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Vol. 35, No. 24d Two Wall Street, New York, New York 10005 • www.grantspub.com DECEMBER 15, 2017

Epitome of the cycle

Masayoshi Son founded what is to- Alibaba Group Holding, Ltd., the Chi- pleted his American high school ca-
day Japan’s fifth-largest listed compa- nese retail, e-commerce and technolo- reer in two—yes, two—short weeks),
ny, SoftBank Group Corp., in 1981. By gy behemoth (BABA on the Big Board; the young entrepreneur invented an
good fortune, it was the same year in Grant’s, April 22, 2016). On this sprawl- electronic dictionary which he sold to
which interest rates started their long, ing and omnivorous enterprise—a kind Sharp Corp. for $1 million. Returning
lucrative descent. We write to pro- of avatar of Everything Levitation—we to Japan, he founded his business with
pose that Son’s telecommunications- are bearish. the help of a friendly branch manager
cum-asset-management-cum-techno- Many are bullish on SoftBank and, of the Dai-ichi Kangyo Bank who ad-
conglomerate owes as much to the bull perhaps especially, on its hyper-intel- vanced him $750,000 against no col-
bond market as it does to digital inven- ligent, ever-restless CEO. “There are lateral and perhaps $10,000 of annual
tion. In this sense, SoftBank—for all its very few places he can go and not be revenue. With such persuasion as we
exposure to e-commerce, artificial in- the smartest guy in the room,” says Ray can only imagine, Son assured the man
telligence, ride-hailing and the like—is Klein, independent investor and paid- seated across the table that the person-
a kind of credit instrument itself. Rates up subscriber. “He’s truly brilliant, and al computer and the software inside it
down, price up—and vice versa. he has boundless energy.” were the wave of the future.
The curious and worldwise subscrib- To be sure. In the late 1970s, while In 1995, Son bought a 35% stake
ers to Grant’s need no persuading to studying economics at the University in Yahoo!, Inc. for $100 million. More
interest themselves in the affairs of of California, Berkeley (having com- than that, he midwifed the creation of
a mammoth, leveraged, complex and
speculative business, albeit one head-
quartered in Tokyo, not New York. One
of these days, perhaps when the credit Telecom pays the bills
markets take an unscripted header, SoftBank’s sales in the past 12 months
SoftBank may make the wrong sort
of headlines. If so, the consequences adjustments*:
Arm Holdings: 2.2%
could ripple far and wide. It would be 2.1%
well, then, to know something about
distribution:
the structure, ethos and vulnerabilities 14.5%
of this boomtime institution. Consider:
SoftBank (designated 9984 on the
Tokyo Stock Exchange and SFTBY in
the American pink sheets) is embarked
on a worldwide buying and borrowing
spree at what is certainly not the bot-
tom of the market. It’s a prolific is- Yahoo! Japan:
suer of high-yield debt, including the 9.6%
single-B-plus-rated 6s and 67/8s subor-
dinated perpetual notes (the payment domestic telecom:
35.0%
of whose coupon management may de- Sprint:
fer at its option). It owns 83% of Sprint 40.9%
Corp. (Grant’s, Dec. 23, 2016). It is the
sponsor of an unorthodox $100 billion *Consists of other revenues and reconciliation of intersegment sales.
venture-capital fund. It owns 30% of source: company data
 article-GRANT’S / DECEMBER 15, 2017 2

Yahoo! Japan Corp., in which joint ven- SoftBank is a holding company with a assets that furnish the cash flow which
ture SoftBank retains a 43% position $92 billion market cap, $79.6 billion in pays the interest, on the terms and
now valued at $11 billion. trailing 12-month revenue, $23 billion conditions under which the debt was
Disappointed by the Japanese gov- in adjusted earnings before income, tax, incurred, on credit spreads and inter-
ernment’s refusal to grant SoftBank the depreciation and amortization (EBIT- est rates. Notable is that the size of the
spectrum it needed to compete in wire- DA), $137.6 billion in consolidated debt debt has jumped to $76 billion from $52
less services, Son managed to do the and $30.5 billion in cash. The company billion in only the past 18 months. Amir
seemingly impossible: In 2006 he bought brings together 761 subsidiaries, such as Anvarzadeh, head of Japan equity sales
Vodafone Japan for $20 billion, borrowing the Japanese telecom business (34.7% at broker BGC Partners Ltd., in Singa-
$18 billion of the purchase price. Once of revenues), Sprint (40.7%), Yahoo! pore, tells Santin, “I think Son is not as
more, he persuaded Japanese lenders to Japan (9.6%), Brightstar Global Group, much of a genius as some other people
trust him, in this case to slash prices, im- Inc. (14.6%), Arm Holdings, plc (2.1%) think he is. I think one of his genius
prove network quality and take market and others (1.6%). It reports its 30% virtues is the fact that he has access
share from the incumbents, which he Alibaba stake along with 129 other as- to cheap money. . . . I give him that.
