As it becomes increasingly difficult to
find undervalued companies in the US and Canadian stock markets, I’ve been looking
at investment opportunities outside of North America. My search has led me to a
unique Japanese company called Softbank Group Corp (NASDAQOTH: SFTBY).
Softbank:
The Berkshire Hathaway of Tech?
I became intrigued by Softbank after reading
a research note from analyst Chris Lane of Sanford C. Bernstein & Co,
proclaiming the Japanese company to be a tech-focused version of Berkshire
Hathaway, the American multinational conglomerate holding company run by
investing legends Warren Buffett and Charlie Munger. While at quick glance it
may seem as though both companies run traditional businesses – in the case of
Softbank its telecom business and for Berkshire Hathaway its insurance business,
nothing about these two massive companies is traditional. Both company’s core
business would be better described as equity investing. Berkshire Hathaway
leverages cash “float” generated from its insurance subsidiaries to invest in a
wide range of different businesses, from Coca-Cola to NetJets to Wells Fargo.
Softbank also uses its cashflow generated from its primary operating business,
it’s Japanese telco operation, to invest. But, rather than investing in old
school businesses like Berkshire Hathaway does, Softbank invests in new school
businesses in the fields of Artificial Intelligence (AI), the internet of
things (IoT), ride sharing and smart robotics.
Each CEO, Warren Buffett of Berkshire
Hathaway and Masayoshi Son of Softbank, are known for their investment prowess.
Interestingly, while Warren Buffett occupies rare air in the annals of
investment legends, you’d had been better off investing in Masayoshi Son’s
Softbank rather than Buffett’s Berkshire Hathaway over the last 15 years. Softbank’s
stock (SFT) has delivered 15.84% annualized returns over the last 15 years as
compared to Berkshire Hathaway’s (class B) 9.99% annualized return (Source:
Morningstar.com, August 28, 2018).
When you invest in Softbank you are really
investing in the bold vision of the company’s tenacious CEO Masayoshi Son. He
has a vision for an information revolution that he wants Softbank to lead, one that
realizes the potential of singularity to transform every industry in the world.
Singularity is when artificial intelligence exceeds human intelligence. And,
Softbank is investing in the companies Masayoshi Son believes will accelerate
this information revolution, such as ARM Holdings, Uber, and Alibaba. Softbank
has helped lead a number of revolutions over the course of its 47-year history,
beginning with software distribution in the 80’s and its more recent successes
in the advertising and ecommerce sectors of the internet, to driving the
adoption of broadband and mobility technologies. Despite his successes, Masayoshi
Son has seen failure. This includes losing 99% of his net worth in 2000. This
is where the similarities to Warren Buffet and his relatively more conservative
investing approach diverge. Masayoshi’s appetite for risk taking offers the
promise of big reward, such as the epic 761 times return on his $20 million
investment in China e-commerce giant Alibaba years ago, but it also introduces
a lot of risk.
It is Softbank’s, and more specifically
Masayoshi Son’s, investment prowess that is such a crucial component of the
Softbank investment hypothesis that it requires proper scrutiny.
CEO Masayoshi
Son’s Investment Track Record
Is it possible to reconcile an investment
track record that includes some of the best investments ever made, after a
total collapse in 2000?
Answering this crucial question at a
surface level you’d conclude that overall Masayoshi’s investment track record is
intact, up there with the legends. Since the crash in 2000 Softbank has grown
their investments 15x from $11 billion to $175 billion.
However, one of the main criticisms
levelled at this track record is the belief Masayoshi Son is a one hit wonder
with Alibaba being the reason Softbank has seen their investments grow 15X. That
is not really a fair assessment. Granted, the Alibaba investment of $64 million
made in 2000 has grown 1,405 times to its current value of $90 billion (as of May
2017, Source: Softbank 2017 Annual Report), but Softbank has a number of successes
to point to – an original investment of $68M in Yahoo Japan that has grown 175
times over a 20 year period (as of May 2017, Source: Softbank 2017 Annual
Report), a $3 billion investment in gaming company Supercell in 2013 that generated
a 2.6 times return when they exited in 2016, and a one year 60% gain from the
sale of their share of India’s largest e-commerce company Flipkart to Walmart.
In fact, Softbank’s Internal Rate of Return
(the financial metric companies use to assess profitability of investments
they’ve made) covering this 18-year period drops only two percentage points
(from 44% to 42%) when you exclude Alibaba, its top holding (as of May 2017,
Source: Softbank 2017 Annual Report). You can see below how Softbank’s IRR does
not drop below 41% even as you exclude it’s top five most profitable
investments.
While Masayoshi Son can stand by his
investment track record, there is new criticism being directed at his company, because
of Softbank’s new Vision Fund. The purpose of the Softbank Vision Fund is to
accelerate Masayoshi Son’s vision of the Information Revolution by making
large-scale, long-term investments in companies and platform businesses. With
over $93 billion raised so far ($100 billion is the goal for the fund), skeptics
suggest it will be quite difficult to invest its unprecedented levels of
capital into high quality companies. As a reference, the Vision Funds target of
$100 billion invested capital equals almost exactly the same amount that all
VC-backed companies received in 2016 (Source: CB Insights).
