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Morningstar | SoftBank’s FVE Increased as Sprint Looks more Likely to Merge & Alibaba Value is Maintained

SoftBank Group’s key Sprint investment has received some encouraging news having gained the support of the Federal Communications Commission, or FCC, Chairman for its proposed merger with T-Mobile. With the approval of the Justice Department still required we raise our expected probability of a successful merger to 75% from 50% previously thereby increasing our fair value estimate for Sprint to USD 7.20 per share from USD 5.60.

Given SoftBank owns 84% of Sprint, we raise our SoftBank fair value estimate to JPY 14,400 from JPY 14,000. Alibaba, in which SoftBank owns an 28% stake and which contributes just over half of SoftBank’s valuation on our estimates, also reported its full-year result last week with the stock having fallen around 8% since the result. We retain our USD 240 fair value estimate for Alibaba post the result with likely near-term reductions in forecast revenue cancelled out by increased margin assumptions. At the current value, we see SoftBank as a 4-star stock.

T-Mobile and Sprint have formally made a series of commitments to the FCC, winning FCC Chairman Ajit Pai’s support and likely assuring the FCC will sign off on the firms’ planned merger. Justice Department approval, which is rooted in antitrust law rather than a public interest standard, remains the biggest hurdle for the deal. The probability of merger approval has certainly increased with this development but remains far from 100%, in our view. We are moving the probability of approval behind our fair value estimates to 75% from 50%, lifting our Sprint fair value estimate to USD 7.20.

With the jump in Sprint shares on the announcement, in our view, the market-implied probability of the deal closing has increased to around 95% from about 80% last week. We believe this percentage is too high. On a stand-alone basis, we believe Sprint is worth USD 3 per share with very high uncertainty around Sprint’s future. We don’t believe the proposed commitments radically alter the long-term competitive dynamics within the wireless industry that would emerge if the deal goes forward. T-Mobile and Sprint have agreed to meet several network coverage targets for 5G technology, committing to use both low- and mid-band spectrum to deliver certain minimum data speeds and provide in-home broadband services. We believe these network commitments are not far off from what the firm would hope to do absent merger concessions. The firms have also reiterated their commitment to hold prices at current levels for three years, but we suspect the short time period won’t sway regulators at the Justice Department.

More radically, the firms have agreed to divest Sprint’s Boost brand to a “credible” buyer and supply the buyer with better wholesale terms that either firm currently provides. While this step could facilitate additional wireless competition, the history of non-facilities-based wireless competitors in the U.S. is mixed, at best. Building a brand around a largely undifferentiated service offering is challenging, especially when competing against the carriers’ own sub-brands (Leap at AT&T; Metro and Virgin at T-Mobile). Critically, in our view, the firms stopped short of committing to divest actual network assets or spectrum licenses. We suspect the Justice Department would favor such divestments, potentially facilitating the cable companies’ entrance into the wireless business as converged, facilities-based competitors that can truly take on AT&T and Verizon over the long run. Notably, T-Mobile and Sprint also agreed to honor Sprint’s wholesale and network sharing agreement with Altice USA, though this firm is relatively small among U.S. cable companies and this commitment didn’t come with penalties should T-Mobile fail to extend the relationship beyond its current scope.

Heading into Alibaba's recent fourth-quarter update, our attention was focused on recent concerns regarding negative trade war headlines and China's overall macro environment, and how these factors would impact its full-year fiscal 2020 outlook. We've long thought that Alibaba and the network effect that underpins our wide moat rating would insulate its business model from macro headwinds, and we see China's recent retail sales deceleration as more of a consumer confidence issue than structural changes in Chinese consumers' ability to spend. Our confidence is rooted in Alibaba's China marketplaces, which offer Chinese consumers access to branded products at competitive prices, and ancillary businesses like Ele.me/Koubei and New Retail/Freshippo stores (formerly Hema) that are increasingly becoming integrated into Chinese consumer behavior.

While management's initial guidance calling for "over CNY 500 billion in revenue" in fiscal 2020 is slightly below market expectations--and likely assumes China retail GMV growth in the high-teens for the full year--we still believe our USD 240 fair value estimate is valid for several reasons. One, economic downturns have historically offered e-commerce marketplaces opportunities to lock in new buyers/sellers, which then engage in other higher-margin products and services as conditions stabilize (which was apparent in the continued strength of Alibaba's local consumer business segment). Two, the Chinese consumer remains relatively healthy, backed by wage growth, solid personal balance sheets, and access to consumer credit. Three, Alibaba appears to be adjusting certain cost line items for current market conditions (most notably sales and marketing) that should help offset the revenue deceleration impact on free cash flow.

We continue to believe Alibaba share price appreciation will be difficult until trade war headlines subside but continue to believe the market is underestimating Alibaba's future growth. However, while we plan to adjust our fiscal 2020 GMV and revenue growth assumptions (roughly 19% and 33%, respectively), we also expect to raise our near-term adjusted EBITDA margins assumptions to the mid-30s (up from the low- to mid-30s) based on cost containment efforts. These changes will effectively cancel one another out, leaving our USD 240 fair value estimate for Alibaba unchanged.