proceeded to do. sociates as equity-method investments. He has access to a lot of retail money
“And then,” colleague Fabiano It owns $24.6 billion in minority stakes where he can actually issue bonds do-
Santin relates, “there is the invest- in hundreds of companies ranging from mestically to the retail investors and
ment that so far outshines all others. China’s ride-hailing Xiaoju Kuaizhi, raise money at fairly low rates.”
In the year 2000, Son saw opportunity Inc., a.k.a. Didi ($5 billion invested), To be precise, SoftBank is paying 2%
in Alibaba and invested $20 million in office-rental network WeWork Compa- on the $31 billion which its Japanese
it. Today, that stake in the Chinese nies, Inc. ($4.4 billion), online sports- creditors advanced. An equal-opportu-
e-commerce, retail and technology apparel retailer Fanatics Holdings, Inc. nity borrower, the company is likewise
giant is worth $134 billion. Since its ($1 billion), biopharmaceutical compa- issuing debt in euros and U.S. dollars.
1998 debut on the Tokyo Stock Ex- ny with a bet on artificial intelligence, In July it sold $4.5 billion of the afore-
change, SoftBank’s stock has deliv- Roivant Sciences Ltd. ($1.1 billion), mentioned subordinated perpetual
ered an 18% annual return in dollars “insuretech” firm ZhongAn Property notes, which S&P rates single-B-plus,
(17% in yen), compared to 3% for the and Casualty Insurance ($500 million), three notches lower than the SoftBank
Nikkei (2.4% in yen) over the same and lots of other speculative plays. unsecured bonds (two notches owing
span. Vitaliy Katsenelson, chief in- Thus, the corporate vital signs. Now to subordination and another on ac-
vestment officer of Investment Man- to disaggregate them. Neither debt nor count of the issuer’s option to defer
agement Associates and a SoftBank revenue, as presented in the consoli- interest payments).
investor, in 2015 inquired of the dated financial statements, is exactly As mentioned, it’s the Japanese tele-
readers of his Contrarian Edge blog, what it seems. As to debt, some $63.5 com operations that generate the cash
‘What would you get if you crossed billion of the obligations of Sprint, Ya- that pays the bills. For the 12 months
Warren Buffett, Richard Branson and hoo! and other subsidiaries are nonre- ended Sept. 30, that key division pro-
Steve Jobs? Answer: Masayoshi Son.’ course to the parent. Concerning rev- duced adjusted EBITDA of $10.3 bil-
Bernstein Research echoed those enue, SoftBank books 100% of the top lion, down from $10.7 billion in the like
words in an Oct. 19 research bulletin: line of Yahoo! Japan, though it owns period a year ago, at constant exchange
SoftBank is ‘the Berkshire Hathaway only 43% of the equity of that subsid- rates. Thus, SoftBank’s leverage is a
of Tech.’” iary (as IFRS accounting conventions meaty 7.4 times adjusted EBITDA, up
So Masa Son’s track record speaks allow). There is accounting-induced from 6.5 times a year ago. Leverage is
for itself, the bulls say (21 buys, 3 misapprehension, too, with respect to heading higher as SoftBank invests to
holds and zero sells is the way the Sprint. The parent consolidates the prepare for better network coverage
sell-side lines up, according to Bloom- telecom subsidiary’s revenues and and to keep up with the Joneses named
berg). Besides, the argument goes, the EBITDA, again in conformity with NTT Docomo, Inc. and KDDI Corp.
