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SoftBank: Analysis Of My Most Recent Buy

|Includes: SFTBF, SoftBank Group Corp. (SFTBY)

Summary:

  • I took an entry position in SoftBank on February 24th based on my research outlined in this article. All exchange rates and financial data in this article have been updated to reflect information at the close of the market on March 6, 2015.
  • A declining Yen and gains being taken by investors following the run up in price since 2012 are two possible reasons for a decline in SoftBank's stock price.
  • Poor guidance from Sprint recently and a possible holding discount are two other reasons.
  • Masayoshi Son, the current Chairman and CEO, has demonstrated a great record of capital allocation, entrepreneurship, and brilliance.
  • The company is moderately undervalued on a relative valuation, slightly undervalued on an intrinsic valuation, and very undervalued on a sum of the parts valuation.

Background:

SoftBank (OTCPK:SFTBY) (OTCPK:SFTBF) is a telecommunications and internet company headquartered in Tokyo, Japan. It was started by Masayoshi Son in 1981. SoftBank's businesses are divided up into five segments: Mobile communications, Sprint (NYSE:S), Fixed-line Telecommunications, Internet, and Others. The Mobile Communications segment provides mobile communication services and sales of mobile devices and handsets. SoftBank Mobile Corp. is the main business that provides these services in this segment, but other companies are: Ymobile Corporation, Wireless City Planning, Brightstar Corp, Supercell, and GungHo Online Entertainment. The Sprint segment provides mobile communication services, sells mobile handsets and accessories, and provides fixed line telecommunication services in the United States.

SoftBank owns a 79.9% ownership interest in Sprint after acquiring it in 2013. Son's motives for acquiring Sprint are consistent with his goal "to be the world's number one company". Acquiring Sprint makes him a competitor in the telecommunication industry within the economy that has the world's largest GDP, the United States.

The Fixed-line telecommunications segment provides telecommunication services for corporate customers. Services include data communication and fixed line telephone service. The companies that make up the Fixed-line segment are: SoftBank Telecom Corp., SoftBank BB Corp., Ymobile Corporation, and Yahoo Japan Corporation. The Internet segment comprises mostly of internet advertising through Yahoo Japan Corporation. Some other companies that make up the Internet segment are: ASKUL, Carview, IDC Fronteir, and ValueCommerce. The last segment, Others, can represent any one of the hundreds of companies that Son has invested in through SoftBank. Some of the investments that are represented in the others segment are: Fukuoka SoftBank Hawks, the company's professional baseball team; Alibaba (NYSE:BABA); Bharti SoftBank; InMobi Pte; and ITmedia.

In 2010, Masayoshi Son created the company's next 30 year vision (1981-2011 was their first 30 years). His 30 year vision is to "alleviate sadness and increase everyone's happiness to the greatest extent possible through the Information Revolution."

A breakdown of net sales and segment income for the fiscal year 2013 are provided from the 2014 annual report below. A footnote reveals that segment income is equal to: net sales - cost of sales - selling, general, and administrative expenses. The reason for using fiscal year 2013 results and not 2014 is the annual report for fiscal year 2014 hasn't been released yet. Reconciliations are adjustments for removing transactions between segments and the corporate general expenses that weren't allocated to each reportable segment.

Fiscal Year 2013; In billions of Yen

Net Sales

% of Total Net Sales

Segment Income

% of Total Segment Income

Mobile Communications

¥3,166.00

47%

¥609.00

69%

Sprint Segment*

¥2,601.00

39%

¥-1.22

0%

Fixed-line Telecommunications

¥548.00

8%

¥108.00

12%

Internet Segment

¥399.00

6%

¥189.00

21%

Others

¥124.00

2%

¥6.00

1%

Reconciliations

¥-172,310

-2%

¥-24,430

-3%

Consolidated

¥6,667.00

100%

¥887.00

100%

*Reflect results of operations since July 11, 2013.

Management:

Masayoshi Son founded SoftBank Corp in 1981 and has been with the company since. He is currently the Chairman and CEO. He studied economics and computer science at the University of California, Berkley and earned his Bachelor's degree in 1980. He is currently 57 years old and as of June 20, 2014, Son holds 231,204,632 shares. There are 1,200,660,000 shares outstanding according to Bloomberg which gives him an ownership interest of 19% of the company.

