnings estimate of $1.16 per ADR for the year ending next March. That's hardly cheap. But if the high-priced PlayStation 3 is a hit, the shares could well take off.