Alarm bells ringing at consumers’ champion

Softbank likes to be known as the champion of consumers, to whom it brings colourful phones and cut-price tariffs; as a technological wunderkind; and as one of
Japan’s rare entrepreneurial companies.

Today, however, the debt-burdened communications conglomerate is in the spotlight for an altogether more prosaic reason: its accounting policies.

Accountancy is at the top of the regulatory agenda in Japan after a string of irregularities, most recently at Nikko Cordial, the brokerage, and electronics manufacturer Sanyo Electric. Both have been forced to restate profits. Their auditor, the PwC unit Chuo Aoyama, renamed Misuzu, is winding down operations after several accounting scandals.

Softbank, headed by billionaire chief executive Masayoshi Son, also used Chuo Aoyama, but has now appointed Deloitte Touche Tohmatsu on a permanent basis. Kieran Calder, telecoms analyst at CLSA Asia Pacific Markets, reckons the timing is significant as the new auditors prepare to sign off the full-year accounts.

“With Softbank’s highly complex structure and accounts, we should expect a high level of scrutiny from new auditors Deloitte Touche Tohmatsu, whose professional reputation is at stake in taking on this new client,” he wrote in a report on Softbank released on Wednesday.

“Given the history of Softbank’s former auditor, there must be a risk of some level of restatement. Also, in the current regulatory background, it must be increasingly probable that the Securities and Exchange Surveillance Commission too would be interested in Softbank.”

The SESC, which regulates the securities markets and keeps its modus operandi under wraps, would not
comment. The Ministry of Internal Affairs and Communications, which has responsibility for the telecoms industry, was more forthcoming. It has been keep­­ing an eye on Softbank’s flexible accounting policy and moun-ting debts. CLSA outlines three issues clouding Softbank’s earnings: scope of consolidation, frequent acc-ounting changes and earnings quality.

Softbank claims 115 consolidated subsidiaries and 71 equity method non-consolidated subsidiaries and affiliates. In addition, there are
64 unconsolidated subsidiaries. Debt – a pertinent issue for a company sitting on $17bn of the stuff – is not a criteria for non-consolidation. “This should be considered a red flag, because off-balance sheet debt that is immaterial under low interest rates could become significant in a rising rate environment,” notes Mr Calder.

The Bank of Japan last month hiked interest rates to 0.5 per cent, though this is still low by global standards.

The frequent accounting changes enable Softbank,
for example, to take depreciation over a longer period by increasing the useful life of assets, and to capitalise expenses. Such changes, says CLSA, contributed 30 per cent of operating profit in the year to March 2006.

Analysts’ concerns over the quality of earnings relate to the frequency of investment disposals – one-off sales that raise cash and boost profits.

“Despite the fact that Softbank’s revenue base is dominated by telecoms businesses which should be stable and predictable, an increasing portion of net profit is from sales of investments,” says Mr Calder.

Other warning flags include a significant discrepancy between capital expen­di­ture and depreciation.

Moreover, CLSA calculates that Softbank’s net debt is closer to Y3,000bn ($25bn), rather than the Y2,100bn claimed in the latest annual report, once adjustments are made. Items that CLSA adds back include capital leases and off-balance sheet debt.

Kazuko Kimiwada, general manager of accounting at Softbank, says Deloitte has seen interim results. “The audit opinion was given to us. Everything in the accounting and auditing situation seems quite normal.”

She says the extended depreciation periods reflect Softbank’s greater experience in telecoms and ability to judge the useful life of assets. As to capital leases and other off-balance sheet items, she said all were
fully disclosed. The non-consolidated companies in the first quarter, she says, had total assets of just Y5bn and “hardly any debt”.

What is clear is that there is plenty for Softbank’s incoming auditors to pick through when they take up the internet group’s books. “Anyone just looking at the annual report would pick up on this stuff,” says Mr Calder. “The weight of evidence” of accounting red flags “is overwhelming”.

For the latest developments on this story and for statements issued by Softbank and CLSA, please follow this link.

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