Over the years, the Japanese internet and communications conglomerate SoftBank has shown impressive growth. Furthermore, its name is getting more known because of its numerous successful investments in internet companies of which Alibaba is the most notable. In this article I will analyse SoftBank and value the company using the sum-of-parts analysis.
SoftBank was founded in 1981 as a company operating in the software wholesale business. Over the years it has expanded its businesses and evolved into one of the largest telecommunication providers in Japan. Combined with its investments in technology companies, SoftBank is forming a ‘strategic synergy group’ centred around the internet and mobile fields and expanding it on a global scale.
SoftBank is currently the third biggest company in the Japanese telecommunications sector. It acquired the struggling Japanese unit of Vodafone in 2006 and improved its networks and services. It has gained market share rapidly in the past years due to its aggressive strategy of offering faster network speeds than the major Japanese internet and telecom operators for lower prices. The two biggest competitors, NTT Docomo and KDDI, significantly lost market share to SoftBank over the last 10 years, On top of being pressured to lower their prices. The following figures show the tremendous growth of SoftBank over the last 5 years. In these years SoftBank has been able to maintain healthy margins despite its ongoing investments. The big increase in net sales can mainly be attributed to the takeover of Sprint in July 2013, while this acquisition impacted EBITDA and Net Income margins negatively.
figure 1: Net sales (mln JPY)
figure 2 : EBITDA and EBITDA margin (mln JPY)
figure 3: Net income and net income margin (mln JPY)
The mastermind behind SoftBank’s success is CEO Masayoshi Son. His keen eye for new businesses and his daring attitude have made him one of the richest people in Japan. He was one of the first investors in Yahoo! when it had not yet developed its web portal services in 1995 and he recognized Alibaba’s potential by investing in it 15 years ago. His aim for SoftBank is to become the world’s leading mobile internet company. He has a clear vision on how to expand SoftBank, which is centred around the further expansion of its role in the growing information industry through different business models. This vision is underlined by the great amount of capital that SoftBank invests in other companies operating in the internet and communications industry.
Current public investments
SoftBank acquired 80% of Sprint in July 2013 as a turnaround play. By buying the struggling telecom company, SoftBank tried to accomplish the same position in the US telecom sector as in Japan. The big similarity between these two industries is that in the US Sprint is dealing with two companies (AT&T and Verizon) dominating the market, just like in Japan. SoftBank aims to use the same aggressive pricing strategy in the US as it did in the Japanese telecom sector. Currently, Sprint’s networks are in the process of upgrading, as a first stage in the turnaround. In the meantime, their financial performance is still quite poor due to high indebtedness and negative cash flows that followed the high capital expenditures of upgrading their networks. Over the year 2014, Sprint was able to report a small profit, in contrast to the losses it suffered in the years before.
Another important holding is their 43% stake in Yahoo! Japan. This joint venture with Yahoo! was created in 1996 as the first Japanese web portal. Currently, it is still Japan’s biggest web portal, with, to strengthen its leading position, no debt and a stable $4 billion cash position ready to invest.
SoftBank’s most valuable public investment is its 32% stake in Alibaba, which had a record-high valued IPO last October and is currently valued at about $200 billion. SoftBank’s first investment in Alibaba was in 2000, which shows that SoftBank and especially its CEO, Masayoshi Son, have an outstanding eye for great up-and-coming companies. This is underlined by SoftBank’s stakes in Renren (42%) and GungHo Online Entertainment (59%). SoftBank invested in both companies at an early stage, both of which showed impressive growth over the past years and are worth SoftBank’s initial investment multiple times.
SoftBank’s non-public investments
SoftBank currently holds (partial) ownership of more than 750 companies. It uses its investment vehicle ‘SoftBank Capital’ to make venture capital investments in young enterprises with high potential, such as Alibaba once was. One of its main goals is to use these young and innovative enterprises as leverage to international growing markets, mainly focusing on companies in the communications and online services industry. SoftBank owns interests in the leading online marketplaces of India (Snapdeal.com) and Indonesia (Tokopedia). Furthermore, SoftBank has large stakes in the leading consumer transportation services of China (OLA), India (Grab Taxi) and Southeast Asia (KuaiDi Taxi). These investments have proven their worth already, while a lot of SoftBank’s other non-public investments contain bright future prospects and will unlock their massive value in the long run. Last November, a few weeks after the Alibaba IPO, Masayoshi Son stated publicly that “SoftBank is a goose with more golden eggs in its belly, even if it’s too early to bring them to the market.”