Supporters will defend this by pointing to the transformational potential of the
company’s Masayoshi Son is investing in as part of the Vision Fund.
Masayoshi Son has made some wildly
successful investments in the past, but will he and his lieutenants be able to
have similar success at this level moving forward? This question generates a
large portion of the risk often associated with an investment in Softbank.
In my opinion investing in Softbank carries
high risk. I believe some of this risk is tempered by Softbank’s investment
strategy they call the “Cluster of No.1 Strategy” – which involves betting a
small stake (20-30% ownership ratio) in the leaders of growing markets. In
contrast, Softbank’s pre-2000 crash Zaibatsu (Japanese conglomerate) strategy
involved making much larger bets (greater then 50% ownership stake) in smaller
players of growing markets. The “Cluster of No. 1 Strategy” has led to
investments in Uber, WeWork, ARM and Nvidia.
I also like how Masayoshi Son has learned
from some of his other mistakes. In 2017, Softbank acquired private-equity firm
Fortress Investment Group to build its investing brain trust. Why this is
important is because Masayoshi Son has been criticized in the past for making some
investment decisions with not enough due diligence. Learning from mistakes and
addressing valid feedback are both hallmarks I like to see in the leaders of
companies I invest in.
Current
Valuation
One of the other attributes that makes Softbank an
attractive investment for me is their current valuation. As of August 28th,
the company is worth $100 billion USD. What do you get for that $100 billion?
If you add up the value of all the diverse parts of Softbank, you would get a
lot more than its current $100 billion market capitalization:
·
$31 billion in cash (as of
March 31, 2018)
·
$139 billion in Alibaba shares
(as of June 2018)
·
$21 billion in Sprint shares (as
of June 2018)
·
$8 billion in Yahoo Japan shares
(as of June 2018)
·
A 75% stake in chip maker ARM
worth $24 billion (as of June 2018)
·
$29 billion in value for its
positions in the Softbank Vision Fund, Uber, DiDi, and some other companies
The full value of this basket of assets
alone is well above Softbank’s current market capitalization of $100 billion (as
of August 28th) – to be specific the total value of the above assets equals
$252 billion. That’s $152 billion you could argue that is not baked into the
current share price of Softbank. This does not even include the value of its
domestic telco business, which is a profitable cash cow for Softbank.
Before we claim that Softbank is currently
undervalued by more than 50%, we must consider its debt. Ah, yes, the chink in Softbank’s
armor. Many investors have stayed away from Softbank because of their higher
than industry standard net leverage ratio. While the company has expressed
their intent to reduce their debt burden, this high debt introduces risk into the
investment thesis. You should consider this when evaluating Softbank as a
potential investment for your portfolio.
To account for their debt, let’s subtract
this from the total dollar value of the different parts of Softbank we calculated
above: $252 billion minus net debt of $89 billion (excludes Sprint related debt
as reportedby Softbank in June 2018). What you are left with is a potential “fair
value” for Softbank, considering the value of all its parts minus its debt
obligations, of $163 billion.
Based on Softbank’s current stock price, there
could be 63% upside in the stock. Keep in mind these are “back of the napkin”
type calculations and do not represent a comprehensive financial analysis, but
I personally see enough upside to make it worth my while to invest.
I’m not the only one who is acting on this
calculus. US hedge fund Tiger Global announced in July
that it had built a stake in Softbank worth over $1 billion. Los Angeles-based
investment firm Capital Research also increased its holding recently (June
2015), shelling out more than $2 billion for their stake. Both firms pointed to
what they perceive as the lower than fair price the company is currently
trading at, as justification for their massive investments.
This renewed confidence in Softbank stems
from their concerted effort to close what the company describes as a valuation
gap in their current share price and what they believe is fair value. This
effort includes drawing greater distinction between its telecom operations and its
investing activities. The best examples of this effort are the recently announced
merger of Sprint and T-Mobile, and their recent filing to take their domestic
telecom unit public. These efforts appear to be paying off with the stock (SFTBY) growing 29% since
June 2018.
My
bottom line
As with any investment decision you make it’s
important to complete your own due diligence and assess if the investment
matches your risk profile. There is no question an investment in Softbank
carries a fair amount of risk. To invest
in Softbank, you must be comfortable taking on this amount of risk in your portfolio.
Based on the investment strategy and track
record of Masayoshi Son, and what I feel is a currently low valuation, I
decided to invest in Softbank a few months ago. To account for the high-risk
nature of this investment, I have drawn from my small pool of funds that I set
aside to make measured and intelligent bets. Bets that I do not take
frequently, nor ones that would cause financial hardship if I am wrong. I
believe Softbank fits these criteria.
The
Investment Hypothesis for Softbank
·
Masayoshi Son’s investment track record suggests the
potential for Softbank’s more recent bets paying off is significant
·
Softbank’s current valuation
indicates Wall Street is undervaluing
the company
·
While Masayoshi Son’s
investment track record the last 18 years is impressive, he did falter before,
and his current investments carry a lot of risk
·
Begin a position in Softbank as
a high-risk investment
·
Sell when stock achieves a
valuation more commensurate with the company’s fair value
Note: The articles posted on this site are my opinions and should note be considered as professional financial advice. Please consult a financial professional before using any information offered on The Informed Investor blog.