Sony to Fund Image Sensor Business with Convertible Bond

Sony SNE announced today that it is planning to issue a 150 billion yen ($1.9 billion) zero coupon convertible bond maturing in 2017. According to Bloomberg, this will be Sony's first bond issue since Moody's lowered its credit rating to Baa3, the lowest investment grade rating. The bond has a conversion price of 957 yen, a 10 percent premium to today's closing price in Tokyo of 870 yen. If fully converted, the bond will dilute existing shareholders by 15.6 percent. The zero coupon convertible bond will be issued in Europe and is not available to U.S. investors. Most of the proceeds of the convertible bond issue will go towards funding previous investment commitments, including the acquisition of an 11 percent stake in Olympus OCPNYfor 50 billion yen ($625 million), 10 billion yen ($125 million) toward the purchase of cloud gaming company Gaikai, Inc. and 30 billion yen ($375 million) toward the redemption of unsecured bonds due in March 2013. The remaining 60 billion yen ($750 million) is slated for the expansion of Sony's complementary metal oxide semiconductor (CMOS) image sensor production facilities in Nagasaki. This is part of Sony's strategy of increasing its market share in high-tech, high value-added electronic components. Sony must get this strategy right if it is to continue to operate as a leader in the consumer electronics industry. Image sensors are used to convert light into electronic signals that can be stored, such as taking a picture on a digital camera results in an electronic file that is stored on a flash memory for later viewing. Every digital camera has an image sensor, regardless of how it is used. There are two types of image sensors, charged coupled devices (CCDs) and CMOS. Each type of sensor has advantages and disadvantages. Generally speaking, CCDs are easier to manufacture but require a separate, complex system for processing the image. CMOS image sensors generally use less power and require relatively little additional image processing “off chip.” Manufacturers choose between CCD and CMOS when designing products depending upon the specific application they have in mind. Sony has developed a new design for CMOS image sensors that the company claims will give it an advantage. By stacking the pixel (image acquisition) layer on top of the circuitry layer (image processing), the manufacturing process can be simplified and the entire image sensor can be made up to 20 percent smaller, an important consideration when designing a smartphone, for example. By increasing production of its stacked CMOS design image sensors, Sony hopes to increase its market share for these high value-added components. Sony intends to use stacked CMOS image sensors in a wide range of its own products, including digital cameras, smartphones, and tablets. Stacked CMOS will also be used in industrial devices such as medical equipment, including endoscopes, which are made by Olympus. Sony plans to sell its stacked CMOS image sensors to third party manufacturers, including Apple AAPL, which already uses Sony image sensors in its iPhone and iPad products. It cannot be emphasized enough: Sony is a deeply troubled company. Stacked CMOS image sensors are generating some excitement because they offer a hint of the “old” Sony, when it was admired all over the world for its technology and its clever, high quality consumer electronics products. Management's strategy of investing in high value-added electronic components and subassemblies with high technological barriers to entry makes a lot of sense. In many ways, it emulates the very successful strategy employed by Nidec NJ, the world's largest manufacturer of spindle motors for hard disk drives. A majority of the hard disk drives used in the world today have a Nidec motor in them. Nidec has built a very profitable business by becoming the go-to supplier for a high value-added electronic component. Nidec's profit margins are much higher than the profit margins at the hard disk drive manufacturers because Nidec has no real competition. All of the hard disk drive makers buy from them. If Sony can do the same thing with its stacked CMOS image sensors, then that could provide a big boost to profitability. Sony management still has to deal with other problems: what to do with the television business, improving profitability in games and exercising proper control over Sony Pictures. But taking a risk by funding the growth of the stacked CMOS business looks like a step in the right direction and should be welcomed by investors, in spite of the potential dilution from the zero coupon convertible bond announced today.