What Sony Ericsson Should Do With Its New $676M

Sony Ericsson's new Yari

Sony Ericsson's new Yari

Like a hard-luck gambler who can’t walk away from the table, Sony Ericsson is once again raising the stakes despite holding an ugly hand. The joint venture said it has secured $676 million in new funding — primarily from parent companies Sony (s sne) and Ericsson (s eric) — even as it posted another losing quarter.

The handset manufacturer saw sales in the most recent 3-month period fall more than 40 percent year-over-year, and estimated that its share of the handset market is at a stagnant 5 percent. And while it said the decline in global handset markets is slowing, it reiterated its outlook for a 10 percent slowdown in 2009 from last year, painting a less optimistic picture than the 7 percent slowdown predicted by Nokia (s nok).

Sony Ericsson is in the midst of a restructuring effort that will eliminate 2,000 jobs, and is betting heavily on a brand makeover and a new lineup of handsets that will hit the shelves in time for the holidays. But it continues to pay the price for its inattention to the low end of the market and a lack of web-friendly phones will solid messaging features. It has suffered substantial brand damage and lost its standing as a premier manufacturer of music phones as competitors such as Apple (s aapl), Research In Motion (s rimm) and Samsung have gained ground.

I don’t think a fresh portfolio and brand facelift can do much to reverse Sony Ericsson’s fortunes, though, and the company doesn’t have many attractive options. While some have suggested that a takeover of Palm (s palm) and its prized webOS might be in order, such a move would require several billion dollars — a price neither Sony nor Ericsson is likely to want to pay. Joining the Android bandwagon could help, but attracting attention in that crowded field of manufacturers wouldn’t be easy.

Instead, I still think Sony Ericsson’s best hope in the long run may be a PSP-branded phone that leverages Sony’s traction in the video game space. The market for a gaming-centric phone is still unproven — see Nokia’s history with the Ngage — but Apple’s iPhone has demonstrated a real demand for on-the-go gaming on a phone. And a hit gaming device could drive growth for Sony Ericsson’s new app store, which will distribute Java and Symbian offerings. That scenario sounds far more appealing than spending hundreds of millions of dollars on a strategy that has managed to capture just 5 percent of the market.