Why has Sony's market value evaporated by about $10 billion?

Zhitong App learned last week that after the tech giant Sony headquartered in Japan lowered its sales expectations for its flagship game console PlayStation 5 for the current fiscal year, Sony's total market value evaporated by about $10 billion in the stock market. Sony (SONY.US) ADR stock price has plummeted over 7% since February 14th in the US stock market. Analysts who already believed that Sony's PS5 sales targets were too high stated that the bigger and deeper issue facing this Japanese tech giant is the persistently low operating profit margin of its key gaming business.

Some Wall Street analysts have raised doubts, pointing out that despite Sony launching profit-generating products such as a digital game sales platform and the PS Plus subscription service, the profit margin of Sony's gaming business has not improved at all.

According to the financial report data released last week, the tech giant expects to sell around 21 million units of PS5 by the end of the fiscal year ending in March next year, down from the previous forecast of 25 million units. The stock markets in Japan and the US reacted negatively to this expectation, causing the company's stock price to plummet after the target adjustment. Since the downgrade of PS5 sales forecast, the company's stock price has evaporated about $10 billion.

Furthermore, the financial report data released by Sony last week showed that in the third quarter of the 2023 fiscal year ending in December 2023, the flagship product PlayStation 5 sold 8.2 million units, about 1 million units lower than market expectations. Sony also expects sales revenue for this fiscal year to be 12.3 trillion yen ($817 billion), lower than the previous expectation of 12.4 trillion yen.

However, analysts are paying close attention to another key performance indicator of Sony - the operating profit margin of the gaming business. According to institutional calculations, the operating profit margin of this business in the quarter ending December 2023 was slightly below 6%. In comparison, the operating profit margin of Sony's gaming business in the fourth quarter of the calendar year 2022 exceeded 9%.

"The downward revision of PS5 shipment forecast... is not a disappointing indicator," said Atul Goyal, a stock analyst at the Wall Street major Jefferies, in a report to clients on Wednesday. "What is disappointing is the consistently low operating profit margin of Sony's gaming business." He added that in the quarter from January to March 2022, the operating profit margin of Sony's gaming business department was around 12% to 13% over the past four years.

Goyal stated that despite various favorable factors that should have raised Sony's gaming business operating profit margin to around 20%, the operating profit margin of this business in the most recent quarter is still in single digits, and added that Sony's current operating situation is "very disappointing."

Analyst Goyal from Jefferies mentioned that these favorable factors include the overall sales of its first-party games, which are increasingly available in digital download form, and its high-profit PS Plus subscription service, with a profit margin of about an astonishing 50%. In a report, Goyal pointed out that their revenue in digital sales, additional content, and digital downloads has reached an all-time high... but their profit margin is at the lowest level in a decade. This may be unacceptable for Wall Street," Goyal stated in the report. Goyal emphasized in the report that Sony's gaming business's current operating profit margin is "almost at its lowest point in nearly 10 years."

This Wall Street analyst questioned why, despite Sony launching profit-generating products like digital game sales platforms and PS Plus subscription services, the profit margin of Sony's gaming business has not seen any improvement.

Serkan Toto, CEO and founder of Tokyo-based game consultancy Kantan Games, believes that the production cost of hardware has actually decreased significantly, as the PlayStation 5 has been on the market for over three years, and Sony even has better economies of scale.

Toto emphasized that one of the reasons for the recent squeeze on gaming business profit margins is the continuous increase in various software production costs.

According to information leaked by hackers cited by gaming website Kotaku, the production cost of last year's release "Spider-Man 2" by Sony's Insomniac Games was a staggering $300 million. Toto commented, "So over time, these budgets seem to have had a significant negative impact on their gaming business profits." Sony and Insomniac Games did not immediately respond to media requests for comments.