SoftBank Group Trades At A Considerable Discount To Its Portfolio – Rightfully So?

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SoftBank Group (OTCPK:SFTBF) (OTCPK:SFTBY) has been many things in its history. It was founded as a shop for computer parts and software. Then it became one of Japan’s biggest telco companies. Along the way the company and its founder Masayoshi Son made some very lucrative investments in what was to become billion-dollar companies. Now SoftBank is in the process of transforming itself into an investment company. It already has amassed a considerable portfolio of innovative businesses – but also a mountain of debt. The company as a whole is currently (as of December 7th) valued at $85.25 billion.

Please note that by “SoftBank” I always refer to the holding company, SoftBank Group, while the telecom operations are “SoftBank Corp.” and the listed web-service operations are referred to as “SoftBank Tech. Corp.”

SoftBank’s Assets

First, let us take a look at SoftBank’s holdings. When it comes to publicly listed assets, I am using the current market capitalization as the basis of my analysis.

Please note that wherever available I am using US-dollar prices to determine the value of assets. Where this is not possible I am using exchange rates as of DATUM (1 USD=112,73 Yen). Prices for publicly listed assets are as of December 7th.

Alibaba

SoftBank holds a stake of about 29 percent in Alibaba Group Holding Limited (NYSE:BABA), making it the Chinese e-commerce behemoth’s largest shareholder. However SoftBank (nor any other non-Chinese investor for that matter) does not have any direct stake in Alibaba. Instead, the company owns a stake in a Cayman Islands-based entity that is entitled to a share in Alibaba’s profits.

SoftBank acquired its stake in Alibaba for an, compared with its present value, insignificant amount of money. Therefore, in case of sale, taxes would apply on the capital gains. However, the stake in Alibaba also serves as collateral for some of SoftBank’s debt.

Based on the current market capitalization, SoftBank’s stake in Alibaba amounts to $115.06 billion.

SoftBank Corp. (Mobile Operations)

I base my estimate here on the fixed IPO price (notably, unprecedented in Japan’s history) of ¥1,500 ($13.31) that SoftBank has announced for its mobile operations, SoftBank Corp. A fixed price as opposed to a price range indicates a considerable level of confidence, thus I will assume the stock price will not fall significantly immediately post-IPO. On the other hand, the price is widely seen as quite high given the financials of the company and considering a possible price war in the Japanese telco market on the horizon. Therefore, I will also assume that there will be no significant gains in valuation immediately post-IPO.

Assuming SoftBank will sell about a third of the company than valued for about ¥2.4 trillion ($21.29 billion), it will own a two-third stake in a company valued at ¥7.2 trillion ($85.16 billion). Thus, the remaining value of this stake would be about $63.87 billion.

Sprint

SoftBank currently owns an 85.87 percent stake in Sprint Corporation (NYSE:S) that, based on the company’s current market capitalization, has a value of $21.05 billion.

Once the merger with T-Mobile US, Inc. (NASDAQ:TMUS) is completed, SoftBank will hold a 27 percent stake in the combined entity. For the purpose of simplicity, I will assume the combined value of Sprint and T-Mobile US as at least the total market capitalization of both companies (possibly in the medium to long term even considerably more, as the deal makes great sense in my opinion). Hence post-merger, SoftBank would own a stake worth about $21.66 billion.

Yahoo Japan

SoftBank is the largest shareholder of Yahoo Japan Corp. (OTCPK:YAHOF) (OTCPK:YAHOY) owning a stake of 48.17 percent. Based on the current market capitalization, SoftBank’s stake has a value of $6.93 billion.

As is the case with Alibaba, SoftBank’s initial investment is almost irrelevant compared with the current value of the holding. Hence considerable taxes would apply in case of a sale.

ARM Holding

SoftBank owns 75.01 percent of British chip-designer ARM Limited (the remaining 24.99 percent being transferred to the vision fund). As the company is no longer publicly listed, it is harder to estimate its value in this case.

