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Morningstar | Softbank Has Slightly Above par Result; Possible Price Cuts, Rakuten Entry Overhang; Maintaining FVE

SoftBank Corp.'s third-quarter fiscal 2018 result (quarter ended December 2018) was slightly above our estimates with revenue increasing by 2.3% and operating income increasing by 23.6%. However, the big Japanese telecom issues of NTT DoCoMo’s upcoming price cuts and Rakuten’s entry remain to play out. Three months ago NTT DoCoMo foreshadowed price decreases that will return up to JPY 400 billion to customers and see operating profit decline with a target of recovering operating profit to current levels by fiscal 2023. Softbank management has committed to continuous and sustainable earnings growth, however management will wait to see what plans NTT DoCoMo implements in April 2019 before deciding on a response. It is likely to use its key brands, SoftBank and Y!Mobile, to respond in different areas depending on whether more data or cheaper prices are required.

We believe SoftBank will likely have to tweak its prices down in certain areas to match NTT DoCoMo. We make mid-single-digit increases to our forecasts post this result with our fair value estimate retained at JPY 1,100 per share. At this fair value, SoftBank would trade on a price/earnings ratio of 10.8 times with a 3.4% dividend yield which would increase to around 7.8% on an annualized basis. We believe the Japanese telecom market is a solid three-player market with manageable competition levels but this looks likely to be challenged by both Rakuten's planned entry as a network operator in 2019 and the government’s influence over operator pricing. Our operating profit forecasts over the next four years assume around 2% per year growth for SoftBank with a slight decline forecast following our forecast of 18% growth this fiscal year. We retain our narrow moat rating based on cost advantage and efficient scale and our negative moat trend based on Rakuten and the expected upcoming pricing pressure.

SoftBank’s shares are trading above our fair value estimate and we prefer KDDI, which is trading on a 20% discount to SoftBank based on forward price/earnings despite being similar companies in the same market with KDDI deploying a far more conservative balance sheet than SoftBank. SoftBank’s net debt/EBITDA is around 2.4 times compared with KDDI at around 0.5 times.

SoftBank’s management provided full year forecasts of revenue of JPY 3.7 trillion, operating profit of JPY 700 billion and net profit of JPY 420 billion. We see these forecasts as easily achievable given they imply a fourth quarter operating income decline of 35%. We now forecast a full fiscal year operating income of JPY 758 billion. We suspect part of the strong operating profit growth this quarter was driven by a weaker third fiscal quarter a year ago (prior to separate listing). That quarter reported an operating profit of JPY 155 billion, much lower than the average of JPY 190 billion in the previous two sequential quarters. The operating profits of competitors, KDDI and NTT DoCoMo, did not see such a large sequential slowdown in the same quarter. There was much discussion at the result briefing about the Government’s plans to separate telecom handset and service sales. This would stop the practice of operators locking customers into long contracts where they are paying off their phones over 2-4 years and would presumably make it easier for Rakuten, as a new entrant, to take existing customers. SoftBank management seemed quite relaxed about it, though. Depending on the implementation details, we see is as a slight negative for the existing operators.