Furthermore, SoftBank has a 55% stake in Supercell, one of the top mobile game developers in the world. In 2014 Supercell reported profits of $565 million with $1.7 billion in revenues. These figures are twice the revenue and profits reported in 2013.These figures show the impressive growth of Supercell. To value this non-public company, I will review its most important peers. Competitors in the mobile gaming market such as King Digital Entertainment, Zynga and Glu Mobile all have a Price/Sales ratio of around 3. Given the valuation of these competitors, Supercell would be worth at least $5.1 billion. Although no rumours of an IPO have hit the markets yet, the current positive state of the market for tech IPOs makes it highly probable that Supercell will be valued even higher than the $5.1 billion I calculated if it were to/will initiate an IPO.
The focus of future investments by SoftBank will be on 30% to 40%stakes in Asian online services companies. SoftBank will use its expertise to help develop these enterprises and expand their position in the Asian online communications sector. It is highly unlikely that SoftBank will make investments in mature slow-growing companies similar to their Sprint investment. In their pursuit of becoming a world-leading mobile internet company it is necessary to remain innovative and investing in mature companies does not comply with this strategy. As explained in the previous paragraph, there are a lot of potential capital gains locked in the interests SoftBank holds in its venture capital investment vehicle. It will not come as a surprise when more of these investments will hit the public markets, earning billion dollar valuations as a result.
A lot of analysts following Sprint are very sceptic about SoftBank´s success in turning the struggling telecom company around. Especially the highly negative free cash flow, caused by the large capital expenditures, is a major concern. Furthermore, it is doubted whether Sprint´s strategy of competing by offering low prices can be profitable in a market that holds a lot of competition and where subscription prices are already under pressure. This shows that the US telecom sector is in a very different situation than the Japanese telecom sector was when SoftBank started and that it is much more difficult to make the Sprint investment a success. However, if SoftBank successfully improves Sprint’s position in the US telecom market a lot of new possibilities will emerge.
Currently SoftBank has a market capitalization of $74.7 billion and $96.7 billion in debt, where most of this debt burden was used to buy and reorganize Sprint. Adding up these numbers gives SoftBank an enterprise value of $142.9 billion after subtracting the $28.5 billion in cash.
To accurately value SoftBank and its investments, I use the sum-of-parts analysis. For reasons of simplicity SoftBank Capital is given a value of zero, while in real life this investment vehicle is worth more due to the prospects of the more than 750 investments in it. This implies that shareholders are given the upside potential of possible successful investments, while the downside risk is practically non-existent due to the zero dollar valuation.
All of SoftBank’s public equity stakes are valued at their current market values, while SuperCell is valued at a 3 times Price/Sales ratio. The total value of these positions is close to $100 billion. To value SoftBank’s Japanese operations two different metrics can be used: the Price/EBITDA ratio and the Price/Earnings ratio. Its two biggest competitors, NTT Docomo and KDDI, trade at a Price/EBITDA ratio of 6 and a Price/Earnings ratio of approximately 17. These ratios give SoftBank’s Japanese operations a value between $73 and $97 billion, as shown in the following table where all numbers are added up and adjusted to SoftBank’s amount of debt and cash
The sum-of-parts analysis shows that SoftBank is significantly undervalued. The possible upside is at least 41% using the Price/EBITDA multiple, while the Price/Earnings multiple gives a possible upside of 73%. Even if the pursued Sprint turnaround were to fail and its equity value would be reduced to zero, SoftBank still has at least a 20% upside according to the sum-of-parts analysis.
In my opinion, the market is too negative about the Sprint takeover. It is more important to focus on SoftBank’s thriving business in Japan, the outstanding capabilities of CEO Masayoshi Son and especially the value that will be unlocked by its investments in high-growth companies. To me it will not come as a surprise if SoftBank continues to show impressive growth in the coming years and becomes one of the world’s leading internet and communications companies.
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Jauke de Jong
Jauke is always looking for the hidden gems of the financial markets.