ARM was acquired in July 2016 for what then amounted to about $31 billion. This price already contained a premium of about 43 percent to ARM’s closing price before the announcement of the takeover. Since then the company has been growing significantly. On the other hand, however, profits have almost completely vanished.

For the sake of simplicity, I will thus assume the value of ARM at the price that SoftBank paid for it. Hence the holding in ARM is valued at about $23.25 billion.

Vision Fund and Delta Fund

I believe that long term, the Vision Fund (and possibly others of its breed) will be the center piece of SoftBank’s strategy. The Vision Fund would be best described, I believe, as a venture fund structured as a private equity fund. Assigning it to a category is indeed not an easy task, as there simply is no other entity such as this, so maybe one must for now accept that currently the Vision Fund is a construction sui generis. Its minimum lifetime is 12 years. The fund is led by Son himself and Rajeev Misra, who serves as CEO of SoftBank Investment Advisers. The companies in which the fund invests are encouraged to cooperate amongst one another.

The fund invests in a wide range of companies both public and private. Investments begin at about $100 million but in some cases reach multi-billion dollar volumes. Besides the 24.99 percent of ARM mentioned above, notable investments include a large position in WeWork Cos. Inc. (which it is reported to be considering to increase), a 4.4 percent stake in Nvidia Corporation (NASDAQ:NVDA) and stakes in numerous start-ups from various fields. The fund also invested $2.25 billion in General Motors’ (NYSE:GM) self-driving car division Cruise Automation. Furthermore, SoftBank will transfer investments including its stake in Uber (UBER) to the Vision Fund. A list of the fund’s investments as of September 30,2018, can be found on page 24 of SoftBank’s consolidated financial report for the first half of the 2018 FY.

Limited partners include Apple Inc. (NASDAQ:AAPL), Qualcomm Inc. (NASDAQ:QCOM), Sharp Corporation (OTCPK:SHCAF) (OTCPK:SHCAY) and Foxconn Technology Group (OTC:FXCOF). However, the biggest investors in the fund are the Saudi Arabian Public Investment Fund (PIF) and state-owned Emirati Mubadala Investment Company, which committed $45 billion and $15 billion, respectively.

The Delta Fund was set up to invest in ride-hailing companies other than Uber without using Saudi money, as Saudis apparently are reluctant to fund direct competitors of Uber in which they have invested through the PIF.

The Vision Fund currently has a volume of $91.7 billion of committed capital, $28.1 billion of which are from SoftBank. The Delta Fund has a volume of $6 billion, with SoftBank accounting for $4.4 billion. So SoftBank owns a third of the funds (although legally, Vision Fund and Delta Fund are different entities I decided to count them as one here due to the circumstances).

Notably, the outside investors will hold 62 percent of their respective investments through preferred shares (7 percent coupon). SoftBank’s stake consists fully of equity shares. Hence SoftBank profits disproportionately once returns are above 7 percent while on the other hand, it is more at a risk in case of lower or negative returns.

To calculate the value of the Vision Fund and Delta Fund is not easy. As the coupon payments on the preferred shares outweigh the management fee, I believe the easiest way would be to measure the value of the funds’ holdings and to calculate from this the value of SoftBank’s stake. However, this again is not an easy undertaking, as most of the companies the fund has invested in are yet private and the necessary data is therefore not publicly available.

My consideration is the following: due to its sheer financial power, the Vision Fund is probably able to almost “force” target companies to take its money – because if they will not, there is the threat of Vision Fund supplying competitors with enough money to disrupt their business as well as to outbid any other prospective investor if it needs to. Furthermore, having the Vision Fund as an investor could itself increase the value of a company, just because it will be indicative of access to (more) capital if needed. Therefore, the fund should be in a very good position in terms of access to investment opportunities it would like to pursue.

Also, I see upside potential in the network effect the fund has on its respective investments. Cooperation between the different companies certainly increases the potential. It seems that SoftBank does not only realize this but actively fosters it.

To be very conservative, I will assume the value of SoftBank’s stake in the Vision Fund and Delta Fund at its current share in the funds’ capital, thus at $32.5 billion. However, I see considerable room for an increase here.