Son is a very driven, aggressive, and ambitious CEO. After the internet bubble burst, Son took the company into the telecom business to give the company a more stable revenue stream. The company had large losses at the time, so Masayoshi Son set up an office next to the department where the problems lied. He reportedly slept in the office sometimes and would call for meetings that could last around 8 hours. This lasted for about 18 months until costs were finally cut and the business had enough customers to reach a profit. In 2006, right after Son brought the broadband division to profitability, he bought Vodafone K.K. (now SoftBank Mobile) and turned it into one of Japan's largest mobile companies.

At a Yen to dollar conversation ratio of .0083 as of 3/06/15, his current salary is 130,000,000 Yen or about $1,079,000. A $1,000,000 salary does seem excessive but he said that he will donate his fiscal year 2011 salary and all of his future salaries for the rest of his life to earthquake relief efforts. Since he is committing his future salary to quake relief, he is much more aligned with shareholders because his future earnings will come from his 19% ownership interest in stock.

Moat:

The telecommunications industry has high barriers to entry due to fixed costs that run into the billions of dollars. These high fixed costs are needed to develop and maintain the networks that provide cell phone service, broadband, fixed line communication, mobile phone internet connection, and many other services. High fixed costs keep out smaller players from entering the industry.

Although Sprint appears to be only an anchor to SoftBank, due to its operating losses and its distant third position in the U.S. communication industry, the company owns large wireless networks that have valuable spectrum. Spectrum has become very valuable over the last 2 decades because of the large increase in demand for data that is required to connect smart phones and tablets to the internet. The Federal Communications Commission (FCC) has taken an approach of auctioning off spectrum to the highest bidder in order to increase government revenue. This auctioning process gives the bigger companies the competitive advantage of economies of scale. Since the bigger companies have larger revenues, they can allocate more money toward bidding for spectrum, and then spread these costs over their larger customer base.

This advantage is shown in the most recent auction. The top 3 bidders were AT&T (NYSE:T), Dish (NASDAQ:DISH), and Verizon (NYSE:VZ); all whom have a market cap over $25 billion. Outbidding new entrants will prevent further competition. Sprint may have a difficult time competing with AT&T and Verizon, due to it's smaller size though. SoftBank will most likely have to divert capital expenditures from their core operations in Japan to Sprint if it isn't profitable by the next auction, which is scheduled for early 2016. Another reason government regulation gives the existing players a moat, is because they require licenses to be obtained before they can acquire spectrum.

Softbank

 

TTM

2014

2013

2012

2011

2010

2009

2008

ROIC

6.47

8.23

7.51

10.56

8.28

5.31

3.98

6.13

ROE

18.08

21.23

16.34

27.1

28.09

14.93

7.14

32.43

ROA

3.31

4.54

5.07

6.57

4.16

2.19

0.97

2.45

Nippon

 

TTM

2014

2013

2012

2011

2010

2009

2008

ROE

6.47

6.96

6.47

5.88

6.45

6.53

7.34

8.71

ROIC

4.38

4.9

4.59

4.11

4.41

4.32

4.79

5.58

ROA

2.72

2.93

2.68

2.4

2.64

2.61

2.89

3.44

Verizon

 

TTM

2014

2013

2012

2011

2010

2009

2008

ROE

37.65

37.65

31.94

2.53

6.45

6.36

8.76

13.93

ROIC

10.44

10.44

12.54

3.72

5.65

4.69

6.51

8.97

ROA

3.8

3.8

4.61

0.38

1.07

1.14

1.7

3.3

Source: Data provided by Morningstar

Looking at the return on equity numbers for SoftBank alone, which range in the high teens and low twenties, shows that this company appears to have a very wide moat. The reason is there is a high amount of debt on the balance sheet resulting in lower equity. Long term debt makes up 46% of SoftBank's assets and total liabilities make up 86.12%. The debt shows up in ROIC which is about 6.5% over the trailing twelve months and about 8% during 2014. This is much lower than ROE and has only exceeded 10% once. Therefore, SoftBank isn't generating enormous returns on invested capital but there does appear to be a slight moat; it just isn't wide enough to earn large returns on capital like Coke (NYSE:KO) or Pepsi (NASDAQ:PEP) would. In comparison to its competitors, it is generating higher returns than Nippon Telegraph and Telephone (NYSE:NTT) but not Verizon.

