Sunday, October 14, 2012

Softbank Stock Looks Compelling


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% ROE’s, the firm has tripled its EPS since 2008.  Oh, and I would throw in an $11BB stake in Alibaba for FREE, 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 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 too in light of the firm’s CEO and founder, the brash and charismatic Masayoshi Son.

Basics:


Softbank Description
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 entrĂ©e into the mobile space in Japan in 2006.  Son also smartly invested a 31.9% stake in the Alibaba Group in 2000, pushing its now famous found 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.

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 that 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 Yen, 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.

Sprint Deal

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 dominate provider of search in Japan and in fact powered by Google’s search technology.  Yahoo Japan shouldn’t scare investors here, they have 56% market share and have great brand equity too.  (In the 1990s, Son acquired 40% of Yahoo when it was still in the start up phase too, not a bad trade).

So, Softbank would tender for perhaps 1.0BB to 1.5BB of Sprints 3BB shares for $6.50, taking what he can get and investing cash for another 1BB share at say $6.  That means Sprint holders likely can sell 1/3 of your 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 right now.

Softbank Valuation
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 growing up a poor Korean immigrant 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. 
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 (ie 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 are 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 comparisons 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, however.  But if a deal falls through, you make perhaps the 17% back from Softbank immediately, or lose 13% in a Sprint investment immediately (5 / 5.75 – 1).  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%.
As far as the downside case, I had to throw a 3x multiple on the Telecom business (half the multiple of most wireless comps and unreasonably low), and a 15% decline on the recently traded Alibaba Group value to get to a down 9% case for Softbank stock.  Seems highly unlikely to me.

Other items:
-          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 recapitalize 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 Yen, 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.  Lots of smart guys have been short JGB’s (Japanese Government Bonds) for years however waiting either 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.

Conclusion

It’s hard to handicap the odds of this deal.  Speculation of Softbank also acquiring MetroPCS 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 US.  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, either one whereby 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 US.  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 a little patience.  Good luck.

Sunday, November 27, 2011

Taking Stock (bad pun) After One Year

I started blogging about the markets a year ago, just after Thanksgiving 2011.  I have quite enjoyed both the writing and the research I have been doing on stocks.  But apart from the enjoyment factor, I thought it made sense to look at the numbers, to see if my stock advice was actually worthwhile.  Admittedly I recommended some bad ones in the past 12 months.  Teva and Hewlett Packard were awful, as was my shorting of US treasuries (long TBF).

But there were also winners too.  Apple has done ok, and Netflix crashed and burned in spectacular fashion.  While the NFLX short idea looked like a terrible prediction shortly after recommending it, my thesis eventually worked out.  Content costs rose dramatically, they had to raise prices, and subscribers bailed along with investors in the past couple of months.  Doing the research does pay off.

Over the past year, as I have recommended buys (or sells) I have kept track.  It wasn't hard, all of them I traded shortly before or after blogging about it.  Subjecting myself to this scrutiny can only make me a better investor I think.  Not doing the work, trading on emotions are enemies of long term returns.  So, if you had traded every idea that I pitched either here or on seeking alpha, then this is about what your portfolio would look like.  Rec Date is the date I recommended the trade.  The dollar values are theoretical only.


Pr Today 


Purchase Pr 

Gain (Loss) 
 % Change
9.91
Long
             933
$10.14
9,249
(218)
-2.3%
08/09/11
EFT
13.98
Long
             700
$13.68
9,786
212
2.2%
12/13/10
PUBDX
10.98
Long
             933
$10.81
10,248
161
1.6%
01/25/11
FXA
97.27
Long
             100
$96.07
9,727
120
1.2%
11/10/10
Short Treasury TBF
31.61
Short
250
$42.22
7,903
(2,653)
-25.1%
12/27/10
CSJ
104.39
Long
             100
$102.47
10,439
192
1.9%






57,352
(2,186)


