JOIN USSoftBank has bigger reasons than Beijing to sell Alibaba
By Tim Culpan
News that SoftBank Group Corp plans to keep selling its stake in Alibaba Group Holding Ltd should come as no surprise. Continued restrictions imposed by Beijing on Chinese industry, particularly the internet sector, may exacerbate the need to reduce exposure to the country. Yet plenty of factors closer to home make cashing out an important strategy.
Let’s take the biggest global stock market selloff in more than a decade as one example. Six years ago, founder and Chairman Masayoshi Son reoriented the software retailer-cum-telecom operator toward being a publicly listed venture capital fund. Whereas phone companies were once considered a great bet in a downturn, relying on a steady flow of share listings has been the core strategy of his SoftBank Vision Fund. Beyond public equities markets, the fund had also been able to reap fat earnings from revaluations at portfolio companies as they raised fresh rounds of cash.
That gravy train got derailed three years ago, with the Vision Funds — there are now two of them — dragging SoftBank Group earnings down quarter after quarter. The primary culprit has been a continued decline in the net worth of the funds’ holdings in both public companies and private unicorns. That value dropped a combined $5 billion in the December period alone, and they’re net losers since inception.
But the rise and fall are only paper profits (and losses). A more pressing issue is the ongoing IPO drought that means fresh money isn’t being brought back into the funds, or SoftBank itself.
Cash is crucial to Son’s empire for multiple reasons. First, he put the Vision Fund on the hook for 7 per cent in annual payments on $40 billion of preferred equity right from the start, regardless of the portfolio’s earnings. While more than half of that prioritised capital has since been returned to investors, the fund still bears the burden of making cash disbursements no matter what happens. The upshot is that any money that does flow in must first go to this special group of shareholders before any can be passed on to SoftBank Group.
Then there’s the rest of SoftBank’s debt. At the end of December, it stood at 31.7 trillion yen; that’s $235 billion at today’s exchange rate. Less than one-eighth of that is interest-bearing liabilities due within a year, but what’s particularly telling is that while SoftBank managed to pay off 5 trillion yen during the nine months to December 31, it also went back out to the market to raise 6.5 trillion yen. The lion’s share of this came from using stakes in both Alibaba and ARM Holdings Ltd as collateral.
Son’s early bet on Alibaba was a career-defining move, and he’s dined out on it ever since. But that investment has run its course. Reports this week that SoftBank will sell more of its stake in the Chinese e-commerce giant should come as no revelation to anyone paying attention. This process started in earnest 18 months ago, amid Beijing’s crackdown on internet companies and at the height of the Covid-19 pandemic, which stymied global trade and hit the Chinese economy hard.
At the end of 2019, SoftBank owned a little over 690 million American Depositary Shares worth $147 billion. Over the next year, the Japanese company used those holdings to raise funds, usually as margin loans, with Alibaba as collateral or as prepaid forward contracts. That latter strategy consists of taking cash from a counterparty and pledging to deliver shares at a pre-determined price and usually on a certain date. One quirk of these forwards is that SoftBank would actually post a loss on the transaction if Alibaba stock rose during the quarter, but it was offset by an increase in holding value.
For most of the following two years, SoftBank’s stake in the company hovered around the same level. Quarterly changes to the value of these shares, and the proportion of the company’s balance sheet attributed to Alibaba, rose and fell according to its price on the New York Stock Exchange.
Then things started to change. The ratio of SoftBank’s Alibaba shares put up for collateral or entered into forward contracts started climbing, from 12 per cent at the end of June 2020 to a peak of 55 per cent two years later, according to Bloomberg Opinion calculations based on company statements. Soon after, its actual holdings started to drop. First gradually — by 5 million ADS one quarter, 17 million units the next. And then precipitously.
The value of SoftBank’s unencumbered stake in Alibaba — meaning not pledged for loans or forward contracts — went from just over $50 billion at the end of 2021 to around $16 billion at the end of December 2022. While a big chunk of that deterioration was due to a 25 per cent drop in share price last year, the simple fact is that SoftBank is getting out of Alibaba. Its stake, free and clear, is now likely in the single digits, according to Bloomberg Opinion estimates.
While this may be a shock to investors in both companies, it makes sense. Son knows that Alibaba’s best days are behind it, and that’s not just because of Beijing’s heavy hand or increased tensions with much of the world, but because the pace of China’s consumer economy isn’t what it used to be.
True, much of Alibaba’s share slide can be connected to antitrust investigations and founder Jack Ma’s harsh criticism toward regulators that preceded him largely disappearing from public life, but the bigger challenge is a malaise in local spending. This culminated in an announcement last month that Alibaba Group will split into six Baby Babas in a bid to unlock value. But instead of hanging on in the hope of a rebound, SoftBank is cashing out and turning its attention to a more important investment: itself.
Beyond servicing debt and looking for new deals, SoftBank is using as much spare cash as it can find to conduct share buybacks to prop up its stock. That appears to be working. A $4 billion spate of repurchasing in the December quarter helped the shares climb 15 per cent in the period, the best return in two years. But the real struggle will come when the Alibaba stake is all gone. Investors can take heart in the fact that SoftBank is about to relist semiconductor company ARM overseas, and we can be sure Son will tap that well as often as needed.