TRADE ALERT: On July 7 2020 I alerted my readers that I sold my entire position in SoftBank for a 28% gain in almost two years. I lost confidence in my original investing thesis for Softbank and thought there were better opportunities.
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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 leveled 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
What Could Go Wrong
· 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
What I Decided to Do
· Begin a position in Softbank as a high-risk investment
· Sell when stock achieves a valuation more commensurate with the company’s fair value
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