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 entrée
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.
