Nanalyze

A Quick Intro to Investing in SoftBank Stock

While Asian cultures are generally pretty endearing to begin with, no other culture in Asia captures that sentiment as well as the Japanese do. It’s not just the incredibly polite people, some of the best food in the world, and some amazing things to see there. Japan also happens to be one of the safest countries in the world (which could also explain why they have the second highest life expectancy in the world). Here’s how crime stacks up there:

The Economist just put out an article titled “As crime dries up, Japan’s police hunt for things to do” and it talks about how this country of 127 million people had just one shooting in 2015. Let’s compare that to Chicago with a population of 2.7 million and 762X as many shooting fatalities (and an additional 3,569 shooting victims that survived… some who will no doubt be shot at again). In that article from the Economist, they talked about how the police actually conspired with Japanese gangsters to import guns so they could meet their quotas for finding illegal weapons. Just how hard up for some action do you have be to do something like that?

The key takeaway for investors here is that Japan is full of people who know how to behave. The likelihood of an Enron type blow up where some Japanese dude just takes your money and disappears is quite low. This brings us to the topic of this article – a Japanese firm called SoftBank.

You may have seen the SoftBank Group in the news recently when they disclosed a $4.7 billion investment in NVIDIA, a picks-and-shovels play on artificial intelligence (AI). News of that investment shouldn’t come as a huge surprise considering that SoftBank has been in the news quite a bit regarding their plans to create a $100 billion technology fund, just over half of that planned for U.S. companies. Before we get too far ahead of ourselves though, let’s learn a little about who the SoftBank Group actually is.

Founded in 1981 by the current day founder and CEO Masayoshi Son, SoftBank is presently the third largest company in Japan behind Toyota and Mitsubishi. With a market cap of nearly $90 billion, SoftBank is almost exactly the same size as NVIDIA is today. The Company trades on the Japanese stock exchange (TYO:9984) and also as an ADR (OTCMKTS:SFTBF) and (OTCMKTS:SFTBY). What’s the difference between those two issues? We have absolutely no idea so we just bought the shares on the Japanese stock exchange in YEN and also received some incidental currency exposure in our portfolio as well.

So what exactly do we buy with shares of SoftBank? Essentially they’re a holding company largely consisting of Internet and telecommunications interests as seen below:

Lets go through each of these primary business areas to see what we’re actually investing in.

What Percentage of Sprint does Softbank Own?

Sprint (NYSE:S) is a publicly traded $34 billion telecommunication holding company which largely operates in the U.S. under the retail brands of Sprint, Boost Mobile, Virgin Mobile and Assurance Wireless. Back in 2013, SoftBank purchased 78% of Sprint for around $22 billion and today that percentage is right at 80%. Back of the napkin math shows that stake to be worth $27.2 billion today, though at one point they were considering selling Sprint per an article on CNBC several years ago:

SoftBank had lost confidence in Sprint and was considering selling it as Sprint had been burning through cash because of monthly leasing plans that require U.S. wireless carriers to pay vendors for devices up front.

However, after Sprint last week reported a smaller-than-expected quarterly loss, as it added a net 675,000 customers helped by promotions and offers such as doubling data capacity, SoftBank assuaged investors’ concerns by saying it had no plans to sell its stake in the wireless carrier.

At the time that article was published, Sprint was trading at around $4.20 a share. Fast forward to today and that share price has doubled to $8.49 per share. In 2016, the Sprint holding was responsible for 42% of sales but only 18% of operating income (Sprint has a tight operating margin of just over 5%).

Yahoo Japan – Remember Yahoo?

While Yahoo has pretty much turned to complete rubbish in the United States, Yahoo! Japan’s web portal is the most visited website in Japan. Yahoo Japan Corporation (TYO:4689) is a publicly traded company of which SoftBank owns 35%. With a present day market cap of around $25.5 billion, that means the SoftBank stake is worth around $8.925 billion. While this stake was responsible for just 10% of SoftBank’s total sales in 2016, it actually accounted for 18.5% of operating income for SoftBank (the Yahoo Japan operating margin is 22.2%).

SoftBank Domestic Telecommunications

SoftBank provides a mobile network and key infrastructure for mobile devices along with a variety of services that include mobile commerce in close association with Yahoo Japan. The one key takeaway here is that this boring old domestic telecommunications segment accounts for over 70% of SoftBank’s profitability as seen below:

Don’t pay attention to the numbers which are in yen or the boring acronyms like “EBIT”. Just look at how much “Domestic Telco” contributes to SoftBank’s 2016 profitability. You can pretty much think of this as the AT&T of Japan, and that we know about telecommunications companies like that is they are traditionally considered lower-risk “defensive” investments that prove to be more resilient during recessions and even outperform. The flip side is that there is very little growth to be had typically but in turn you get strong dependable cash flows.

ARM Holdings – Chips for the Internet of Things

Before you start to worry too much about owning a boring telecommunications company, take a look at the largest deal that SoftBank has made to date. In September of 2016, SoftBank bought a British chipmaker called ARM Holdings for $32 billion. SoftBank estimates that ~90% of the chips used for the Internet of Things come from ARM and specifically purchased the company for that reason.

ARM doesn’t actually produce chips but rather licenses out their technology to other chipmakers. How successful is this business model? In 2016, there were over 15 billion ARM chips sold which generated revenues of around $1.25 billion.

