SFTBY - SoftBank Group: Significantly De-Risked And Positioned Well For The Future

2023-05-23 11:01:23 ET

Summary

• SoftBank shares have fallen out of favor with investors and are well off their pandemic era highs.
• The company has massively de-risked their business over the past year and shares are trading well below their NAV.
• The company has focused on making VC investments in emerging tech such as AI and these investments could pay off big.
• The arm IPO is coming soon and could help SoftBank shares close the gap between NAV per share and the current share price.
• The combination of a de-risked business trading well below NAV, strategically positioned investment portfolio, and upcoming arm IPO make SoftBank a speculative buy at these levels.

Thesis

SoftBank Group ( SFTBY ) shares have fallen precipitously from their pandemic era highs. The shares are now trading well below their NAV. The company has massively de-risked over the past year through selling most of their Alibaba (BABA) stake and lowering their debt burden. Their focus on investing in emerging tech will likely pay off in the future with concepts such as AI based tools becoming more popular. An arm IPO is on the way, giving SoftBank yet another opportunity to monetize their private holdings. The combination of a de-risked business trading well below NAV, strategically positioned investment portfolio, and the upcoming arm IPO make SoftBank a speculative buy at these levels.

(All uses of "SoftBank" in this article are referring to "SoftBank Group").

NAV Discount

As of March 31 SoftBank Group had a NAV of $105.8 billion. With a market cap of $54.9 billion the company appears to be massively undervalued. Unfortunately for us, investing is not that simple. The market is currently disputing the value assigned to SoftBank's assets, which is why shares are trading at such a drastic discount to NAV. An investor interested in taking a position here should evaluate SoftBank's assets and come to their own conclusion of how much they are actually worth, and invest accordingly.

In our opinion SoftBank is undervalued because they have taken many steps to de-risk their business. Their investment portfolio is well positioned to benefit from emerging technologies such as AI, and the arm IPO is just around the corner. For these reasons the actual value of SoftBank seems at worst to be their NAV, with significant upside from these levels.

De-Risking the Business

SoftBank has entered a mode they describe as being defensive. The company may finally be curtailing their sometimes reckless investing behavior (looking at you WeWork) and is entering a new era of risk management.

As we can see in the graphic below, SoftBank has reduced their LTV from 20.4% in March 2022 to 11% as of March 2023.

The company has materially increased their cash position and will be able to take advantage of investment opportunities in the future.

Keeping with the theme of risk management, SoftBank has sold out of most of its Alibaba position. In the past the size of their Alibaba position has represented a large amount of concentration risk and turned away investors who are bearish on China. The company is now much more diversified than they were two years ago and is no longer exposed to an oversized amount of China risk.

The company seeks to stick to their financial policy outlined below.

SoftBank has done well to reduce the risk of their business and appears to be entering a new era focused on risk management and sensible investing.

Investment Portfolio

45% of the equity value of SoftBank comes from the combination of Vision Funds 1 and 2 and their LATAM funds. These funds primarily consist of VC investments. Some of those VC investments continue to be held after the company has gone public.

The main focus of their investment funds is to fuel the technological innovations of the future. Some of these technologies include generative AI, quantum computing, self-driving, biotech, gene editing, robotics, metaverse, and blockchain.

Unfortunately for investors their focus on emerging technologies has produced lackluster results so far, with their combined vision funds being in the red since inception.

That being said, now may finally be the time for their portfolio companies to thrive. Their investment focus on emerging tech could reap massive rewards due to adjacent technological advancements. A simple example of this is semiconductors becoming more advanced allows AI to be trained faster and at a lower cost. While some emerging tech will probably end up being more hype and less substance, there will be some areas where the hype and valuations are justified. We believe that on average SoftBank's equity portfolio should be worth at least what they claim it is now, with potential for further upside as technology continues to progress at a rapid pace.

Arm IPO

Arm may be the most hotly anticipated IPO of 2023, and it is easy to see why. The company owns the semiconductor IP that powers many semiconductor chips around the world, with Apple being their most notable customer.

The company is showing modest revenue growth; however, they are just beginning to ramp up adjusted EBITDA. This shows the ability of arm to gain increased operating leverage out of their model.

As more companies switch to arm based designs the company may see a re-acceleration in growth going forward.

According to CNBC :

"Arm plans to sell its shares on Nasdaq later this year, seeking to raise between $8 billion and $10 billion, people familiar with the matter said. In a statement, which confirmed an earlier Reuters report on the planned IPO, Arm said the size and price range for the offering has not yet been determined."

It's likely that arm will go public at a market cap higher than the $32 billion they paid for the company in 2016. SoftBank's own $54.92 billion market cap could be lower than the eventual range the arm IPO is priced at, which is yet another example of the investor pessimism that surrounds SoftBank. The arm IPO may serve as a catalyst for the company to close some of the gap between the current market cap and NAV.

Price Action

SoftBank Group is trading at levels that could be seen five years ago. In that time the value of SoftBank's equity portfolio grew rapidly during 2020/the start of 2021 only to deflate over the next several quarters. At this point we view the selloff as being overdone, especially in light of the de-risking the company has done. Reducing exposure to China-based risk is more important than ever, and with their Alibaba sales SoftBank has removed a major concern surrounding the company. In addition to this their focus on investing in emerging technologies such as AI may reap significant benefits for investors. We believe the company is well positioned for the future.

Valuation

While SoftBank Group does have some operating segments, we believe that the best valuation metric is NAV. In our opinion SoftBank Group should trade at around 80% of their NAV, if not more. There will generally be some form of discount due to the taxes they would need to pay if they sold some of their equity holdings, but the current discount appears to be far too much.

SoftBank Group has a current market cap of $54.92 billion and a NAV of $105.8 billion (as of March 31). We believe the fair market cap should be at least $84.64 billion, which represents around a 54.12% upside from these levels.

Risks

A risk to this bullish thesis is the possibility that SoftBank's private market investments are in low quality companies and that there are significant write downs coming in the future. This is certainly possible, especially given how many duds SoftBank has pumped money into for big losses (WeWork, Greensill Capital, Wag, Katerra, Oyo, DiDi, the list goes on). We view this risk as being acceptable because a lot is already priced into the shares and losses are part of the nature of investing in early stage companies. Their portfolio is positioned to take advantage of technological advancements that were not as viable in the past as they are in the present/future. As long as they hit a few homeruns the poor investments will be more than made up for.

Another risk is the potential for geopolitical risks to negatively impact SoftBank and their portfolio companies. The drawback of having a globally diversified portfolio is some geographies may have a more difficult time recovering from economic hardships than others. This normally wouldn't be that big of a deal in the long run, except for the fact that SoftBank makes a lot of investments in small private companies that are sometimes pre-revenue, and are often losing massive amounts of money. These companies could go to zero if their home markets enter a severe economic downturn. This risk is very real but has also been somewhat baked into the share price already.

We view the risk/reward as being favorable at this time. SoftBank is a company that in the past has had too many question marks surrounding it, but now may finally be a good opportunity to invest for the reasons we have discussed.

Key Takeaway

SoftBank Group appears to be becoming a more mature company and is selling at a significant discount to their NAV. We believe that the de-risking of their business, emerging tech focused nature of their equity portfolio, and the arm IPO make SoftBank Group a buy at these levels. If the stock rallies from here and begins to trade at a premium to NAV, bullish investors should probably take another look and think about selling.

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