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Morningstar | SoftBank’s Underlying Results in Line, Look at Vision Fund 2, 2:1 Stock Split Coming; FVE Increase

Softbank’s underlying fiscal 2018 (quarter-ending March 2019) result was in line with our expectations with revenue up 4.8%, and operating earnings up 9.6%, ex-SoftBank Vision and Delta Funds. The reduction in the operating profit from Yahoo Japan was more than offset by operating profit increases from Softbank Corp and a reduction in losses from others. The company also announced a 2 for 1 share split which will be effective on June 28, 2019.

We increased our fair value estimate to JPY 14,000 per share from a split adjusted JPY 12,000 per share previously. This was driven by an increase in our valuation of both SoftBank Corp and the Vision Fund as well as time value of money. Our no-moat rating is also retained as we rate SoftBank as an investment holding company rather than an operating company. While the weighted average moat rating of the companies currently in the company’s portfolio would point toward a narrow moat company, we do not have confidence that SoftBank will continue to hold these companies over a 10-year period.

The stock looks 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 and the narrow sector focus and leverage within the Vision Fund and some of its subsidiaries. At the result briefing, management again outlined a rough sum-of-the-parts valuation for the company of JPY 21 trillion with nearly 80% of this value underpinned by listed shares owned by the group. Given the current Softbank market capitalization is around JPY 12.7 trillion, management continues to see its shares as vastly undervalued.

The performance of the Vision Fund has so far has been impressive. It reported JPY 1,379 billion in gains from continuing investments and a JPY 147 billion gain from the sale of Flipkart shares. The Vision Fund holds 69 investments at a cost of USD 60 billion with fair value totaling USD 72.3 billion. During the year, two investees, Guardiant Health and Ping An Good Doctor listed with Uber, WeWork and Slack having filed documents related to initial public offerings. As a recap in Vision Fund 1 SoftBank holds nearly half of the USD 58.6 billion of equity in the fund with the remaining USD 40 billion in preferred equity with a 7% fixed distribution. SoftBank also disclosed VF1 Limited Partner net equity internal rate of return, or IRR, of 45% and net blended (preferred and ordinary equity) IRR of 29% over the past year. SoftBank’s own IRR from the Vision Fund is 62%. SoftBank also disclosed for the first time that it is starting to prepare for a second SoftBank Vision Fund (VF2) and it is looking at similar size to VF1 (around USD 100 billion). Given the strong performance of VF1 so far, existing investors are showing interest in VF2 and SoftBank also claims to be receiving significant external interest.

Softbank’s 85% owned Sprint’s saw familiar themes on display in its fiscal 2018 fourth-quarter results, with accelerating customer losses set against relatively stable revenue per customer as the firm tries to balance growth and profitability. Net postpaid phone customer losses totaled 189,000 during the quarter, Sprint’s worst showing in four years, despite a steady increase in the number of postpaid customers signing up under brands other than Sprint, such as Boost. In our view, Sprint has bought growth in the past via heavy promotions but subsequently disappointed customers with relatively poor network quality. Sprint is still far from a level of profitability that would enable the business to be self-sustaining. Capital spending in fiscal 2018 increased to USD 4.3 billion from USD 2.8 billion the year before, causing Sprint to burn about USD 1.9 billion before asset sales. We continue to peg Sprint’s stand-alone fair value at about USD 3 per share, though we caution that the firm’s weak financial and competitive position leaves a lot of room for error. Our fair value for Sprint’s shares of USD 5.80 assumes a value for Sprint’s shares of USD 8.60 if the T-Mobile merger closes and a 50% chance of this happening. The announcement of a successful merger would therefore currently add around 5% to our SoftBank fair value.

The 66%-owned domestic telecom business, SoftBank Corp, provided solid guidance for this year at its result. Softbank Corp has also announced its intention to acquire all the 1.511 billion new shares to be issued by narrow-moat-rated Yahoo Japan for JPY 456.5 billion, increasing its stake in the company from 12% to 45% and moving to consolidate Yahoo Japan in its accounts from April 1, 2019. The transaction is expected to close by the end of June 2019. SoftBank Corp’s management guidance for EBIT to increase by 3.5% to JPY 890 billion this year implies a core business (ex-Yahoo) EBIT forecast of around JPY 745 billion, using the midpoint of Yahoo Japan’s own guidance for this year. This would imply a 3%-4% increase in underlying SoftBank Corp’s EBIT which was above our forecast of a slight EBIT decline. SoftBank Group sold a 34% stake in SoftBank Corp at JPY 1,500 per share in December 2018 and the stock has since traded down 7% to JPY 1,402 per share. We value the business at JPY 1,200 per share so believe SoftBank Group sold at a good price. Rakuten is set 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 l cause some serious pricing pressure for as long as it is in the mobile market.

ARM Holdings, the U.K.-based semi-conductor design business, contributed flat full-year revenue of JPY 203 billion with adjusted EBITDA down 21% to JPY 24 billion. Sales momentum seems to be accelerating though with fourth quarter sales up 11%. 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. Sixty-five percent of its revenue comes from technology royalties with another 25% coming from technology licensing.