shares trade at a 40% to 50% discount IFRS. Reading those figures, an inves- In neither the United States nor Ja-
to the sum of the corporate parts. Of tor may assume that the funds are the pan is SoftBank more than a telecom
this value-themed contention, more parent’s to use as it sees fit. The truth also-ran. Sprint is the fourth-largest
in a moment. We would remind the is the opposite. Sprint is an equity in- wireless carrier in America. SoftBank’s
enthusiasts that the price of SoftBank vestment that may or may not pan out. telecom business is the third-largest in
shares registered a 99% decline at the Its revenue and cash flows (currently Japan, where it commands a 27% share
close of the 1990s tech bubble (to cash-burning) may never be available of revenue vs. 40% for Docomo and
¥276 in 2002, from the all-time high to SoftBank. The essence of SoftBank 33% for KDDI.
of ¥20,222 on Feb. 18, 2000). No loss today—distinct from the dreams of At last report, $6.1 billion in trail-
in the founder’s formidable IQ ex- tomorrow—is the Japanese telecom ing 12-month operating income for
plained it. Valuation, crowd psycholo- business, which (excluding Sprint and the Japanese telecom business cov-
gy, illiquidity and the cycles of finance Yahoo!) generates 70% of revenues and ered interest expense, at the holding
rather played their customary parts. 100% of EBITDA. company, by a factor of 4:1. Squinting
Such forces are recurrent. They have Even after stripping away the non- into next year, management projects
certainly helped on the upside. recourse portion of the debt, SoftBank a coverage ratio closer to 3.6:1. The
... owes $76 billion. Whether that is a lit- dip is attributable to the rising invest-
tle or a lot depends, of course, on the ment required to increase network
 article-GRANT’S / DECEMBER 15, 2017 3

A bubble, then a rally valuation, according to The Wall Street

¥22,000 ¥22,000 Journal. For its part, WeWork has pur-
Softbank Group Corp. share price
20,000 20,000
chased stakes in a maker of wave pools,
Wavegarden; in a fitness club, Rise by
18,000 18,000 We; and in a coding academy, Flatiron
School. The unicorn is also preparing to
16,000 16,000 close on the $850 million purchase of
14,000 12/12/17: 14,000 Lord & Taylor’s flagship store in New
¥9,444 York City, space which one year earlier
12,000 12,000 bore an appraisal of $650 million.
in yen

in yen
SoftBank’s purchase, in February,
10,000 10,000
of Fortress Investment Group for $3.3
8,000 8,000 billion, a 38.6% premium to the previ-
ous day’s close (Grant’s, Feb. 24), like-
6,000 6,000 wise fits the acquisitive, open-handed,
sometimes strategically puzzling pat-
4,000 4,000
tern. It’s unclear how a private-equity/
2,000 2,000 hedge-fund manager fits into Son’s
strategic picture, unless, as Santin sug-
0 0 gests, the technological visionary is
1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 12/12/17
source: The Bloomberg
striving to become the Earth’s largest
asset manager. Which brings us to the
SoftBank Vision Fund.
coverage and stay current with the deleverage, as some investors thought There has never been anything quite
growing demand for data transmission. he could, or should, have done. Expect, like it—no fund so big, none (of any
Meanwhile, as Bloomberg reported on then, more cash infusions into the remotely comparable size) so lever-
Dec. 1, the Japanese government is needy American carrier.” aged. As of Sept. 30, capital commit-
leaning on operators like SoftBank to Yahoo! Japan, in which SoftBank ments were within a few trivial billion
reduce their customer charges. owns the previously mentioned 43% of $100 billion—Saudi Crown Prince
Sprint is unlikely to prove Son’s stake, is suffering an operational droop Mohammed bin Salman, a.k.a. MBS,
shrewdest investment, whatever the of its own. For the first half of 2017, ad- reportedly circled $45 billion. In toto,
final reckoning. For its 83% portion of justed EBITDA fell by 8.4%, to $956 third-party investors were on board
the wireless provider, SoftBank paid $22 million, from $1.04 billion in the year- with $65.2 billion, consisting of $24.8
billion in 2013. At the current Sprint earlier stretch. EBITDA as a percent- billion of equity and—this is where the
share price of $5.50, that stake is worth age of revenue has plummeted to 25% leverage comes in—$40.4 billion of 7%,
$18 billion—or less. Telecom special- from nearly 50% in 2014, in which year payment-in-kind preferred. SoftBank
ist Craig Moffett, founder and one-half the subsidiary’s share price peaked. is contributing $32.5 billion in equity.
