This report does not constitute a rating action.
The investment performance of SoftBank Group has become more volatile. A number of factors are behind this situation. First, there is growing uncertainty over the global economic outlook. Then, there's the distress some financial institutions in Europe and the U.S. face. In addition, rising interest rates have led to a worsening funding environment. And finally, volatility has risen in the stock market.
In particular, the fund business, through which SoftBank Group invests in unlisted companies under its growth strategy, has been hit hard. Investment losses in the business in fiscal 2022 (ended March 31, 2023) were ¥5.3 trillion (before deducting third-party interests), compared with ¥3.4 trillion yen a year earlier. Deterioration in the investment performance of the fund business led us to believe that the asset risk of the company's entire investment portfolio has increased more than we previously assumed.
Consequently, S&P Global Ratings downgraded SoftBank Group Corp. (BB/Stable/--) on May 23, 2023 (see "SoftBank Group Downgraded To 'BB', Subordinated Bonds To 'B' On Higher Asset Risk; Outlook Stable"). Here, we present frequently asked questions from investors about the rationale behind the downgrade and our outlook on SoftBank Group.
Frequently Asked Questions
Why did you downgrade SoftBank Group now?
We determined that negative factors for the business resulting from the volatility of its investment portfolio and increased asset risk are significantly greater than we had previously assumed. We do not think the situation will change soon. However, we see the company's financial management capability, high level of cash, and holding of shares in Arm Ltd., which could be listed, as factors underpinning the rating.
Negative factors for SoftBank Group greatly outweigh those underpinning the rating, in our view. In addition, the asset mix of the investment portfolio has changed significantly in the past year. Now, the asset liquidity of SoftBank Group's investment portfolio is likely to remain substantially below the tolerance range for our previous 'BB+' long-term issuer credit rating on the company unless Arm is listed.
On Nov. 17, 2022, we revised the outlook on our 'BB+' long-term issuer rating to negative from stable. This reflected the worsening condition of the company's liquidity and the creditworthiness of its investment portfolio. We expect both to remain significantly deteriorated over the next year or so owing to low prices of technology stocks. We said we might consider downgrading the company if the proportion of listed assets (including those in SoftBank Vision Funds (SVFs) 1 and 2) in its portfolio does not recover from the level of Sept. 30, 2022, in the next six to 12 months.
What do you consider to be the negative aspects of the group's fund business?
The fund business is one of the most unpredictable and high-risk assets in the group's investment portfolio, in our view. An increased proportion of riskier assets heightens the asset risk and volatility of its entire investment portfolio. The fund business in SoftBank Group specializes in investments in unlisted companies. We consider such companies to be less competitive and more susceptible to the external environment, including financial market developments. As a result, the fund business has potentially higher volatility. In addition, asset liquidity stays low until companies go public, in our view. The proportion of SoftBank Group's fund business to overall business has risen to nearly 40%. Unlisted companies made up 69% of SVF1's investment assets and 85% of SVF2's as of March 31, 2023.
In addition, the fund business invests intensively in global technology companies. These tend to have to potential to be highly volatile. Cumulative investment losses for SVF1 and SVF2 since launch widened to $8.5 billion as of March 31, 2023 (before deducting third-party interests). They were $1.5 billion at the end of September 2022. We attribute this to lower stock prices for companies in which SVF1 and SVF2 have invested and significant declines in the corporate value of unlisted companies.
How would the listing of UK-based Arm Ltd. affect SoftBank Group's rating? Would a delay in listing impact SoftBank Group's rating?
We regard SoftBank Group's holding of Arm shares, the largest asset in the portfolio, as a positive factor. This is because Arm would, as a listed stock, be a sizeable asset. Listing would improve asset liquidity in the future. In the rating analysis of investment holding companies, their ability to sell assets quickly is the ultimate source of debt repayment if they cannot refinance maturing debt. Therefore, higher asset liquidity is a positive factor. Arm accounts for 26% of the investment portfolio as of March 31, 2023.
Arm confidentially submitted a draft registration statement on its initial public offering plan with the U.S. Securities and Exchange Commission on April 29, 2023. This marks progress for a listing. However, the timing and value of a listing remain uncertain. As a result, we do not incorporate a listing of Arm in our base-case scenario.
Even if Arm's proportion of SoftBank Group's investment portfolio increases as a result of the listing, we believe that it will not lead to significant improvement of the asset credit quality of the entire investment portfolio. We do not believe Arm's creditworthiness is as high as that of China-based Alibaba Group Holding (A +/Stable /--), which had previously boosted the asset credit quality of the portfolio.
We have incorporated into our stable outlook on SoftBank Group the likelihood of Arm going public in the next six to 12 months. Accordingly, we might consider lowering the rating on SoftBank Group if listing Arm is significantly delayed, and at the same time the company spends a large amount of cash on investments and share repurchases.
How do you factor SoftBank Group's ample cash at hand into its ratings?
The company's maintenance of a high level of cash is a positive factor for the rating analysis. Specifically, we have maintained We maintain our positive assessment of the company’s comparable rating analysis, by incorporating the likelihood of the company maintaining a high level of cash and the likelihood of Arm going public in the next six to 12 months. A positive assessment in comparable rating analysis has the effect of raising the anchor, which we derived from the business risk profile and financial risk profile, by one notch. SoftBank Group's anchor is 'bb-'.
How do you incorporate SoftBank Group's resumption of new investments into your analysis?