Fortress

SoftBank fully owns Fortress InvestmentGroup LLC. SoftBank waived day-to-day control of Fortress in order to gain CFIUS approval for the acquisition. Consequently, Fortress continues to operate as an individual business within the SoftBank Group.

SoftBank paid a total of $3.3 billion in 2017 which means almost 39 percent premium on the share price before the announcement of the deal. After the acquisition by SoftBank was announced, Fortress Logan Circle partners sold to MetLife (NYSE:MET) for a reported $250 million.

For the past few years the growth in assets under management at Fortress has been rather slow compared to its peers. Taking into account the considerable premium that SoftBank paid for the company and the limited influence it has on day-to-day operations, I would assign a value of about $3 billion to this asset.

Other

Other assets of SoftBank include among others full ownership of Brightstar Corp., a US distributor of mobile phones and devices founded by SoftBank COO Marcelo Claure. SoftBank is reported to consider a sale of Brightstar. It could be valued at about $1 billion.

SoftBank Group also owns 48.4 percent of listed SoftBank Technology Corp. (OTC:SFBTF), a service provider for information and communication technologies. It maintains control over SoftBank Tech. Corp. due to the subsidiary holding 11.3 percent of its own shares. The stake in SoftBank Tech Corp. currently has a value of $164 million.

The group also owns and operates, for example, a baseball team, renewable energy operations and has purchased robot maker Boston Dynamics from Alphabet Inc. (NASDAQ:GOOGL) (NASDAQ:GOOG). A list of SoftBank subsidiaries can be found here.

As financial data of most of these non-listed assets is not publicly available, I feel unable to reasonably estimate their value.

So, all in all, I would assign a value of at least $266.82 billion to SoftBank’s portfolio. On top of that comes the combined value of all other businesses which I struggle to assign a value to due to lack of data.

A Mountain of Debt

But SoftBank does not only have a considerable portfolio. On the other hand, there is also the company’s considerable (and growing) amount of debt.

As of September 30, SoftBank had a total debt of ¥17,987,757 million (about $159.4 billion). Please keep in mind that this number is not adjusted for cash holdings. The total debt was up 5.55 percent for the six-month period.

It should be noted that Sprint’s debt, while appearing on SoftBank’s balance sheet, is non-recourse. So even if Sprint would go into bankruptcy SoftBank would only lose its equity stake in the company, not more.

Furthermore, Sprint’s debt might – on paper – disappear from the balance sheet once the merger will be completed, as SoftBank will no longer be legally required to fully consolidate due to its lower percentage-wise stake in the new entity. This could reduce the company’s debt by about $40.7 billion – that is, again, on paper. Notably, Moody’s views the merger as credit-positive for SoftBank.

Nonetheless, SoftBank is still a highly indebted company. And not only that: it seems as if SoftBank is constantly looking for ways to increase its ability to borrow even more.

A Considerable Discount

As mentioned above, SoftBank has a total debt of about $159.4 billion. At the same time, the company had ¥ 3,161,672 million (about $28 billion) in cash and cash equivalents. So all in all, SoftBank has net debt of about $131.4 billion.

However, as both total debt and cash and equivalents are spread across the subsidiaries (and thus already included in their respective valuations) I believe one should refer to the total debt here.

Still, after deducting total debt from the portfolio value calculated above, we would arrive at a value of $107.42 billion. At the current share price, this would amount to a considerable discount of 20.64 percent.

And remember: that does not yet include the positive effects of a Sprint/T-Mobile US merger (debt reduction, possibly more valuable combined business) nor the additional cash from the SoftBank Corp. IPO (while at the same time only counting the post-IPO share in the business among the assets). It also does not include assets that I felt unable to reliably assign a value to due to lack of publicly available data and values the Vision Fund extremely conservative. On the other hand, of course, I did not include taxes on capital applying in case of a hypothetical sale of either Yahoo Japan or Alibaba, as I do not expect such sales.

This all leads up to one main question: is this discount justified?

For an answer I believe a number of factors to be worthy of consideration.

