Description

Softbank is a Japanese multi-national holding company run by Masayoshi Sun comprised of wholly owned, majority and minority owned public/private consolidated and non-consolidated subsidiaries operating in the telecommunications, media and technology sectors. The company consists of over a hundred consolidated subsidiaries and 65 equity-method subsidiaries. Softbank’s major wholly owned businesses include its broadband business, Japan telecom (fixed line telecom business) and former Vodafone KK (mobile business). Softbank also has large stakes in Yahoo Japan, Alibaba and Yahoo. 

 

Beginning with the background, Softbank acquired the mobile business, the primary asset of any value, in an LBO type transaction from Vodafone in April 2006. The business was poorly managed by Vodafone which standardized handsets across its subsidiaries around the world without regard to differing consumer preferences in each market. While Softbank paid a high multiple for the business, around 8x EBITDA (high for a slow growth, highly penetrated market like Japan) the intention of Son was to raise margins through its Yahoo Japan relationship (Yahoo Japan web buttons on phones), reinvigorating the handset lineup and a better quality brand name in Japan, Softbank vs. Vodafone. The stock ran on the strategy as well as Son’s charisma while fundamentals in the business began to deteriorate. A Barrons article in August/September of 2006 discusses initial red flags in the business, but I couldn’t seem to find a link to include here. In December 2006, in an effort to reduce the rate on the bridge loan from the acquisition, Softbank securitized all debt related to the mobile business with receivables and assets of the mobile business and essentially de-linked the debt from the balance sheet at the holdco level. In 2007, Softbank began cutting prices and later adopted a handset installment sales method and consequently a pricing war ensued with Docomo and KDDI.

 

In this trade, we short the Softbank stub by shorting Softbank (9984 JP) and go long a proportional amount of Yahoo, Yahoo Japan and Alibaba, essentially isolating the misvaluation in the mobile business. The stub looks misvalued due to accounting irregularities and deteriorating fundamentals in the mobile business, due to changes in pricing.

 

New Pricing Plan:

The company began offering a new pricing plan last year with extremely low monthly fees, free calling to anyone about 16 hrs a day, free Softbank to Softbank calling and a handset for free upfront with installment sales in which the subscriber pays for the handset for the last 24 months of a 26 month contract, where Softbank is partly subsidizing the handset.

 

Three Major Issues Associated with New Pricing:

(1)     Softbank is booking handset revenue upfront and accounting for the lack of cash flow with a handset receivables line item and extremely high negative working capital changes, so while earnings are growing from handset sales, cashflow is deteriorating and from a DCF perspective the business is worth almost nothing. Moreover, when the street compares profitability between operators, they look at EBIT, which is ridiculous in this case given the lack of cash flow from new subscribers

(2)     Since they’ve been attracting subscribers with low priced plans and free internal calling, net adds have looked great, but most are children and elderly people with a virtually non-existant ARPU. In terms of incremental ARPU, for the FY 3/08, assuming the base subs ARPUs are not changing, the 15% increase in subs results in a 15% decrease in ARPU, thus the incremental subs are pretty low ARPU. As they continue to push the white plan, ARPUs will continue to drop off and when that finally stabilizes, there will be no new handset revenue

(3)     In the handset receivables balance sheet item, they are not accounting for very much in bad debt reserves from phones, so we could potentially see writedowns here in the future

 

This model looks wrong on so many levels. First, they are turning a company with measurable invested capital in a network into a technology distribution business, subsidizing handsets and distributing them to new customers at a very low ARPU. Also, from a NPV perspective, a dollar realized today is obviously better than one two years from now, from handset installment sales, especially when Softbank is paying for the handsets upfront. Finally, as I’ll show below, regardless of the installment sales and degradation of the business, IE projecting ARPUs and associated margins two years from now when they have no more new customers to sign up to inflate revenue and EBITDA but incredibly low ARPUs, the stub still looks expensive on 3/09 FY numbers that the street is projecting vs. its competitors, which are actually profitable.

This business is basically being run fraudulently with inflated revenue and earnings but no cash flow to back it up.

Additional shady issues include rumors that analysts with sell ratings have been threatened to ‘improve’ their analyses (I spoke to an analyst for a bulge bracket that depicted a very different picture to me once than was in his report). Thankfully this is anonymous so Son can’t come hunt me down! Also, Goldman had been their banker for years but pulled out of a credit facility last year pretty suspiciously. Finally, we can’t forget that there’s an extraordinary amount of leverage on this business, 5x consensuses EBITDA (which doesn’t take into account a loss in handset installment sales and the actual degradation of the business).

 

I’ve copied my Softbank SOTP model below and will walk through the general assumptions; if I gloss over anything, please question me. 

 

The top right is pretty self explanatory; Softbank share price, shares outstanding, Yen/Dollar exchange rate, date and yen HK$ exchange rate. Next, I list the public companies in which Softbank has a share, noting which are consolidated in Softbank financials. For the consolidated subs, we back out EBITDA and net debt from the Softbank reporting segment in which they are classified. We list prices in Yen, number of Softbank shares and total value as well as value per Softbank share in order to calculate the stub at the bottom.

 

Under Non-pub consol subs, we list the Softbank ownership in the portion of Alibaba that is not public and value it at the FD carrying value Yahoo uses.