Relative Valuation:

 

Market Cap (Billions) US$

P/S

P/E

P/B

P/CF

Dividend Yield

Interest Coverage

Debt/Equity

SoftBank

$68.93

1

13.7

2.2

7.1

.3

4.4

2.4

Sprint

$20.70

1.1

Negative

0.9

Negative

0

-1

1.4

China Mobile

$261.46

2.5

14.1

2.0

7.5

3.0

480

0

Verizon

$200.66

1.5

20.0

16.3

6.3

4.5

4.1

9.0

AT&T

$173.77

1.3

28.1

2.0

5.6

5.5

3.8

0.9

Nippon T&T

$66.77

0.8

15.1

0.9

3.3

2.6

28.1

0.4

NTT DoCoMo

$71.90

2.0

21.6

1.6

8.7

3.0

688.9

0

Vodafone

$87.38

1.4

59.6

0.8

9.5

5.4

-8.5

0.3

Industry Average

$15.58

1.2

22.4

1.9

N/A

3.6

-483.2

1

S&P 500

N/A

1.8

19.5

2.8

11.8

2.2

N/A N/A

Source: Data provided by Morningstar

Since SoftBank owns 80% of Sprint and considers it a main business segment, I added Sprint's relative ratios for illustrative purposes. The relative valuation of SoftBank does looks favorable on a relative basis, except price to book looks expensive and debt to equity isn't so comforting compared to peers. The price to book ratio is expensive due to the excessive debt on the balance sheet. More debt on the balance sheet results in less equity, which in turn causes the price to book ratio to be higher.

SoftBank's price to sales ratio of 1 is good, price to earnings is moderately low at 13.7, and price to cash flow is favorable at 7.1. Price to free cash flow (not listed) is negative though, due to high capital expenditures of ¥1.371 trillion during 2014. Capital expenditures are up over 100% since 2013 and the reason is because of the acquisition of Sprint. SoftBank is required to consolidate Sprint's financial statements with theirs even though they only own 80%. Due to the consolidation, debt to equity will appear to be less favorable than it really is also. SoftBank will add 100% of Sprint's debt on its books even though it only owns 79.9%. This will overstate SoftBank's debt position by 20%, but equity should be the same because there is a 20% minority interest that is subtracted. If the extra 20% of debt is removed from the balance sheet, I calculate the debt to equity to be 1.95. This adjustment makes debt more manageable. The consolidation of Sprint will still keep debt as a percentage of assets and equity appear high for the foreseeable future though. Good news for investors is that the debt in Sprint is non-recourse debt. Capital expenditures will likely be high as well due to Son's vision of turning Sprint into a viable competitor in the United States.

Dividend seeking investors shouldn't be interested in SoftBank. It has the lowest dividend yield in the sector (not including Sprint) at .3%. Masayoshi Son will most likely use the excess earnings to try to turn around Sprint, continue to try to achieve his vision of becoming "the world's number one company", and invest them himself due to his history of consistently allocating capital at high rates of return.

Sum of the Parts:

The most optimistic valuation from a sum of the parts standpoint would be to take SoftBank's ownership interest in Alibaba of 36.7% and multiply it by Alibaba's market capitalization of $209.9 billion (price at the close of 3/06/15). This results in a market value of $77.03 billion which exceeds SoftBank's current market cap of $68.9 billion alone. Using Alibaba's current market cap would be a faulty assumption from my point of view because buying internet companies selling at 18 times sales would be forgetting Scott McNealy's quote after the bursting of the tech bubble.

Assuming a more conservative valuation, if Alibaba were to sell at 5 times TTM revenue of CNY $70.81 billion, then that would yield a market cap of CNY $354.05 billion. At the current exchange rate of 6.26 at the close of 3/06/15, the market cap would be 56.58 billion dollars. SoftBank's ownership interest of 36.7% would then be worth 20.76 billion dollars or 30% of its $68.9 billion market cap. Adding in the 80% interest in Sprint would add another 16.54 billion dollars. This results in a little bit more than half of SoftBank's $68.9 billion market cap. Under these circumstances, the market is valuing Son's managerial and capital allocation abilities, the hundreds of other investments Son has made, and SoftBank's primary assets in fixed line communications and mobile communications at only 50% of the current market cap. Too small of a price for these assets in my opinion.