Key Man Risk

First of all, SoftBank is highly dependent on its leader, founder Masayoshi Son. Son, who is often referred to as “Masa,” is the mastermind behind SoftBank’s investments. During his studies at UC, Berkeley, he built not only one but two million-dollar businesses. He founded SoftBank after returning to his home country in 1981 as a computer parts and software store.

While it might appear as if luck played a significant role in his success, given the fact that a considerable share of it comes from only two investments (Alibaba and Yahoo Japan), I would name the sale of Finnish video game maker Supercell to Tencent (OTCPK:TCTZF) (OTCPK:TCEHY) or the sale of its stake in Indian e-commerce company Flipkart to Walmart (NYSE:WMT) as counter witnesses. Also turning the Japanese business of Vodafone Japan, which SoftBank acquired from the parent (NASDAQ:VOD) in 2006 for about $15 billion at 2006 exchange rates into today’s SoftBank Corp., underlines his ability. Further evidence against the case for Son being a “one- (or let’s say two-) hit wonder” is that he managed to recover after the dot-com crisis (and losing over 90 percent of his wealth) and to reclaim the position as Japan’s richest man.

With all due respect to Rajeev Misra and the rest of the Vision Fund’s leadership, I also believe that it is Son’s reputation and charisma above everything else that made investors such as the Saudi PIF and Mubadala to commit the amounts of capital they committed to the fund. Without the Son factor, I expect there is not really a reason why the Saudis or Emiratis should not build their own venture funds. People the likes of a Rajeev Misra, Colin Fan or Jeffrey Housenbold may be a scarce resource. However, if you have the money (and hey, the Gulf nations definitely have the money) it is absolutely possible to acquire a team of highly skilled investment professionals. But what cannot be bought with money is a second Masayoshi Son (luckily for investors, the one Masayoshi Son that exists happily accepts your money in the form of borrowing).

SB Investment Advisers CEO Rajeev Misra, SoftBank Group Chairman and CEO Masayoshi Son and His Excellency Yasir al-RumayyanRajeev Misra, Masayoshi Son and H.E. Yasir al-Rumayyan, CEO of the PIF; source: SoftBank Investment Advisers

Son as a personality is also instrumental to gain access to many of the companies in which SoftBank and especially the Vision Fund seek to invest. It is a rather easily reached conclusion, I believe, that a person like Son is much more appealing to a start-up’s founders than say Rajeev Misra who, while no doubt highly qualified, has a somewhat mixed reputation due to mainly his previous station at Deutsche Bank (NYSE:DB) or another ex-investment banker.

So, all in all, I believe that SoftBank is one of the companies that has the biggest key man risk.

Son’s Links Could Cause Suspicion

Another risk worth considering arises from Son’s ties to Saudi Arabia. Especially the involvement of the Saudi government – after all, the biggest investor in the Vision Fund through its PIF – could potentially cause problems in the short term. In the worst case, I believe it to be at least a possibility that the United States might take measures against the country’s crown prince, His Highness Mohammed bin Salman, as a consequence of the Khashoggi incident. At the time of writing there were already considerations of possible sanctions in the Senate. I do not believe that it is unthinkable that there might be restrictions on Saudi money in the process (although as of now I think it is rather unlikely). However, even without formal sanctions at least in the short term, until the Khashoggi case is out of the focus, it could lead to difficulties due to founders and entrepreneurs potentially being reluctant to accept Saudi money.

More broadly, it might also prove increasingly problematic that SoftBank is a Japanese company while potential investment targets are often American. US regulators might be increasingly cautious when it comes to foreign investments in industries of strategic importance. A Japanese company led by a Japanese with good ties to China and funded by Saudi Arabia could cause some scrutiny. Hints in that direction were visible, for example, in the case of Fortress or Boston Dynamics where SoftBank had to make certain concessions in order to gain regulators’ approval. I encourage investors to also consider the failed Qualcomm acquisition – where risks to the national security were cited – despite Broadcom (NASDAQ:AVGO) not only being led by an American but also planning to relocate to America.

