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Capital Markets

SoftBank's bullish business scares off cautious Japanese investors

CEO Son's big deals, fuzzy finances make it harder to raise fresh funds at home

Masayoshi Son

TOKYO -- Japanese telecom giant SoftBank Group has been struggling to raise money in domestic capital markets, which seem nervous about its expanding balance sheet as a result of big takeover deals and pressure on net profit from complicated derivatives deals.

Such worries are also starting weigh on the company's stock price.

Conservative Japanese investors have been skeptical about placing bets on Chairman and CEO Masayoshi Son's sprawling empire, even as foreign investors have shown enthusiastic demand for its foreign currency denominated bonds.

SoftBank is set to issue four foreign currency denominated bonds -- two dollar-based, and two euro-based -- worth some $5 billion in total. The debt will mainly be raised from foreign institutional investors and used to repay loans. SoftBank has already raised $4.5 billion through the July issuance of "hybrid notes," a form of subordinated debt.

Yet it appears to have suspended issuance of yen-denominated subordinated bonds, initially planned for around summer this year.

Lack of appeal

From time to time SoftBank has sought to enlarge its issuance of bonds targeting domestic institutional investors. But it appears to have concluded this time it will not be able to lure the money it needs from such investors.

In September last year, SoftBank raised 471 billion yen ($4.25 billion) through yen-denominated hybrid bonds, with small investors accounting for about 400 billion yen. Institutional investors did not seem too interested in the fundraising exercise.

The weak response to SoftBank's fundraising attempts at home compared to that from overseas, can attributed partly to a difference in risk tolerance. Most Japanese institutional investors are allowed by internal rules to only buy securities with a low-risk investment grades. SoftBank holds a BB rating from the two major rating agencies, S&P Global Ratings and Moody's, putting it at "speculative" grade. Despite any interest in high-yield SoftBank bonds, a number of investors are not even allowed to buy them.

Meanwhile, some investors seem to have been discouraged by uncertainty about the future of the conglomerate's finances. SoftBank has made some aggressive purchases overseas in recent years, including U.S. mobile carrier Sprint in 2013, and British chip designer ARM Holdings in 2016. Accordingly, interest-bearing debt across the SoftBank group has piled up to about 15 trillion yen at the end of June this year.

The growth strategy for Sprint could further affect the parent company's financing. Son is looking at various options for the future of the No. 4 U.S. carrier, including a merger with rival T-Mobile US, the third-largest, and a partnership with major cable TV providers. SoftBank's financing could be significantly affected by how any consolidation in the mobile sector plays out.

A new worry

For the stock market, one apparent concern is a derivative contract SoftBank arranged last year in relation to a convertible bond issuance.

SoftBank concluded a forward contract to hedge possible price fluctuations of shares of Alibaba Group Holding, a SofBank partner, on the issuance of the trust securities that bear a mandatory condition to be exchanged to American depositary receipt of Alibaba in 2019.

Through the contract, SoftBank Group has already fixed future gains at the exchange of the trust securities to Alibaba ADRs on its books. But until the 2019 settlement date, changes in Alibaba share prices are reflected in SoftBank's financial statements as derivative gains or losses. If Alibaba shares soar, for example, SoftBank's derivative valuation loss grows.

This unrealized twist -- typical in derivative transactions -- is only for accounting purposes that do not involve cash-out activities, and dissolves once the contract expires.

The bottom line is that the derivative contract can weigh on the group's net profit. For the April-June quarter this year, SoftBank posted a derivative valuation loss of 257 billion yen, while group net profit fell as much as 98% from a year earlier to 5.5 billion yen.

Gains in Alibaba share prices should essentially be a positive for SoftBank shares. But SoftBank's shares have been struggling since the negative effect of the derivative contract on earnings became more visible earlier this year. The effect could last until the contract is settled in 2019.

To regain confidence in domestic financial markets, SoftBank may need to explain itself better and be more open to dialogue with market participants over its increasingly complicated finances and business structures.

Earlier in September, the company held a briefing on the accounting treatment of its SoftBank Vision Fund, worth up to $100 billion, set up in May. The explanation involved a number of assumptions, even though the fund is within the scope of the group's consolidated financial reporting. Market participants appeared dissatisfied with the lack of accountability.


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