Monday, 29 September 2014


The most talked about event in financial news this month had to be the highly anticipated listing of Alibaba. Following the listing the stock went up to the low $90s (from the $68 IPO price), however their largest shareholder Softbank is down about 10% in the same period as people can now buy direct access to Alibaba.

In case you haven’t yet heard of Softbank, it’s a Telco, Internet and media holding company founded by a Korean-Japanese entrepreneur Masayoshi Son, who owns a 19% stake in the business. Softbank is listed in Japan while ADRs also trade on the NYSE. The market cap of Softbank is around $86bn (yes, it doesn’t fall into the usual small cap category but I cannot pass up on a mispricing).

To give you a sense of the background of Softbank, it was founded in 1981 as a software company in Japan. Son’s idea was to create a media ecosystem around the Internet and have various tentacles in certain sectors (Telco, e-commerce, software, gaming etc and now potentially movies – see P.s.).

Softbank has been very acquisitive under Son’s leadership and has been involved in publishing, IT distribution and so on. It was a large investor in Yahoo and eventually started a JV with the company (Yahoo Japan) in 1996. In 2000 it made an investment of $20m in Alibaba, which has to be one of the most remarkable investments in history (current stake value is around $72bn).

One of the most daring investments in corporate Japan had to be Son’s foray into mobile communication with the acquisition of Vodafone’s Japanese operations in 2006. With the initial substantial price-cutting it really upset status quo of the heavily concentrated Japanese wireless market. To note Son has always been an outsider in Japanese business, partly due to his Korean background, but certainly this step made him the least popular person that year in the industry. Interestingly, due to Son’s relationship with Steve Jobs Softbank was the first to sell iPhones/iPads in Japan.

He has proven to be a great capital allocator worthy of the Outsider CEO title, especially in the context of Japanese companies where returns have been largely subdued due to the convoluted corporate structures (keiretsu) and maintenance of status quo vs profits as the MO. All of the above resulted in a 16% compounded total return in Softbank’s share price and growth in book value.

Softbank’s current market cap is around $86bn and estimated NAV around $107bn ($36/ADR and NAV at $45/ADR) for 25% upside (to note I take a 30% tax on the equity investments, which is up for debate).

You can look at Softbank as the following (discussing major holdings):
  • Telco business (mobile, fixed, internet), which is expected to generate around $11-12bn in EBITDA in the next fiscal year. Assigning a 5x multiple (roughly in-line with comps) you get around $55-60bn EV
  • Investment in Alibaba – at current market it’s worth $72bn ($51bn post tax)
  • 80% stake in Sprint, which Softbank acquired in 2013, worth $20bn
  • 43% stake in Yahoo Japan, which is worth $9bn
  • HoldCo net debt (ex Sprint and Yahoo Japan) of $36bn

If you tot all the above up you get to around $107bn NAV (there are some other small investments as well) or a 25% upside from current. As noted above I assign a 30% tax rate on Alibaba based on a mix of ownership via Japanese and Singaporean subsidiaries. It’s questionable whether one should do it. Softbank said that they don’t expect to sell their holdings so in that case it’s irrelevant (they’ll likely use as collateral for acquisitions). However, if you want to stay on the conservative side you should. If you assume no tax you get to around 50% upside to NAV.

Holding companies are expected to trade at a discount especially if incompetent management runs them and to allow for some tax in the case of asset sale. While the holding structure is certainly a bit complex here that should not deter from the valuation much, as the management is very apt and generated strong returns to shareholders historically. Anybody ever looked at the holding structure of Berkshire with all the insurance companies in the web or John Malone’s alphabet soup of companies? Now that Alibaba is public and there is a public market-clearing price the stake becomes easier to value (though Alibaba’s fundamental value is worth another post for sure) as well as Softbank. I was expecting some volatility in Softbank as Alibaba was going public but as this quiets down we will be back to fundamentals.

Looking at Softbank another way; for the $86bn you get an Alibaba stake that’s worth $51bn (post tax), Yahoo Japan, Sprint and a few other companies for another $33bn, which means that the operating units are valued at $2bn. Last year they generated $11bn in EBITDA (there is about $36bn net debt against it). I’m no genius but this clearly doesn’t make sense.

It is possible that investors are pricing in a drop in Alibaba share price. Alibaba at current market cap makes up 48% of NAV (post tax). Now assuming that the valuation is very much stretched the company would have to see a 40% drop in share price to wipe off any upside in Softbank’s NAV. That would imply Alibaba market cap of around $130bn. If Alibaba falls 20%, roughly to the same valuation before it went public the upside narrows to 13%. If it’s a 30% drop ($160bn valuation) upside is 7%. Assuming, the valuation of the other assets don’t change there is protection on the downside.

Subject to Abenomics, currency movements could impact your investment. You can buy the shares in Japan and hedge the currency or just the ADRs in the US. I normally don’t worry about hedging FX as generally the results are mixed. Figuring out where stock prices will be in 6 months is a difficult enough job not to mention figuring out where currencies will be.

Some risks to consider are: Softbank is very acquisitive and there’ll bound to be failures in the process (currently they have 1,300 investments in a range of companies). Debt levels are very high as a result, though not unmanageable. Developments around Sprint in the US (competitive position, recent M&A news etc). Son is clearly eccentric and has a longer term time horizon than most investors (have you read his 30 year plan)? It’s very encouraging and I certainly prefer this approach but by and large the market doesn’t and there’ll be swings in the share price.

I highly recommend reading further about Softbank and Son. His career, approach to investing and track record are worthy of an Outsider CEO title
Book about him (it’s translated from Japanese so on occasions a bit hard to understand, nevertheless you get a really good picture of his story)

P.s. It was announced on Monday that Softbank is looking to buy Dreamworks at a c. 50% premium to the closing on Friday. Following the sell-off in Dreamworks earlier in the year I’ve been watching the stock with a potential to add to it. The deal is not done yet and there are some speculations whether it's actually going to happen. Some articles indicate that the discussions are not that serious or there could be other considerations, perhaps a JV between the two companies. Let's see.