Darling of the TSE spooks investors

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Masayoshi Son, who heads Softbank, is in many ways a throwback to the days of telecoms derring-do – bold, acquisitive and visionary.

So when it transpired that he had lent one third of his personal holdings in the telecoms and internet conglomerate, at least partly as collateral for loans, investors were left puzzling over his motives.

Softbank has acknowledged that Mr Son used shares as collateral for loans, but would not comment further. At best, the non-collateral loans represent ordinary stock-lending – an activity that would give him a few basis points’ extra yield on his stock.

At worst, investors fear it may be a way of liquidating holdings since the stock could be seized if, for example, Mr Son reneged on loan repayments. An initial 18m shares were lent in a transaction relating to Gravity, a US company, although this would have swollen following margin calls as Softbank’s share price fell. The terms of that stock lending agreement say the deal would be automatically scrapped if Softbank’s share price falls below Y2,000. Softbank shares closed at Y2,220 on Friday.

The latest concerns come as Softbank, Japan’s most popular stock, has already spooked investors twice in recent months – first by over-paying for Vodafone’s struggling Japanese assets, and second about worries over accounting practices. The latter development, raised by an analyst report from Lehman Brothers, lopped 15 per cent off Softbank’s share price in the space of two days last month.

Softbank’s first set of earnings including Vodafone Japan cast Mr Son in a glowing light. Two months after it paid Y1,800bn ($15.4bn) for Vodafone Japan, Softbank had fattened up operating margins – although the accompanying balance sheet also revealed that it had almost halved the value of Vodafone’s fixed assets.

The balance sheet itself is strained. Having launched Japan’s biggest leveraged buyout in order to pay for Vodafone, Softbank is now sitting on Y2,200bn of net debt. On a blended basis, the cost of servicing the Vodafone debt comes to about 4-5 per cent, and it is now in negotiations to roll over the bridging loan.

Combing through the annual report, it appears that the Japanese group helped lift profitability in part by clever accounting. Softbank has a penchant for capitalising losses, so they no longer dent the bottom line, and capturing revenue streams up front through securitisation deals. It makes generous use of goodwill, which it can amortise over a longer period, and extends the life of assets to lower the annual cost of depreciation.

The footnotes in Softbank’s last annual report offer a glimpse of how these changes translate into operating profit.

The company decided that transmitters and exchanges at Japan Telecom, the fixed-line network that once belonged to Vodafone and that Softbank acquired in 2004, had a useful life of 10 years rather than six. This was based in part on the – presumably elongated – “technological innovation cycles in the telecoms industry” and added $120m to operating profits. Buildings were similarly subjected to new treatment, worth $8.7m of operating profit.

There were other changes too. Capitalising network line construction expenses that previously appeared as selling, general and administrative expenses contributed an extra $27.5m. In aggregate, three changes in accounting policies added $156.2m to operating profit, or almost one-third of the total Y62.3bn. At the operational level, Softbank’s penchant for selling units does not appear to stop it benefiting from the income streams in these units.

The modem rental business, which Softbank sold last year, is a case in point, according to Lehman Brothers analyst Nicholas Spratt. Softbank claims average revenue per user of Y4,387 per month for its broadband infrastructure arm, marginally up on an annualised and quarter-on-quarter basis and thus bucking the trend of its peers. However, part of that revenue bypasses Softbank, since it goes to the new owner of the modem business.

A Softbank executive says: “The contract is with modem investors that we serve as ADSL carrier so we can expect continuous business to collect money and maintain business.”

Moreover, the average revenues apply to fewer customers than the 5.1m on Softbank’s books, since only 88 per cent of broadband subscribers – or 4.5m – actually pay. “It’s the nature of our business to have non-payers, and the variance is stable at around 600,000,” Softbank says.

Investors concerned by Mr Son’s stock lending activities are increasingly scrutinising just what is the nature of Softbank’s business.

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