30 October 2014 Asia Pacific/Japan Equity Research Integrated Telecommunication Services (Telecommunication Services (Japan)) / MARKET WEIGHT Softbank (9984 / 9984 JP) Rating OUTPERFORM* Price (29 Oct 14, ¥) 7,509 REINSTATEMENT Target price (¥) 10,000¹ Chg to TP (%) 33.2 Market cap. (¥ bn) 9,015.76 (US$ 83.39) Valuing large unrealized gains, FCF of over ¥1tn Enterprise value (¥ bn) 16,299.76 Number of shares (mn) 1,200.66 ■ Reinstate coverage: In conjunction with Credit Suisse's initiation of Alibaba Free float (%) 65.0 Group Holding coverage (The Giant Marches On), we resume coverage of 52-week price range 9,220 - 6,766 *Stock ratings are relative to the coverage universe in each Softbank with a ¥10,000 target price (potential return 33%) and analyst's or each team's respective sector. OUTPERFORM rating. The stock is currently trading at around ¥7,500, but ¹Target price is for 12 months. we think the market is undervaluing the company’s investment securities and Research Analysts existing business and has not priced in annual FCF in excess of ¥1tn or the Hitoshi Hayakawa future value of the company’s debt-funded global business strategy. 81 3 4550 9952 [email protected] ■ Unrealized gains on Alibaba shares, abundant FCF could support new M&A: Softbank generates annual FCF of more than ¥1tn from existing businesses, and the value of its shares in Alibaba mean it now has even greater scope to borrow. We see potential for another M&A deal of some several trillion yen if the right target emerges. However, a major deal could be a negative for the stock in the near term. Experience suggests active buying is the right approach when the stock falls after M&A deals. ■ Catalysts/risks: Factors likely to impact the share price include a rise (fall) in the value of investment securities holdings, news of a major M&A deal, and an improving (deteriorating) competitive environment in the domestic mobile business or the US mobile business. ■ Valuation: We base our ¥10,000 TP on a Sum-of-the-Parts (SoTP) valuation. In addition to the value of investment securities, we apply EV/EBITDA multiples of 6x for the domestic mobile business and 4x for the fixed-line business (using our FY3/16 estimates). Share price performance Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 6,666.7 8,090.0 8,191.4 8,375.8 10000 400 8000 300 Operating profit (¥ bn) 1,077.0 1,258.4 1,360.5 1,454.4 6000 200 Recurring profit (¥ bn) 924.0 1,455.7 1,288.1 1,465.6 4000 100 2000 0 Net income (¥ bn) 578.3 917.4 823.1 936.4 EPS (¥) 204.8 756.4 678.7 772.1 Change from previous EPS (%) n.a. 117.0 51.0 IBES Consensus EPS (¥) n.a. 504.5 523.1 636.8 The price relative chart measures performance against the EPS growth (%) -37.6 269.3 -10.3 13.8 TOPIX which closed at 1270.64 on 29/10/14 P/E (x) 38.1 9.9 11.1 9.7 On 29/10/14 the spot exchange rate was ¥108.12/US$1 Dividend yield (%) 0.51 0.53 0.53 0.53 EV/EBITDA(x) 9.2 6.8 6.2 5.8 Performance Over 1M 3M 12M P/B (x) 12.2 3.3 2.6 2.0 Absolute (%) -3.8 -0.8 1.9 ROE(%) 36.1 40.4 26.2 23.3 Relative (%) 1.2 0.6 -4.6 Net debt/equity (%) 397.7 266.9 193.1 142.4 Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 30 October 2014 Valuation Reinstate coverage with ¥10,000 TP Softbank has been on our Restricted list for some time. Following Alibaba’s IPO and other developments, we reinstate coverage of Softbank with a ¥10,000 TP (potential return 33%) and OUTPERFORM rating. We continue to view a SoTP approach as the best way to value Softbank. We think the key to valuing Softbank is in its holdings of investment securities, which have increased to several trillion yen regardless of which valuation method we use due to Alibaba’s IPO having provided the company a market value. Enterprise value approach Our ¥10,000 TP translates into enterprise value (EV) of ¥16tn. This breaks down into three main parts: the values of investment securities holdings, the mobile communications business, and the fixed-line telecommunications business. Investment securities are further divided into three key holdings: investment securities listed on domestic markets, shares in Alibaba Group Holding, and shares in Sprint. Figure 1: Softbank enterprise value (¥mn) Figure 2: Softbank enterprise value (%) Fixed Line and Fixed Line and other business other business 624,000 Alibaba 6,553,738 4% Alibaba 75.4% Sprint 15.4% Sprint 1,336,425 Yahoo Japan 7.3% Yahoo Japan 632,692 Others 2.0% Others 174,580 Investment Mobile Mobile securities Investment Business Business securities 7,320,196 values 8,697,436 44% values 52% Note: Share prices as of 28 October 2014 Note: Share prices as of 28 October 2014 Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates To calculate the value of Softbank’s holdings of listed securities, we multiply the market Discount of 35.64% used for value of each company by Softbank’s stake in that company to work out the total market non-Alibaba businesses value of all its holdings. We then apply a discount, which in the case of non-Alibaba businesses is the Japanese corporate tax rate of 35.64%. We use a discount of 24.4% only for Alibaba Group Holding. This is because a domestic Discount of 24.4% used for subsidiary holds 60.4% of Softbank’s stake in the group, while a subsidiary in Singapore Alibaba to reflect stake held holds the remaining 39.6%; we therefore apply the domestic corporate tax rate of 35.64% in Singapore to the stake held in Japan and Singapore’s corporate tax rate of 17% to that held by the subsidiary in Singapore. The above approach yields a total value for Softbank’s investment securities holdings of ¥8.69tn. We estimate the value of Softbank’s investment securities holdings, before applying the Value of securities holdings above discounts, at ¥12tn, which is ¥3.1tn higher than Softbank’s total market cap as of 28 without application of October (¥8.9tn). Even taking into account net interest-bearing debt of ¥4.6tn, the recent discount share price would therefore suggest that Softbank can acquire the domestic mobile communications business of roughly ¥1.4tn with the remaining annual EBITDA of ¥1.5tn, equating to a low EV/EBITDA multiple of around 1x. Our TP without applying the discount would be around ¥12,000, or roughly ¥2,000 higher than our actual ¥10,000 TP with application of the discount. Softbank (9984 / 9984 JP) 2 30 October 2014 Application of a discount therefore has a significant impact on our valuation of Softbank. What is a fair discount? There is no consensus on how to value investment securities. One investor may see applying a discount as unnecessary, while another might agree with us and view the application of the effective corporate tax rate as the minimum required adjustment. Either way, Softbank’s share price is finding its natural level against this backdrop of differing views. In other words, there may be little value in arguing the need for a discount, or indeed, what type of discount should be applied. Based on Softbank's share price since Alibaba Group Holding listed, the market does seem to be applying some sort of discount to the value of Softbank’s investment securities. We apply a 6x multiple to our FY3/16 EBITDA estimate for the mobile business, resulting Valuing the domestic mobile in an EV of ¥7.32tn. Our multiple is the simple average of the FY15E EV/EBITDA multiples business for the world’s leading integrated telecommunications companies and the world’s leading mobile communications companies (6.0x and 6.4x, respectively). We estimate EV for Softbank’s fixed-line business is ¥624bn, based on an EV/EBITDA multiple of 4x. We therefore value the domestic business at ¥7.944tn, comprising ¥7.32tn for the mobile business and ¥624bn for the fixed-line business. Figure 3: EV/EBITDA multiples for the world’s leading communications companies Telefonica 7.5 Verizon 6.5 Mobile telecom 6.4 Global telecom 6.2 Integrated telecom 6.0 America Movil 5.8 AT&T 5.8 Vodafone 5.7 Note: Share prices as of 28 October 2014 "Mobile telecom" is the average of 14 companies including Vodafone, and" Integrated telecom" is the average of 16 companies including AT&T and Verizon. "Global telecom" is a simple average of "Mobile telecom" and "Integrated telecom. Please see Figure 4 for the list of companies. Source: Company data, Credit Suisse estimates Softbank (9984 / 9984 JP) 3 30 October 2014 Figure 4: Global telecom sector valuation Data as of MktCap MktCap Closing Target EV/EBITDA (x) 10/28/14 US$m Rating* Curr.