As its sale of Arm collapses, the tide is turning against SoftBank

FEW COMPANIES are more emblematic of the tech-obsessed, easy-money era of the early 21st century than SoftBank, the Japanese investment conglomerate founded and run by Son Masayoshi, or Masa for short. Starting life as an obscure Japanese software distributor in 1981, it has made one debt-fuelled bet after another to become an internet firm, a telecommunications giant, and then what Mr Son last year called the world’s biggest venture-capital (VC) provider, comfortably ahead of Tiger Global, a New York hedge fund, and Sequoia Capital, a VC powerhouse. Parts of its balance-sheet are opaque yet it continues to borrow heavily and is one of the world’s most-indebted non-financial firms. Like many of the Silicon Valley firms it invests in, it has a dominant founding shareholder who is not averse to spouting gobbledygook. Mr Son says he invests with a 300-year horizon, making SoftBank as close to immortal as financial firms get. But it is the here and now that he should be most concerned with.

That is because the tech boom, which SoftBank has both fuelled and benefited from, may be coming to an end. In the face of the highest rates of inflation in decades, central banks have started to raise interest rates. That threatens to tighten credit markets for highly leveraged entities like SoftBank. More important, higher rates make a big difference to the long-term value of the sort of high-growth tech startups it invests in, whose profits are in the distant future. As one of the highest rollers in two of the business megatrends of the past few decades, it is worth asking what would happen if tech fandom and easy money prove evanescent. As Warren Buffett once said, it’s only when the tide goes out that you can see who is swimming naked. What, Schumpeter wonders, is the state of Mr Son’s bathing attire?

Mr Son, like Mr Buffett, enjoys a colourful turn of phrase. On Feb 8th, reporting an 87% year-on-year slump in SoftBank’s net profit in the nine months to December, he was blunt. Not only was the company in the midst of a blizzard that started last autumn, he said. The storm had got worse in America and elsewhere because of the threat of rising rates. Though SoftBank eked out a small profit in the most recent quarter, the two most important variables that Mr Son watches like a hawk deteriorated sharply. One was the net value of SoftBank’s portfolio of assets, which fell by $19bn to $168bn. The other was the value of its net debt relative to equity, which reached the highest level since 2018 when SoftBank floated its Japanese telecoms business.

To gauge the risks, start with the asset side of those calculations. However much of a brave face Mr Son puts on it, good news is scant. On the day of its results SoftBank confirmed that it had called off the sale of its British chip business, Arm, to Nvidia, a California-based semiconductor firm, because of regulatory pressure. At Nvidia’s highest price, the implied sale value was above $60bn, or about twice what SoftBank paid for Arm in 2016. Instead SoftBank will sell shares in Arm in an initial public offering (IPO) in the next financial year. Mr Son noted that the underlying profits of Arm’s chip business are estimated to have improved recently, which may make it more attractive. Yet Kirk Boodry of Redex Research, an investment adviser, reckons an IPO has little chance of generating as much value as a sale. Moreover, potential investors need only look at the poor public-market performance of almost all the 25 companies SoftBank listed in the past ten months to know that tech IPOs are no longer a gravy train.

Also on the asset side are SoftBank’s troubled investments in China and in its two Vision Funds, which invested in a whopping 239 young companies last year. Alibaba, the embattled Chinese tech giant, was once the cornerstone of SoftBank’s investment strategy, accounting for 60% of net assets. Now SoftBank treats it like a get-out-of-jail-free card, selling stakes to fund riskier ventures elsewhere. Its weight in the portfolio has shrunk to 24%. On February 7th Alibaba’s share price fell by 6% on fears that SoftBank would cut its stake yet more. For SoftBank, Alibaba is now vastly eclipsed in importance by its two Vision Funds, which account for almost half of the group’s net assets. These inched up in value in the most recent quarter, mostly because of valuation gains in unlisted firms. If the stark sell-off of SoftBank’s publicly traded firms is any guide, however, it may be only a matter of time before valuations of firms in the pre- IPO stage stagnate or even in some cases start to slide.

SoftBank’s debt is worrying, too. It said its loan-to-value (LTV) ratio, or net debt as a share of the equity value of its holdings, was 22% at the end of December, up from 19% three months earlier; it considers 25% to be reasonable in normal times. However, others calculate the ratio more conservatively, including additional liabilities such as margin loans, investment commitments and share buybacks that SoftBank excludes. Sharon Chen of Bloomberg Intelligence, a financial-analysis firm, says that based on her measurements, SoftBank is getting close to the 40% LTV threshold that S&P Global, a ratings agency, has said could be a trigger for a debt downgrade (though the plan to list Arm could ease the pressure). A further sale of Alibaba shares could be used to cut debt, but might also lower the quality of the portfolio—another rating-agency red flag.

Wetsuit, speedos or nothing at all?

SoftBank has had enough debt-related troubles in the past for Mr Son to realise the dangers. It has long pledged to keep enough liquidity on hand to fund two years of debt payments. It also benefits from a pool of banks and ordinary savers in Japan who like the high yields it provides compared with other Japanese borrowers. But its longer-term financial stability rests on two variables—the value of its assets and the size of its debts—which in current circumstances would benefit more from prudence than growth. More than a pair of speedos, Mr Son needs a wetsuit. ■

Read more from Schumpeter, our columnist on global business:

How Sony can make a comeback in the console wars (Feb 5th)
Lakshmi Mittal transformed steelmaking. Can his son do it again? (Jan 29th)
Making sense of the East-West divide in tech (Jan 22nd)

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This article appeared in the Business section of the print edition under the headline “Does Masa have his trunks on?”