the eponym of MoffettNathanson Re- Weaned in bull markets and imbued There’s a five-year investment period,
search, forecasts that Sprint will burn with entrepreneurial optimism, Masa and a minimum life of 12 years.
an average of $3.5 billion for each of Son doesn’t mind writing big checks. The general partner—that’s Soft-
the next four years while facing average He paid a 43% premium to the market Bank—charges a management fee of
debt maturities of $4.3 billion per year price, and a 65 times earnings multiple, 0.7%–1% and a performance fee of 20%
until 2024. So reckoning, Moffett pegs to secure Arm Holdings in last year’s for returns above an 8% hurdle rate, ac-
the value of the stock at $2 a share, im- $32 billion acquisition—the invest- cording to the Financial Times. At 1% on
plying an $11 billion haircut to the sum- ment is said to have dumbfounded the $24.8 billion in third-party equity,
of-the-parts calculations on which the even those close to the man who made the management fee just barely covers
bullish case for SoftBank partially rests. it. Arm earns royalties by licensing mi- operating expenses (running at an an-
“Masa Son has already stated that croprocessor designs to chip makers nual rate of $198 million since the fund
the United States is his most impor- and reflects Son’s bet on artificial in- launched on May 20).
tant market,” Santin notes. “He has telligence, augmented reality and the What could hurt the limited part-
high hopes for the ‘internet of things,’ internet of things. A sign of the CEO’s ners more than management fees are
too, which relies on wireless services. commitment to this particular wave of the dynamics of the payment-in-kind
In October, SoftBank held merger the future is that R&D spending and structure. In a bear market, or even
talks with T-Mobile, the third-largest new engineering hires are both on the a blah market, it’s possible for the
American carrier. Negotiations report- upswing (head count is up by 27% in accrued interest on the preferred shares
edly broke down over the refusal of the the past year, to 953 employees). Prof- to snowball. The longer a period of sub-
famously hands-on Son to cede control itability will have to wait. standard performance lasted, the worse
of the combined entity. The failure WeWork, at least, books revenue, as it would be for the equity holders. And
seemed to confirm Son’s intention to much as $1 billion a year, even if there is substandard is the norm if you overpay
keep the Sprint stake at any cost in- no net income just yet. In August, Soft- for investments. Recall that Arm, which
stead of selling it or reaching a deal to Bank invested $4.4 billion in the free- will represent about 8% of Vision’s as-
speed up the generation of synergies to lance office-rental outfit at a $20 billion sets, did not come cheap. Its 65 times
 article-GRANT’S / DECEMBER 15, 2017 4

P/E multiple equates to a 1.5% earnings ers by allowing Masa Son to drop his thus SoftBank’s increasing exposure to
yield, and even that seems optimistic. dogs into the fund, what does that say it) and the Japanese company’s grow-
The royalty-licensing company delivered about the chairman, who has assumed a ing debt levels, a fall in BABA could
a $130 million loss in the six months to fiduciary duty to his third-party limited deal a significant blow to Masa Son.”
Sept. 30, as SoftBank reported. partners? Furthermore, will competi- ...