Equity Book







13.45
Long
             733
$13.80
9,863
(257)
-2.5%
12/08/10
UTF
15.32
Long
             600
$15.13
9,192
114
1.3%
01/10/11
NFLX
63.86
Short Sell
             (60)
$178.50
(3,832)
6,878
64.2%
09/01/11
YPF
32.58
Long
             250
$33.83
8,145
(313)
-3.7%
08/15/11
GLRE
21.91
Long
             500
$21.75
10,955
80
0.7%
08/15/11
RJF
26.2
Long
             375
$25.50
9,825
263
2.7%
08/15/11
BRK
72.89
Long
             150
$71.00
10,934
284
2.7%
08/09/11
WMT
56.89
Long
             175
$49.14
9,956
1,357
15.8%
12/28/10
CSCO
17.5
Long
             483
$20.21
8,458
(1,312)
-13.4%
09/01/11
FDO
55.8
Long
             200
$51
11,160
960
9.4%
12/10/10
NEM
63.77
Long
             175
$60.59
11,160
557
5.2%
02/11/10
MU July 9 strike Puts
3.5
Long
          1,000
$0.40
3,500
3,100
775.0%
02/15/10
NLY
15.94
Long
             590
$16.03
9,405
(53)
-0.6%
2/111/11
GLD
163.4
Long
               75
$132.40
12,255
2,325
23.4%
TD AMERITRADE
15.19
Long
             533
$18.40
8,101
(1,712)
-17.4%
AAPL
363.57
Long
               30
$341.00
10,907
677
6.6%
02/04/11
TEVA
36.91
Long
             200
$51.09
7,382
(2,835)
-27.7%
01/05/11
HPQ
26.38
Long
             223
$43.46
5,892
(3,815)
-39.3%
12/27/10
SPY
116.2
Short Sell
             (78)
$125.50
(9,102)
729
7.4%






201,507
7,027








4,841














Bonds

 $     57,352
28.5%
 $     (2,186)




Stocks

 $   144,155
71.5%
 $       5,439




Portfolio Size

 $   201,507






Return

2.4%















SPY yr end 2010

 $     125.75






Market Return YTD

-7.6%





The stock prices are adjusted downward for dividends, in case you are wondering why some of these prices look a tad lower then where I recommended them.  Overall, I cannot complain, despite the fact that this portfolio is only up 2.4%.  The S&P is down 7.6% year to date.  My biggest winner actually was puts on Micron Technology, MU, which I seemed to have timed perfectly.  In theory, $400 in put options turned into $3100 in profits as the stock fell by half.  I am thinking that I will use more options next year.

Real World Portfolio

Overall this portfolio is up 1.6%, but my real world portfolio is barely flat.  Why?  Well, I carefully follow a 10% stop loss on trades, keeping me out of continued losses in names like TEVA and HPQ as they plummetted, but causing me to miss the complete meltdown of NFLX.  That tells me that my stop losses have hurt returns, albeit admittedly my portfolio showed less volatility than this one.  More volatility, more return.  The stock picking isn't bad, but I am going to revisit my stop loss rule, or perhaps trade more gradually into stocks.

Time Arbitrage

There is a phrase I heard recently that makes a ton of sense to me:  Time Arbitrage.  Humans beings by there very nature are extremely short term focused.  We think 6 months is a long time, and nobody can even really conceive of 20 years.  A "lifetime" to many people.  Given the increasing number of dollars flowing into hedge funds, who have quarterly liquidity, the pressure to produce instant returns is high.  One bad year can kill a fund, either from heavy investor redemptions or from the problem of not making money until high water marks are met.

Furthermore, if a common hedge fund rule is to stop loss a trade at down 10%, then is it a coincidence that the market seemingly is gyrating up and down by 10% at a time?  Going forward, I think the best trades are going to be the ones that seemingly won't pan out for at least 6-12 months.  Yes, perhaps there will be some sitting in a value trap name, but clearly its better to be early than late.  Buying late usually means you have missed most of the run, and risk is much higher too.

Tomorrow I am going to buy back Teva around $38.  Its a classic example of this.  Generic drugs have tons of growth over the next 5 years.  However, there aren't any major drugs going off patent until 2012, meaning that their numbers will look weak until perhaps even 2013.  I'll collect the 2% dividend yield (better than treasuries still), and sell some $35 puts too.  That means that if TEVA falls below $35, I will automatically buy more at that price, less the premium I received to sell the put (last quote was around $3.20 for June 2012 puts).