 

Next, we list the other non-consolidated subsidiaries that Softbank has that are of great value. Historically, (pretty much only bc of Yahoo Japan and Alibaba), Softbank has returned 3x its invested capital in these startups, so in order to be conservative on the short, we value all these at 3x invested capital.

 

Next, we look at Softbank’s venture capital funds which we value at 20% returns. I’ve gotten stats from some LPs on these funds and the returns aren’t close to what we’re valuing them here, 20% IRRs. Next, we look at Softbank’s consolidated operating subsidiaries, taking out the value of the consolidated public companies. In the stub I’ve built, we only short out Yahoo, Yahoo Japan and Alibaba, so I only take out the consolidated EBITDA and net debt of Yahoo Japan.

 

For the reporting segments, my estimates are based on street numbers and I value each business using the EBITDA multiples listed based on growth and margins in each business.

 

In order to calculate the value of the stub, we take the Softbank share price and back out the value per Softbank share of Yahoo Japan, Alibaba and Yahoo. This gives us a current Softbank price of 552 yen vs. our fair value of 309 yen, thus a 44% downside.

 

However, this estimate is conservative. When I run a DCF on the cashflows from the mobile business, given the high changes in working capital and the network investment cost (Vodafone underinvested in the network), we get fair value of the mobile business of 75 yen vs. 236 yen when we use a 5x EBITDA estimate in the analysis below. That brings down fair value of the stub from 309 yen to 148 yen, thus 73% downside.

 

 

 

 

Softbank Sum of the Parts
9984
Price	2080
S/O	1080.4
Exch Rt	103.55
Date	4/23/08
HK$ Exch Rt	13.2819
		Consol		Ticker	Price		Shares		Value				Per Share		3/09 EBITDA
			Yahoo	YHOO	2,907.7		52.3		151,933				140.63
			Alibaba	B28Q94	162.3		1196.0		194,122				179.68
		Y	Yahoo Japan	4689	52,300.0		24.9		1,304,771				1207.67		157205
			UTStarcom	UTSI	317.3		14.7		4,650				4.30
			GungHo	3765	211,000.0		0.0		8,175				7.57
		Y	Broadmedia	4347	200.0		23.2		4,631				4.29		1400
		Y	Softbank Tech	4726	950.0		5.4		5,099				4.72		2200
			Vector Inc	2656	83,500.0		0.0		2,689				2.49
			Cyber Comm	4788	72,800.0		0.0		1,905				1.76
			MP Tech	3734	50,000.0		0.0		887				0.82
													1553.93
			Non Pub Non Consol		Percent		Total
			Alibaba (Non-Public)		29.30%		517,750		106,191				98.29
			Other Non-Consol Subs	Investment	Implied Ret				Value
			MPT BB	50	3.0x				150				0.14
			Telecom Service Co	495	3.0x				1,485				1.37
			ValueCommerce	833	3.0x				2,499				2.31
			NC Japan KK	375	3.0x				1,125				1.04
			IMX	718	3.0x				2,154				1.99
			Movida Holdings	100	3.0x				300				0.28
			Avanquest	100	3.0x				300				0.28
			CJ Internet Japan	1100	3.0x				3,300				3.05
			Fishing Vision Co	1141	3.0x				3,423				3.17
			Nihon Eiga Satellite	333	3.0x				999				0.92
			E-Book System	182	3.0x				546				0.51
			Overseas Funds	Softbank Inv	Size	Return			Value
			SOFTBANK Tech Vent	3365.375	250	20%			4,038				3.74
			SOFTBANK Tech Vent	15687.825	500	20%			18,825				17.42
			SOFTBANK US Ventures	50273.525	500	20%			60,328				55.84
			Softbank Businesses	3/09 EBITDA		Multiple			Value				Debt
			Broadband	62997.7		6.0x			377,986
			Fixed Line	31241.9		4.5x			140,589
			Mobile	354340.5		5.0x			1,771,703				1,516,334		255,369
			eCommerce	8391.7		6.5x			54,546						236.364844
			Internet Culture	467.5		6.5x			3,039
						Consol EV			2,347,862
						Net Debt			2,247,702
						Market Val			100,160				92.71
									Value/Shr				1836.99		-11.7%
			Stub Analysis	Price	Shares	Value			Per Share
			Softbank	¥2,080	1,080	2,247,232
			Yahoo Japan	¥52,300	24.9	1,304,771			¥1,208
			Yahoo	¥2,908	52.3	151,933			¥141
			Alibaba	¥162	1196.0	194,122			¥180
			Softbank Price ex Yahoo Japan						¥872
			Softbank P ex YHOO and YHOO Jap						¥732
			Softbank ex YHOO, YHOO JP, Alibaba						¥552
			Softbank Bus Consol EV			2,347,862
			Total Softbank Net Debt			2,247,702
			Softbank Business Market Value			100,160							¥93
			All Other Cos ex YHOO, YHOO JP, Alibaba								¥216
			Stub Price Target									¥309
			Mispricing									-44.0%

 

 

 

 

 

 

 

 

 

 

Catalyst

Continual degradation of the business until subscriber growth begins to slow in late 2009/early 2010, resulting in exposure of true revenue and EBITDA from the service business rather than a combination of service and equipment revenue. Cash flow analysis from the sell side rather than just revenue and EBITDA.