Does Son have another Alibaba up tor companies outside the fund make
his sleeve? The fund isn’t wanting for it more difficult to cooperate with the Critics of Alibaba harp on related-
boldface names that seem to think so. fund’s investees? Why should Waymo, party transactions, borrowing to fund
The roster of limited partners features Google’s self-driving car company, make money-losing affiliates and the dis-
Public Investment Fund of the King- its technology more accessible to Didi, semination of potentially misleading
dom of Saudi Arabia, Mubadala Invest- which is now partly owned by Apple operating metrics, such as overstated
ment Company of the United Arab through the Vision Fund? Apple, after gross merchandise value. Alibaba, too,
Emirates, Apple, Inc., Foxconn Tech- all, is developing its own self-driving makes many seemingly random in-
nology Group, Qualcomm, Inc. and vehicles. Will this massive investing vestments, sometimes in harness with
Sharp Corp. machine come back to bite SoftBank in SoftBank, its No. 1 shareholder; Didi
In its 2016 annual report, SoftBank unforeseen ways? Today’s technology and SoftBank’s robotics business are
invited its stockholders to compare industry is much more competitive than examples. In June 2016, Alibaba and
Vision, at nearly $100 billion, to the it was even 15 or 20 years ago, when Son its management team (“the Alibaba
$64 billion that venture-capital pro- was in his glory.” Partnership,” comprising 36 members
moters the world over had raised in There’s been nothing more glori- of Ma’s inner circle) purchased $2.4
the just-completed 12 months. The ous—to date—than Alibaba. Sum-of- billion worth of BABA at a price of
comparison, flattering to itself, glided the-parts analyses value BABA at $134 $74 per share. They bought it directly
over one small detail. “[Vision] is not billion (market value), compared to from SoftBank.
a venture-capital fund,” Steven Kaplan, $60 billion for the second most impor- A less obvious risk to SoftBank is
Neubauer Family Distinguished Ser- tant piece, the Japanese telecom unit, Mr. Market’s evident reluctance to
vice Professor of Entrepreneurship and and $18 billion for the third-largest afford Softy the benefit of the doubt.
Finance at the University of Chicago subsidiary, Sprint. What might these “First, show me the money,” is the
Booth School of Business, tells Santin. parts be worth to SoftBank? gentleman’s message nowadays. The
“It’s a growth equity/buyout fund, so After applying the Japanese capital- so-called singularity, the future jubilee
it’s [misrepresented], and you see the gains rate, 23.4%, BABA deflates to in which artificial intelligence surpass-
deals that they’ve invested in are really $103 billion. Add Japanese telecom es human intelligence, is one of Son’s
too big to do much early-stage stuff. and Sprint, and you get $181 billion. preoccupations. When it will come (if
It’s four times bigger than the biggest Combine with another $60 billion, rep- ever it does) is anyone’s guess. Anyway,
private-equity fund.” resenting the estimated value for all re- investing in millennial story stocks may
You can’t say that Son is investing in maining assets. It comes to $241 billion not be the safest course in a late-cycle
the unknown. SoftBank’s equity con- in assets against $61 billion in net debt. market, especially using leverage. “I’m
tributions to the Vision Fund (so far) “Asset values are contingent, but debt concerned that at some point Masa Son
largely consist of positions in existing is forever,” was a rueful epigram that may drink a lot of Kool-Aid and then he
SoftBank portfolio investments, includ- came out of the junk-bond crackup of may leverage the company a lot more
ing Arm ($3.8 billion) and Didi ($3.6 bil- 1989–90. Variable and volatile, certainly, than I’d like,” a skeptical Katsenelson
lion). Hence, such in-kind transfers to- is the value of Alibaba, which appreci- tells Grant’s.
taled $7.4 billion through Sept. 30, from ated by 90% in the past year. This meant Where are the chinks in SoftBank’s
a total of $32.5 billion that SoftBank $212 billion in incremental wealth for armor? Not short-term funding, we
has committed. Might some fear that Jack Ma’s shareholders, $64 billion for think. As of Sept. 30, SoftBank Group
the parent could use Vision as a dump- Son’s (i.e., 30% of $212 billion). (ex-Sprint and Yahoo! Japan) owed
ing ground for SoftBank’s less inspired “Observe that, in the same 12 $23.6 billion maturing in the next 12
ideas? To allay any such concerns, Son months,” notes Santin, “SoftBank’s months. Of that grand total, $9 billion
has agreed to contribute not just some, stock rose by 23% in U.S. dollars, which was a bridge loan (it financed the Arm
but any, investment over $100 million meant ‘only’ $17 billion in additional acquisition), which, by now, if all went
to the Vision portfolio. value. Looking from a different per- according to plan, has been converted
“Still,” Santin observes, “a SoftBank spective, since the IPO of September to long-term bank debt. If so, SoftBank
shareholder, having invested in com- 2014, BABA short sellers would have should have no pressing short-term obli-
pany stock because of his confidence suffered the 157% surge in share price, gations—the remaining debt, $52.4 bil-
in Son, is now seeing his original in- while SoftBank short sellers would have lion worth, takes the form of medium-
vestment being diluted on some of more than survived the 5.6% SoftBank term notes and bonds.
