(Bloomberg Opinion) -- Just six weeks ago, Chairman Masayoshi Son was crowing about the value of SoftBank Group Corp. and brushing off the notion that he should sell his prized stake in Alibaba Group Holding Ltd. after a terrible quarter and massive asset writedowns.
Things change. In a surprise announcement Monday, the Japanese conglomerate said it plans to peddle or monetize up to 4.5 trillion yen ($41 billion) of assets over the next year. It plans to use that cash to execute 2 trillion yen of buybacks as well as redeem debt and repurchase bonds.
Make no mistake, this is a fire sale. Son’s most likely source of cash over the next few years was supposed to be his $100 billion Vision Fund, but with the Covid-19-spurred global stock meltdown adding to his ill-advised investment in The We Co. (better known as WeWork), that spigot won’t be flowing any time soon. Meanwhile, activist shareholder Elliott Management Co. is pushing the SoftBank boss to buy back shares, and there are at least 1 trillion yen in bond redemptions between now and the end of next year.
So instead of just one challenge or two, SoftBank is facing a barrage and equity investors know it. That’s sent the company’s shares down 45% from a recent peak.
Making that trauma worse: Shares of Alibaba are off 21%. SoftBank’s 25.2% stake in the Chinese e-commerce giant is now worth at least $33 billion less than in mid-January, highlighting the cold reality that an upward trajectory for Son’s most beloved investment isn’t assured. Not only is Alibaba SoftBank’s largest asset — 54% of holdings at the end of December — it’s a chief source of both net income and cash flow. The stake in Alibaba has to be at the top SoftBank’s “for sale” list. Son has had trouble making successful deals lately, so it undermines his reputation to see the crown jewel also lose its shine. Yet it’s partly because of the details of Alibaba’s contributions that SoftBank is vulnerable and those shares need to be sold.
Almost half of SoftBank’s pre-tax net income for the nine months to Dec. 31 were pure paper profits tied to Alibaba. A quarter came from a revaluation of its stake when Alibaba listed in Hong Kong last November. Another portion came when Alibaba took equity in its fintech unit, Ant Small and Micro Financial Services Group Co. If not for these one-time gains, SoftBank’s pre-tax profit would have dropped 34%.
While Son proudly notes that Alibaba enjoys an A+ credit rating and churned out 900 billion yen ($8.2 billion) in free cash flow in the second half of last year, none of that money went to SoftBank, the single-biggest shareholder. Alibaba doesn’t pay dividends.
To monetize its stake in China’s most valuable company, SoftBank has been forced to take out margin loans with Alibaba shares as collateral. In the last three quarters of 2019, it boosted borrowing against Alibaba shares by $4.4 billion, or an additional 83%. That takes the total to over 1 trillion yen. Another 179 billion yen came from settling a derivative contract tied to that stake.
SoftBank has managed to rustle up more cash by selling stakes in some companies to the Vision Fund, which it manages. But by and large, the chief source of cash flow has been to continually tap debt markets with its own assets as collateral.
With more than $100 billion of Alibaba shares on hand, it’s possible that SoftBank will try once again to tap this vein. But it’s also likely that wary creditors will already be gun shy about taking on more equity as collateral as global markets post some of their worst declines of the last few decades.
An interesting twist is that SoftBank’s loans against Alibaba shares are non-recourse. If SoftBank can’t pay back the debt or the value of the pledged shares falls (by an amount not publicly specified), then creditors have an early settlement clause that could see them take ownership. If push comes to shove, the message from creditors will be: If you don’t sell Alibaba shares, then we will.
But there’s a complication. According to its Hong Kong listing prospectus, Alibaba has the right to defer any attempts by SoftBank to sell its stake by up to 90 days “if our board of directors determines in good faith that such registration and offering would be seriously detrimental to us and our shareholders.” With the global economy plunging toward recession, it’s not a stretch to think that unloading a chunk of shares would be seen as bad for Alibaba.
That makes for a high-priced game of hot potato. Creditors won’t be keen to take on more SoftBank debt, and Alibaba’s board surely won’t want to approve the sale of more shares, especially with them now trading below their Hong Kong listing price.
If Son is to pull off this cash-raising plan, he’s going to need to swallow his pride and accept letting go of at least some of his Alibaba stake. Certainly he, and his investors, would have preferred doing so when shares were trading 20% higher. But better to start now than get caught another 20% lower.
SoftBank has made a lot of money from Son’s early belief in a young Chinese entrepreneur named Jack Ma. Now’s not the time to squander that success by chasing more.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Tim Culpan is a Bloomberg Opinion columnist covering technology. He previously covered technology for Bloomberg News.
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