 

SoftBank's Ownership Percentage

Holding Value in Billions of Dollars

Comments

Alibaba

36.70%

$20.76

Valuation at 5 times TTM revenue of CNY 70.810 billion and CNY-USD exchange rate of 6.26

Sprint

79.90%

$16.54

Valuation at Sprint's current market cap of $20.7 billion

Total of Alibaba and Sprint

 

$37.3

The rest of SoftBank's investments, assets, and Son's management skills are valued at a little less than half of the current market cap

SoftBank

 

$68.90

Market cap of SoftBank as of 3/06/15

Intrinsic Valuation:

 

Sales in US Dollars

Net Income (Net of Preferred Dividends) in US Dollars

Sales in Yen

Net Income (Net of Preferred Dividends) in Yen

Profit Margin

2007

$21,117.02

$239.16

¥2,544,219.00

¥28,815.00

1%

2008

$23,042.20

$ 901.59

¥2,776,169.00

¥108,625.00

4%

2009

$22,186.49

$358.33

¥2,673,035.00

¥43,172.00

2%

2010

$22,001.05

$802.74

¥2,650,729.00

¥96,716.00

4%

2011

$24,938.51

$1,574.61

¥3,004,640.00

¥189,712.00

6%

2012

$26,580.21

$2,604.14

¥3,202,435.00

¥313,752.00

10%

2013

$28,040.43

$2,402.04

¥3,378,365.00

¥289,403.00

9%

2014

$55,333.20

$4,374.39

¥6,666,651.00

¥527,035.00

8%

TTM

$70,849.75

$5,035.20

¥8,536,115.00

¥606,650.00

7%

Average

$28,203.43

$1,661.18

¥3,398,003.73

¥200,141.73

4%

In the chart above, I converted sales and net income from yen to dollars at the JPY to US dollar exchange rate of .0083 on 3/06/15. For my intrinsic value, I used TTM net income of $5.035 billion and grew this by 5% a year for the next 5 years. 5% assumes the company will achieve net income of $6.4 billion in 5 years. Discounting each year's net income over the next 5 years at 10% yields a total of $21.944 billion. 10% is not a WACC calculation. It is more of a personal required return and is arbitrary.

The two charts below show that growth in consolidated income has been greater than 5%, so they demonstrate the possibility that a 5% growth rate can be achieved. Both charts are taken from past annual reports. FY 2013 and FY 2012 are segment income, which as stated earlier is equal to net sales - cost of sales - selling, general, and administrative expenses, and FY 2007 to FY 2011 is operating income. There is no footnote for operating income so I assume the standard measure of EBIT.

Segment Income In Billions of Yen

FY 2013

FY 2012

Mobile Communications

¥608,950.00

¥517,120.00

Sprint Segment (Reflect results of operations since July 11, 2013)

¥-1,216.00

N/A

Fixed-line Telecommunications

¥108,612.00

¥114,232.00

Internet Segment

¥188,949.00

¥180,720.00

Others

¥6,041.00

¥6,400.00

Reconciliations

¥-24,430.00

¥-20,851.00

Consolidated

¥886,906.00

¥797,621.00

Operating Income In Billions of Yen

FY 2011

FY 2010

FY 2009

FY 2008

FY 2007

Mobile Communications

¥429,237.00

¥402,412.00

¥171,390.00

¥174,570.00

¥155,743.00

Broadband Infrastructure

¥34,328.00

¥43,154.00

¥47,253.00

¥39,700.00

¥26,810.00

Fixed-line Telecommunications

¥57,950.00

¥38,006.00

¥18,968.00

¥3,340.00

¥-2,965.00

Internet Culture

¥156,822.00

¥150,306.00

¥125,098.00

¥115,237.00

¥96,544.00

e-Commerce

N/A

N/A

¥4,636.00

¥3,157.00

¥6,681.00

Others

¥8,800.00

¥7,092.00

¥-194.00

¥-5,121.00

¥-4,730.00

Elimination or Corporate

¥-11,854.00

¥-11,807.00

¥-8,030.00

¥-6,596.00

¥-7,017.00

Consolidated

¥675,283.00

¥629,163.00

¥359,121.00

¥324,287.00

¥271,066.00

I used a 3% terminal growth rate, so net income in the terminal year is $6.619 billion. The 3% terminal growth rate is the expected growth rate of the global economy. The IMF expects global growth to be around 3.7% for 2014 and 3.9% for 2015. The difference of about 1% gives me an extra margin of safety in my analysis. The terminal value in year 5 is $95 billion ($6.619 billion/(.10-.03)). $94.5 billion discounted at 10% results in a discounted terminal value of $58.713 billion. Adding up the discounted earnings of $21.944 billion and the discounted terminal value of $58.713 billion gives a value of $80.657 billion or with 2.37 billion shares, a price per share of $33.93.