SoftBank Group will likely gradually increase investments, mainly in its fund business, using the abundant cash that it gained by monetizing Alibaba shares. This is because the company has articulated a very aggressive growth strategy. It secured ¥4.5 trillion (US$33.7 billion) in cash as of the end of fiscal 2022, increased from ¥ 2.7 trillion as of the end of fiscal 2021.
In fiscal 2021, the company invested US$44.3 billion, mainly in the fund business. Conversely, in fiscal 2022 when financial stress intensified, it sharply reduced its investment to US$3.1 billion. We do not expect the company to return to rapidly investing the large amounts that we saw in 2021.
How does you assess SoftBank Group's strategic investment capability as an investment holding company?
We consider the company's ability to make strategic investments to be neutral to its rating assessment at this stage. We believe that an investment holding company's strategic investment capability--its ability to make profitable investments, execute timely acquisitions, and divest companies on attractive economic terms--is critical to its success in this industry. Specifically, we scrutinize investment discipline, risk analysis, return analysis, portfolio rotation, and value creation.
The company has, in our view, flexibly replaced and shuffled investment assets in its portfolio. It has, for instance, invested and corrected funds in the fund business, sold stakes in Alibaba and its domestic telecom subsidiary, SoftBank Corp., and is preparing to list Arm.
In terms of investment discipline, the company makes clear it has an LTV ratio target as a factor to underpin its creditworthiness, even though the company has higher leverage tolerance than other rated investment holding companies. We see no particular issue on the company's the investment decision-making process, including the involvement of the company's board of directors.
On the other hand, because significant fluctuations in the investment performance of the fund business has affected the overall investment performance on SoftBank Group, we believe that investment return is below the average of rated investment holding companies. We also believe that the net asset value (NAV) of the company is below the average of them in terms of value creation. We compare its NAV with the world's major equity indices for technology stocks and that of venture capital firms. This is because technology stocks and unlisted companies are the company’s major investment assets. We believe its NAV development has trailed those of technology stocks and venture capital firms.
How do you view the company's financial discipline?
SoftBank Group aims for disciplined financial management even in a difficult operating environment. This is likely to continue to underpin the company's creditworthiness, in our view. SoftBank Group secured a total of ¥5.7 trillion in cash mainly through the monetization of Alibaba shares. It repaid ¥2.4 trillion debt in fiscal 2022 (ended March 31, 2023). Throughout this period, stock markets were on a downward trend globally. Moreover, it secured ¥4.5 trillion in cash as of the end of fiscal 2022 by considerably curbing new investments. As a result, the company's LTV ratio (as we define it) improved to about 24% as of the end of fiscal 2022 from 31.7% a year earlier.
We think the improved ratio will allow the group to control leverage at a level commensurate with our rating, even though it is resuming investments.
What are your assumptions on the company's LTV ratio?
We expect the company to control its LTV ratio (as we define it) at 25%-30% through a cycle of stock market over the next year or so. Our assumption reflects our view that, despite recent improvement in its LTV ratio, the ratio could potentially move, given the high volatility of technology and unlisted stocks as the main investment assets. As a base case, we assume the value of the company's investment assets remains about ¥11 trillion-¥13 trillion, slightly lower than their current value, for about one year, given stock market volatility. The value of the company’s investment assets was ¥15.6 trillion as of March 31, 2023.
Our calculation of the LTV ratio differs in some respects from that used by the company. Specifically, we treat margin loans and variable prepaid forward contracts differently. We do not deduct the amount of margin loans from the asset value because we assume that the company will repay the debt by cash and add margin loans to debt. This is one of the major differences between the company's calculations and ours. Meanwhile, we deduct the amount in prepaid forward contracts from the asset value because we assume the company will repay the debt through stock sales and not add such contracts to debt.
We keep a close eye on the company's financing policy and settlement methods and review our adjustments to make sure our calculations remain accurate.
How do you assess SoftBank Group's funding capability?
We regard the company's funding capability positively. We believe it has a wide range of financing options for managing its large debt. SoftBank Group has a record of issuing bonds in both domestic and overseas markets (senior unsecured bonds and subordinated bonds) and maintains relationships with a wide range of domestic and international financial institutions. The company's investment portfolio has enough liquid stocks that can be monetized if necessary.
The company has been active in asset-backed financing (such as margin loans), using shares in major investments such as Alibaba and Arm, as one way of financing. In general, higher reliance on margin loan financing could have a negative impact on our assessment of asset liquidity, as it increases the likelihood of that the quick sale of portfolio assets could be impeded, in our view. The company has repaid margin loans using shares of Alibaba and T-Mobile US Inc. over the past year. However, it has still some reliance on margin loans. Also, it has relatively high reliance on hybrid bonds and loans. Combined with some reliance on margin loans, we believe this could be a factor in increasing the complexity of the company's debt and capital structure. We may come to see the company's financial policies in a negative light because of nonstandard, complex, or overengineered balance sheets.
- SoftBank Group Downgraded To 'BB', Subordinated Bonds To 'B' On Higher Asset Risk; Outlook Stable, May 23, 2023
- SoftBank Group Corp., April 10, 2023
- SoftBank Group's Exposure To Market Volatility Strains Creditworthiness, March 17, 2023
- SoftBank Group Outlook Revised To Negative From Stable On Continuing Investment Weakness; 'BB+' Ratings Affirmed, Nov. 17, 2022
|Primary Contact:||Makiko Yoshimura, Tokyo 81-3-4550-8368;|
|Secondary Contacts:||Kei Ishikawa, Tokyo 81-3-4550-8769;|
|Hiroyuki Nishikawa, Tokyo 81-3-4550-8751;|
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