SoftBank’s core bets (ride-hailing and increase during the period—and that’s We judge the immediate risks rath-
Arm, for instance). And whatever great despite SoftBank’s ¥500 billion ($4.5 er to be Sprint and, especially, Ali-
opportunity, if any, comes knocking on billion) buyback in 2016 that retired baba. “The market was predicting that
SoftBank’s door, that investment will 8.3% of shares outstanding. In the past Sprint’s bankruptcy was imminent in
have to be shared with the Vision inves- three years, the market hasn’t been early 2016,” Santin observes, “when
tors. If one makes the argument that the generous to SoftBank’s stock and now, some of Sprint’s senior unsecured bonds
fund actually helps SoftBank sharehold- because of BABA’s meteoric rise (and traded down to as low as 60 cents on
 article-GRANT’S / DECEMBER 15, 2017 5

the dollar and the company’s five-year of the dollar gains it had on the past 12 “Every cycle has its poster child,”
credit default swap traded up to 1,800 months, or about $40 per share. Given says Brian Horey, president of Aure-
basis points (implying that Sprint had that SoftBank owns about 768 million lian Management. You can’t be sure
an 80% probability of default in the shares, a $40 ding would reduce Soft- who it will be until upside excess
next five years) from 400 basis points in Bank’s market cap by more than $30 has turned into its downside mirror
mid-2015. The wireless carrier’s stock billion, or more than ¥3,000 per share.” image. But for him, and for us, Soft-
plummeted to under $3 from $5 a share, Nikesh Arora was the second-in- Bank is a leading contender for the
which implied a ¥650 (per share) im- command at SoftBank who quit in 2016 cyclical laurels.
pact on SoftBank’s stock. SoftBank trad- when it became evident that Son was in Mix the CEO’s exuberance with
ed down to less than ¥5,000 from the no hurry to make him first-in-command. cheap debt, high leverage and record
near-¥7,000 level during most of 2015. In a post-resignation interview with For- asset values. Add the excitement of
The market might have been anticipat- tune magazine, Arora confessed that he today’s startling advances in robotics
ing that Sprint could be written down to didn’t know how to value Didi, China’s and artificial intelligence. Combine
zero or that SoftBank could have been version of Uber, in which SoftBank had with the karmic report that the afore-
required to infuse it with cash. made an investment. Nor, he added, did mentioned “MBS,” the Vision Fund’s
“Since then,” Santin proceeds, he know “the right valuation for any of No. 1 limited partner, is also the ru-
“Sprint has gotten some added support these companies”—i.e., early-stage tech mored buyer of that $450 million
by mortgaging anything that wasn’t businesses—in the SoftBank portfolio. road-show da Vinci. Totting them all
nailed to the ground; it raised cash by As for Son, the former No. 2 went up, what do you have? Perhaps a cor-
issuing debt secured by wireless spec- on, he “has an idea per minute,” works poration destined to read about itself
trum. Although Sprint’s stock recov- 12 to 16 hours a day and is slow to sell on page one of The New York Times—
ered quite well and traded as high as $9 an investment (sometimes, as in the and not in a flattering way.
a share earlier this year, it’s quoted at case of Yahoo!, much too slow). He is
less than $6 today. “an extremely positive person. Once
•
“Alibaba could present a bigger prob- he gets optimistic, I think sometimes
lem. Suppose that BABA gave back half he gets carried away.”

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