EUR 850.00 For Business Accounts Only

Morningstar | SoftBank's Underlying Results Disappoint but FVE Increased to JPY 12,600 on Alibaba. See Updated Analyst Note from 06 Aug 2018

Softbank's underlying first-quarter fiscal 2018 (quarter-ending June 2018) result was slightly below expectations with revenue up 2.8%, EBITDA down 0.7% and underlying operating earnings down 23%, ex-SoftBank Vision Fund and Ex-Delta Fund. The reductions in the operating profit from ARM, Yahoo Japan and Brightstar were the main drivers of the consolidated operating profit decline and Rakuten's potential entry into the Japanese telecom market could further dampen prospects in the domestic telecom business, at least in the short term. We make only minor changes to our consolidated business forecasts with our fair value estimate increased to JPY 12,600 from JPY 11,000 per share primarily on the back of an increase in our Alibaba fair value. Our no-moat rating is also retained based on the increase in deal activity in what were previously seen as core businesses for SoftBank, as we rate SoftBank as an investment holding company rather than an operating company. While the weighted average moat weighting of the companies currently in the company's portfolio would point toward a narrow moat company we no longer have confidence that SoftBank will continue to hold these companies over a 10-year period. The stock looks slightly undervalued at current levels with investors seemingly applying a discount to plausible sum-of-the-parts valuations on uncertainty about what the business might buy next.

SoftBank's investment in Alibaba is by far its most valuable asset, representing around 50% of its value at current prices even after factoring in potential capital gains tax on any sale of this stake, however it is accounted for as an investment therefore its results do not hit the earnings statement. Over the past few years, Alibaba has transitioned from a traditional e-commerce marketplace to a big data-centric conglomerate, with transaction data from its marketplaces, financial services, and logistics businesses allowing the company to move into cloud computing, media/entertainment, and online-to-offline services. We've long thought that a strong network effect can allow e-commerce players to extend into other growth avenues, and nowhere is that more evident than Alibaba. Alibaba's Internet services affect the vast majority of Chinese Internet users in some way, including a 70% penetration rate for the Taobao/Tmall e-commerce marketplaces and 80% penetration rate for Youku Tudou (video). This provides Alibaba with an unparalleled source data that it can use to help merchants and other consumer brands develop personalized mobile marketing and content strategies to expand their target audiences, increase click-through rates, and improve return on investment. Alibaba's marketplace monetization rates continue to improve, indicating that sellers are becoming increasingly dependent on Alibaba's marketplaces and payment solutions, and retail revenue per active user continues on an upward trend, owing in part to an emphasis on higher-quality merchants. While we view the Taobao and Tmall marketplaces, Cainiao, and Alipay as Alibaba's core cash flow drivers, we also believe Ant Financial, AliCloud, globalization, and digital entertainment offer long-term potential. While AliCloud will probably remain in investment mode near term, we believe accelerating revenue per customer trends suggest a migration to value-added content delivery and database services that can drive segment adjusted margins improvement over time. On globalization, third-party merchants are having success reaching Lazada's active users across Southeast Asia, something that should persist in the years to come as the company rolls out incremental personalized mobile marketing and content opportunities in this region. While early, we share management’s views about digital entertainment being an important user acquisition and retention tool. Our fair value for Alibaba is USD 240.

Softbank's 85% owned Sprint reported first fiscal quarter results that were broadly in line with our expectations. Reported revenue declined 0.4% year over year. Sprint added 87,000 postpaid phone customers in the quarter, its 12th consecutive improvement. However, it was less than Verizon and AT&T gained. New CEO Michel Combes has already started to have an impact. We were pleased to see him discuss the importance of balancing growth and profitability. This is similar to what he said when he was CEO at Altice. The early results are positive, as the firm generated its highest quarterly EBITDA in 11 years at $3.3 billion, though that was partially due to changes in accounting standards. We think the increased focus on profitability should help the entire industry, as Sprint has often been the most aggressive in pricing promotions despite this not leading to many new subscribers. Unlike Verizon and AT&T, which saw substantial improvements in free cash flow from the changes in the new tax law, Sprint did not, with its net debt rising USD 300 million over quarter to USD32.2 billion. With increased capital expenditure for a 5G network upgrade looming in 2019 or 2020 we believe the proposed T-Mobile merger is a much-needed escape clause. Unfortunately, we see the chance of regulatory approval for the merger at only 50%.

The domestic telecom business showed decent revenue generation with revenue up 5.4% but margins reduced slightly with EBITDA rising 2% and EBIT rising 3%. The company is reviewing a potential IPO of the domestic telecom business. We note that the recent performance has been below its competitors and Rakuten has also announced its intention to launch mobile network service in Japan in 2019. While we doubt if Rakuten will be successful in building a scale business, it may well launch and cause some serious pricing pressure for as long as it is in the market. Given Rakuten’s network is likely to have inferior coverage relative to the incumbents, it is likely to need to offer significant discounts at the beginning of its service to build up its customer base. At the least, it is likely to provide some negative background and uncertainty for the Softbank’s planned float.

We had a mixed impression of Yahoo Japan's June quarter results. On the positive side its paid search advertising revenue increased 13.8% from the previous year, which is the largest growth in the past five years. The transaction value of its e-commerce business also increased 25% from the previous year, exceeding our forecast of 20%. Meanwhile, on the negative side, we were concerned that excluding the one-time profit of selling shares of IDC Frontier, its organic operating income fell to JPY 40.8 billion from JPY 48.2 billion, owing to the larger investing expense. Following the result we retained our fair value for Yahoo Japan at JPY 420.

ARM Holdings, the U.K.-based semi-conductor design business, contributed JPY 41.5 billion to revenue (a decrease of 12%) but a loss of JPY 16.2 billion to operating profit in the June quarter excluding the large one-off gain on loss of control of its Chinese subsidiary. Softbank seems to be increasing its investment into ARM to support its very bullish views on the long-term growth prospects for this business. With limited disclosure it is difficult for us to assess whether this investment is justified but we note that the number of technical employees of ARM has risen by 10% over the past year, but interestingly fell 2% on the March quarter. The SoftBank CEO was again emphasizing the importance of singularity and his view that Artificial Intelligence will be the biggest revolution in human history. SoftBank's Vision Fund and its cluster of number one AI company investments strategy is designed to best position Softbank in this world.