What would you say if I told you that you could buy Japan's best wireless telecom carrier (growing at 8%), coupled with the Google of Japan, for only 3.3x EBITDA? Investment grade rated with 40% ROEs, the firm has tripled its EPS since 2008. Oh, and I would throw in an $11BB stake in Alibaba for FREE, an extremely capable founder/CEO who owns tons of stock, plus an option to buy 70% of Sprint shares for $6.25, which are likely worth $10+ in 2 years.
This is the value proposition for Softbank (SFTBY.PK) today, ticker 9984 out of Tokyo, also with an ADR that trades under the ticker symbol SFTBY in the US.
This week, Sprint (S) and Softbank confirmed that talks were in the works for Softbank to acquire a majority plus stake in Sprint. Reportedly, management of the Japanese conglomerate would like to pay less than $6.50 a share to acquire 70% of Sprint. That math works out to around $6.25 per Sprint share based on rumors of a ¥1TT deal (or $12.8BB). I'll get to the potential deal dynamics below.
Sprint stock unsurprisingly zoomed from $5.00 to roughly $5.75 per share, while Softbank surprisingly fell 17% in one day on the news! To put some numbers around that, Softbank shed $7.1BB in market cap for a deal that is only $12.8BB in total invested capital. Is Softbank really overpaying by $7BB for Sprint shares? The market thinks so. Sprint, by the way, gained $2.2BB in market cap.
Put differently, the market suggests that Softbank is overpaying by $3.54 a Sprint share, meaning if the deal goes through, you effectively as a Softbank holder today are investing in Sprint at the bargain price of only $2.71. (Math is $6.25 Sprint purchase price less $7.1BB lost market cap divided by 2BB shares of Sprint they are buying.)
Even factoring in a worst case scenario for Softbank, which entails buying Sprint at a full $6.50 a share, Softbank shares are a compelling long based on a sum of the parts and FCF yield analysis. Much of the investment has to be considered in light of the firm's CEO and founder, the brash and charismatic Masayoshi Son.
Softbank is 21% owned by Son, who founded the firm in the 1980s to distribute Microsoft software in Japan. The firm evolved into a telecom and internet conglomerate, with Softbank's purchase of Vodafone Japan for $17BB - his entry into the mobile space in Japan in 2006. Son also smartly invested in a 31.9% stake in the Alibaba Group in 2000, pushing its now famous founder Jack Ma to start Taobao to compete with a then well-established eBay, which was making forays into China in 2002. This is a great history of Softbank and its founder.
Much has been made of Son's willingness to make huge acquisitions fueled by debt, and while that resonates to some wary long-term investors in Softbank, the Sprint deal actually is a good one despite the fact that it is one that Softbank intends to borrow to finance. Not only that, but the company is only 0.8x levered today (Debt/EBITDA), and would be only 1.76x levered under a fully debt financed Sprint deal. That is still within investment grade land. After the Vodafone deal in 2007, total debt then was ¥2.4TT, which at the time implied Debt/EBITDA of 3.83x.
Here is a financial snapshot of Softbank:
One item of note here. Capex will be much higher in FY 2013 (year ending March 2013) as Softbank builds out en masse its 900MHz base stations. Post this, capex is expected to normalize at ¥450BB. FCF per share works out to ¥290 this fiscal year on a ¥2395 share price using the normalized capex figures.
It's unclear exactly how a Sprint transaction will shake out, as Softbank is reportedly attempting to buy 70% of Sprint stock by tendering for existing shares, and also by putting in fresh capital in return for new shares. I suspect that a tender offer for $6.50 is in the cards, as well as a deal to invest a significant amount of cash for newly issued Sprint shares at current prices. I think shareholders in Sprint perhaps are missing out on the fact that Softbank does not want to outright buy Sprint. In fact, reportedly, a number of large holders would turn down a deal for Sprint at $6.50.
That is fine with Son, who likes to take big stakes at attractive valuations and let them ride. In addition to Softbank's Alibaba 32% stake, the firm also owns 42% of Yahoo Japan, the dominant provider of search in Japan, which is, in fact, powered by Google's search technology. Yahoo Japan shouldn't scare investors here. They have 56% market share and great brand equity too. (In the 1990s, Son acquired 40% of Yahoo too when it was still in the start up phase - not a bad trade).
So, Softbank would tender for perhaps 1.0BB to 1.5BB of Sprint's 3BB shares for $6.50, taking what he can get and investing cash for another 1BB of shares at say $6. That means Sprint holders likely can sell 1/3 of their shares at $6.50, and keep the rest which will likely trade at current levels give or take. (It's hard to assume anything different, but anything is of course possible).
So, at $5.75, while the upside to Sprint is decent over the next 2 years, in the near term, I can make 75c on 1/3 of my shares perhaps, but then the other 2/3s will likely trade at current levels. That gets me 25c of upside with a Softbank deal, but without a deal, downside of 75c a share!
See my write-up on Sprint at $2.45 when I originally purchased the name last December. I do believe it's ultimately an $8-10 stock in a couple of years, but the better risk/reward is in Softbank near term.
First of all, owning big companies run by tough, smart, competitive founders is usually a win. Buying them at hugely discounted valuations is even better. What has Microsoft done without Bill Gates? Oracle has been phenomenal under the leadership of Larry Ellison.