More Capital Out Than In

The most important risk factor, however, is – at least in my opinion – SoftBank’s constant need of cash. Many moves the company recently took served the main purpose of increasing its ability to borrow even more money to invest into target companies. This might work out at the moment, however, it puts the company at considerable risk.

The main problem is that the majority of the companies that SoftBank invests in is not profitable, on the contrary. Take for instance, WeWork. The company burns more capital than it has revenue. At Uber, there is a similar picture (only on an even larger scale). Even at ARM, the profitability deteriorated massively after SoftBank acquired it. You could continue this list for quite a while. Those companies represent valuable assets; however, to keep this value from deteriorating it might become necessary to inject further cash to cover the losses they amass.

One could in a way compare this situation to having a collection of valuable classic cars: while the collection represents a huge value it requires maintenance in order not to lose this value. This maintenance, however, requires cash which the collection does not generate. And if you are forced to sell pieces to cover the maintenance expenses, you will most likely not get the best price for it. Luckily for SoftBank and its investors, unlike classic cars, innovative technology companies have a chance to one day produce positive cash flows. But to reach this stage they first have to survive. And for the company to reap the profit it has to be able to keep them until that point.

The other side of the problem is that the annual amount of cash it receives from its profitable businesses might decrease. First of all, one should be aware of the fact that the IPO of SoftBank Corp. will reduce the cash inflow from this source. Of course, the company will receive a large one-time inflow from the proceeds. But on the other hand, SoftBank will no longer have full access to SoftBank Corp.’s profits which it will have to share with the new owners of one third of the companies in the future. There are also signs that SoftBank Corp. might come under increasing pressure going forward as there could be a price war of Japanese telecom players on the horizon.

As SoftBank Corp. is far bigger than Yahoo Japan and Alibaba does not pay dividends, any decrease in SoftBank Corp.’s dividend (which would become inevitable if the profit was to decline given the already high payout ratio of about 85 percent) could severely harm SoftBank.

The Sprint/T-Mobile US merger could ease this situation a little as the combined entity would be considerably more likely to pay a dividend to its shareholders – which Sprint at the moment does not do.

The picture at the Vision Fund is similar. Due to its structure, it needs about $2.83 billion to pay the annual 7 percent rate on the preferred shares while generating approximately $650 million in management fees. So there is still the need to come up with $2.18 billion in cash. As the majority of portfolio companies is not profitable and therefore does not distribute capital to shareholders, the Vision Fund must either sell some of its holdings – which is not that easy as the majority of the portfolio consists of non-public companies – or borrow money. And guess which way they prefer. As of September 30, the Vision Fund had borrowed almost ¥636 billion ($564 million).

One should also consider that the Vision Fund tends to invest at rather high valuations. Therefore, the upside potential for a sale or IPO is somewhat limited. I do therefore see the risk of an unhealthy debt spiral. Even more so due to the fact that, as mentioned, I believe that additional capital will be needed to keep the companies from losing value.

All in all, I believe both SoftBank and its Vision Fund to get into existential danger if they do not come up with a way to increase profitability of their respective portfolio companies before at a faster pace than the debt. Especially, the Vision Fund might also suffer majorly if the valuations at which start-ups are traded deteriorate as in that case it would have to finance the preferred share rate (and possibly additional debt) at a shrinking portfolio.

Conclusion

SoftBank trades at a considerable discount to its portfolio value. However, I believe this discount to be justified by the risks attached to the company and especially its debt reliance. If an investor can stand the risk, however, the stock offers the chance at considerable upside. Under the condition that SoftBank finds a way to better manage and ultimately reduce its debt and if its investments’ profitability develops in a favorable way it could gain massively in value. For this exact reason, I would also be reluctant to short the company as the risk of such position could be immense.

All in all, I consider SoftBank to be worth consideration for investors who believe in the potential of its startup portfolio and are willing and able to afford the – not unrealistic – possibility of a total loss.

Disclaimer: All research contained in this article was done with utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his own due diligence and research.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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