At the current price of $29.00 per share on the close of March 6th, there is a 17% margin of safety. If a terminal growth rate of 4% is used instead, the margin of safety is 32%. This margin of safety isn't too big, but the sum of the parts valuation and Masayoshi Son's managerial skills compensate me enough as an additional margin of safety.

Growth Rate: 5%

TV Growth Rate: 3%

Required Rate of Return: 10%

   

Years

 

Dollar Values in billion USD

TTM

1

2

3

4

5

TV

Net Income

$5,035.20

$5,286.95

$5,551.30

$5,828.87

$6,120.31

$6,426.33

$6,619.12

Required Rate of Return

 

0.91

0.83

0.75

0.68

0.62

 

Discounted Net Income

 

$4,806.32

$4,587.85

$4,379.31

$4,180.25

$3,990.24

 
Sum of Discounted Net Income $21,943.99  
     
Net Income in Terminal Value Year $6,619.12  
Multiple 14.29 Equal to: 1/(.10-.03)
Terminal Value $94,558.80  
Discount at year 5 0.62  
Discounted TV $58,713.58  
     
Sum of Discounted Net Income plus Discounted TV $80,657.57  
Shares Outstanding (millions) 2,376.91  
Value Per Share $33.93  
Price per share on close of 3/06/15 $29.00  
Margin of Safety 17%  
 

Catalysts:

  • The Sprint acquisition turns out to be successful like Son's acquisition of Vodafone KK.
  • The market realizes that the company is undervalued based on a sum of the parts valuation.
  • SoftBank's core operating assets in Japan continue to be profitable and Son continues to reinvest these earnings at high rates of return.
  • The Yen stops depreciating against the dollar.

Risks:

  • The acquisition of Sprint has led to an increase in debt on the balance sheet. Although the debt is nonrecourse and isn't likely to be an issue in my opinion, the added debt can still become an anchor on existing and future operations if the company needs to borrow. It will result in higher interest costs and lower income for shareholders.
  • High capital expenditures and lots of resources will be needed to turn around Sprint. Son turned Vodafone into a profitable company, but that was in his home market of Japan. Sprint is based in the US and companies who venture overseas tend to have a much lower success rate.
  • Son is a brilliant capital allocator but his investments in so many different businesses can lead to diworsifation, resulting in less synergies.
  • The Yen continues to depreciate against the dollar.
  • After the internet bubble burst, Son reportedly lost $70 billion personally as Softbank's share price fell over 90% from its high of $180 billion. This occurred due to large investments in internet companies that Son made at the height of the bubble such as Kozmo.com, more.com sportsbrain.com and Webvan. With valuations in the social media sector appearing to be overpriced now, Son continues to make purchases. He most recently bought ownership stakes in Dramafever and Legendary Entertainment. On the optimistic side, a sum of the parts valuation throws in most of these investment companies for free. So even if these turn out to be duds, shareholders may not have paid much for them.
  • A natural disaster such as an earthquake can have a material effect on business operations.
  • The company experiences an undesirable outcome involving regulation from the government.

Conclusion:

SoftBank provides mobile service, internet access, fixed line communications, and many other services that I don't see going away any time soon. Large capital expenditures, sub-par returns on capital of around 8%, a declining yen, and a difficult venture into turning around Sprint will certainly be headwinds. The overall economics of the business and the valuations are all favorable in my opinion though. Also, Son's managerial skills, SoftBank's core operating assets, and the many growth-potential investments that Son made in the past haven't been given enough value from the market. This gives the investor an additional margin of safety.

Disclosure: I am long SoftBank. This article is not a recommendation to buy. Each investor has different risks and should do their own research before buying.

Disclosure: The author is long SFTBY.