Son is the Japanese version of these guys, working 19 hour days and a desire to make Softbank a top 10 company in the world. Interestingly, Son grew up a poor Korean immigrant, quite a disadvantage in a socially rigid Japanese world. This is the kind of guy that bucks the establishment and is keenly interested in growing shareholder value, a trait surprisingly uncommon in Japanese society.
As for valuing Softbank, it's pretty straightforward. Some notes: Yahoo sold half of its stake in Alibaba at a $35BB valuation last May, and Dan Loeb's reason for owning Yahoo is based on the future of Alibaba (which looks quite solid and why they only sold half), as well as Yahoo's stake in Yahoo Japan. He should sell his Yahoo and buy Softbank where he gets the Alibaba stake for free essentially, as well as the Yahoo Japan stake that is still growing. But I digress.
Softbank's consolidated subsidiaries include tons of businesses, but generally can be broken down into its Telecom businesses (mobile, fixed, and broadband), and its Internet Culture businesses (Yahoo Japan). Then Softbank has dozens of unconsolidated subsidiaries which are accounted for under the equity method (whereby the financial statements generally do not consolidate the cash, revenues, etc. except under one line on both the Income Statement and Balance Sheet).
The most important of the unconsolidated businesses is of course Alibaba, but also Renren (which trades on the NYSE), Ustream, Wireless City Planning, and Zynga to name a few. I have only given the firm credit for Alibaba and Renren (in Other Value below), and consider the others free options. As a side note, the stake in Zynga is undisclosed.
Note figures are in BB of Yen except per share amounts or USD amounts where labeled. I also modeled Sprint as a loser investment in my base case, dragging down the valuation by ¥232BB. That still offers upside of 63% for Softbank holders.
For direct comparison's sake, I modeled a $9 Sprint scenario in 2 years, which offers a double (up 105%) in the case of owning Softbank, and upside of 56% for Sprint holders (9/5.75-1). Arguably, you could own both.
But if a deal falls through, you make perhaps the 17% back from Softbank immediately, or lose 13% in a Sprint investment immediately. Again, the risk reward is skewed given the asymmetrical movements in the 2 equities post this news.
Finally, the biggest piece here is the telecom multiple. Nippon (NTT) trades at 5.25x EBITDA, and a 9.1% FCF yield. Slapping a 9.1% FCF yield on Softbank, and adding in the Alibaba stake would imply a ¥4000 per share value for Softbank, for upside of 67%. That is $25.50 on SFTBY, from $15.50 currently.
As far as the downside case, I had to throw a 3x multiple on the Telecom businesses (half the multiple of most wireless comps and unreasonably low), and a 15% decline in the recently traded Alibaba Group value to get to a down 9% case for Softbank stock. Seems highly unlikely to me.
- Softbank has offered to acquire eAccess, a rival in Japan, in a $2.2BB stock swap. The terms of the deal include a provision that if Softbank shares drop by more than the ¥3108 base price, then eAccess shareholders can receive more shares from Softbank. The math is that if the average price 10 trading days after October 1st is 15% below the 3108 base price, then the swap ratio gets recut in eAccess' favor. However, with only 2 days left, the stock would have to fall impossibly low (below allowable circuit breaker rules on individual stocks) for the deal terms to change. I also have not factored in any gains or synergies from this deal, as Softbank stock rallied over 4% on news of this takeover.
- Much speculation as to Softbank acquiring Clearwire (CLWR) seems to have pushed that stock up dramatically too. I wrote up Clearwire as well when it was around a buck, and at $2.32 I think the speculative fervor is a tad high. I'd scale back. Ultimately, I give it low odds that Softbank would re-capitalize the $4.4BB of Clearwire debt (and growing) needed to avoid a restructuring, although this is pure speculation on my part.
- Reuters reported late Friday that Softbank is in talks to borrow ¥1.8TT, which is much higher than the original ¥1.0TT reported by the Wall Street Journal. Perhaps they are looking to purchase more than 70% of Sprint, or perhaps they are merely putting in place revolving debt capacity to fund the deal as well as some refinancing of Sprint's or Clearwire's debt.
- I haven't factored in interest cost savings that the investment grade rated Softbank brings to the table for Sprint (junk rated), as well as purchasing synergies (for phones, iPhones, tower equipment, etc) that seem likely as well.
- Yen risk is real. The yen is currently quite strong and could fall for a variety of reasons that any good macro analyst will tell you (extremely high Debt/GDP, awful demographics, export dependent economy). Lots of smart guys have been short JGBs (Japanese Government Bonds) for years however, waiting either for the collapse in the Yen or a hike in yields.
- If a deal is reached, Softbank shares could stay in the penalty box while Japanese investors grapple with the implications of a seemingly non-synergistic international acquisition.
It's hard to handicap the odds of this deal. Speculation of Softbank also acquiring MetroPCS (PCS) have reportedly been denied by those in the know. That is good; I am not sure it makes sense for Softbank to go hog wild snapping up all the third tier mobile operators in the U.S. In fact, Sprint's board also kiboshed the idea of a competitive bid for MetroPCS (which Deutsche Telecom is acquiring).
In any case, Softbank is cheap under almost any scenario, whether they purchase Sprint or not. I am sure Japanese investors do not see the value in buying the #3, money losing wireless company in the U.S. Fears of an eAccess stock ratio redo probably also contributed to the sell off in Softbank.
In any case, while it may take a couple of years and some bumps along the road, Softbank with or without Sprint is a compelling long - one that could be a double with some patience.
Disclosure: I am long SFTBY.PK.
Additional disclosure: Long 9984, Softbank Corp traded in Tokyo.