All classes of computing devices use chips that license ARM technology along with nearly every single smartphone out there. It even gets more exciting when you find out that ARM Holdings builds GPUs – lots of them:

The ARM® Mali Graphics Processing Unit (GPU) is the number one licensable GPU in the industry. In 2014, ARM shipped 550 million Mali GPUs in a wide range of devices from the newest premium range smartphones to the latest low-power wearables. Mali is not only the most popular, but also the most scalable GPU in the world.

While these aren’t the types of GPUs used for artificial intelligence like the ones NVIDIA builds, they’re incredibly powerful and may enable virtual reality on your smartphone that doesn’t involve trying to play origami with a piece of cardboard. ARM is also going into the AI chip market with their “DynamIQ” chip architecture that will be available next year. Oh yeah, and ARM Holdings only accounts for less than 2% of SoftBank’s revenues.

The SoftBank Fund

The SoftBank Vision Fund is a massive $100 billion technology fund that has already secured commitments totaling $93 billion. Focus of the fund will be on investing in emerging technologies including but not limited to:

Here are some basic facts about the fund with key points highlighted:

Of that $100 billion amount they plan to raise (with 93% already raised), SoftBank plans to pitch in $8.2 billion in shares of ARM so that means that they would contribute no more than $19.8 billion in cash to the fund. Given that they presently have $26.09 in cash that seems to make sense.

So why would all these large investors want SoftBank to manage their funds? The answer is probably the incredible track record that SoftBank has when it comes to creating value through large technology investments:

While the founder and CEO Masayoshi Son is the richest man in Japan with a net worth of around $20 billion, he’s not immune to losses having been drained of somewhere around $70 billion during the dot-com craze.

Investing in SoftBank Stock – What You Get

While the fund hasn’t quite closed, things are already starting to kick off. Here are a few indicators of what’s to come:

SoftBank Group makes for quite an interesting investment considering that if you bought the entire $90 billion company right now you would basically get the following:

  • $27.2 billion in Sprint shares
  • $8.9 billion in Yahoo Japan shares
  • $26.09 billion in cash (as of Q3 2016)
  • A $31 billion chip company
  • A 28% ownership of Alibaba ($84 billion)

So with all the above, we’re at about $177 billion which exceeds the present market cap of SoftBank by 2X. Now, let’s throw in a quite profitable and lower-risk domestic telecommunication cash cow as well plus the potential of the $19.8 billion investments they plan to make with most of that cash.

Of course we then need to take into account how “leveraged” Softbank is. According to a recent article by Bloomberg, Softbank’s debt could exceed that of Venezuela:

Source: Bloomberg

While our MBAs on staff tell us that most back-of-the-napkin valuation models are crude and unrefined, (kind of like how some of our writers get during a big night out), we wanted to keep this analysis as simple as possible because there is so much complexity in a “foreign multinational technology conglomerate” already. For non-Japanese investors, it’s that complexity which provides us with a strong diversification effect that helps limit our downside.

In the spirit of full disclosure, we picked up shares in SoftBank nearly two years ago. While we’d like to just forget about that investment and check back in 12 years, we may provide yearly updates on SoftBank if our readers show interest. If you want to buy shares in SoftBank and grab a seat on the sidelines with us, use Zacks Trade.

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  • Peter

    You left out the $30 billion in Alibaba shares. Why??

    • Nanalyze

      Thank you for the comment Peter.

      Softbank publishes their financials in a massive spreadsheet that can be seen below:
      https://cdn.softbank.jp/en/corp/set/data/irinfo/presentations/results/xls/2016/softbank_presentation_2016_004_002.xlsx

      While that workbook contains information as minute as which chips ARM is selling the most of, it obfuscates the current holding in Alibaba. From their last earning report seen below, the Alibaba holding is estimated at around 9 trillion yen (after they divested $8.8 billion in shares to retire some debt).

      This means that the Alibaba holding is worth somewhere around $84 billion at today’s prices (28% ownership). We updated the article to that effect and also added their investment in OneWeb.

      Can anyone explain how it’s possible that the Softbank Alibaba holding is roughly the same size as the total market cap of Softbank?

  • Nanalyze,
    Thank you so much for the excellent breakdown and analysis!
    Do you have any insight into how the fund is structured? The company makes reference to being a general partner of the fund. I’m guessing this means they are going to assess a fee. If this results in even a 1% of assets fee, that’s an extra $750 million in income to the company (after accounting for their contribution to the fund). At a 15X P/E, the fund management business alone might be worth another $11.2 billion!

    • Nanalyze

      Hi Jay,

      This is an excellent question and something we were curious about. People throw around the $100 billion number but need to focus on what Softbank actually contributes and the fees they will collect on the rest.

      Here’s from the FT:

      As fund manager, SoftBank will retain roughly 20 per cent of returns over an 8 per cent threshold, a standard construct for operators of private equity vehicles. It will also receive management fees ranging between 0.7 per cent to 1.3 per cent of the capital committed, depending on each investor.

      We were frankly bummed that this article didn’t get any shares (that’s one good measure of success for an article, the willingness people have to share it with others). We really appreciate your feedback!

      Very surprised more people don’t find this as appealing as we do. We doubled our position.

  • Domen

    Is the Vision Fund a separate, privately funded entity… or do you own a fraction of it by owning Softbank stock?

    • Nanalyze

      You own a fraction of it by owning Softbank stock (about 28%). Softbank will also collect management fees as seen below:

      As fund manager, SoftBank will retain roughly 20 per cent of returns over an 8 per cent threshold, a standard construct for operators of private equity vehicles. It will also receive management fees ranging between 0.7 per cent to 1.3 per cent of the capital committed, depending on each investor.

      • Domen

        Great, thank you.

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