Outlook On SoftBank Group Revised To Negative On Aggressive Financial #BB+# Issuer, All Issue Ratings Affirmed

Stocks and Financial Services Press Releases Monday February 26, 2018 18:06
TOKYO--26 Feb--S&P Global Ratings

TOKYO (S&P Global Ratings) Feb. 26, 2018--S&P Global Ratings today said it has revised to negative from stable its outlook on its long-term corporate credit rating on Japan-based telecommunications and internet company SoftBank Group Corp. We have affirmed our 'BB+' long-term corporate credit rating and all of our issue ratings on the company.

The outlook revision reflects our view that SoftBank has adopted a more aggressive financial policy, as demonstrated by its tolerance of accelerated investment in its fund business, SoftBank Vision Fund. Because of this shift, we see a greater likelihood of key financial ratios for the company deteriorating more substantially than we had assumed.

The outlook also reflects our view of the fund business' impact on SoftBank, and we have newly incorporated this into our rating, given the business' importance to the company's growth strategy. We believe downward pressure on the company's credit quality might grow through continued investment in the fund business over the long run and increased weight of the business in the company's business portfolio. We believe the fund business carries higher risk than the company's other existing businesses because of its focus on unlisted stocks with low liquidity. Meanwhile, we affirmed our ratings on SoftBank because we believe it can somewhat lessen its debt burden through sales of noncore assets bearing large unrealized capital gains.

Profits in SoftBank's domestic mobile communications business are likely to decline year-on-year in fiscal 2017 (ending March 31, 2018) because of investments to acquire and retain subscribers amid progressing market maturation. These investments, though, will enable the business to keep profits around current levels in fiscal 2018 and beyond, in our view. Its U.S. mobile communications business, Sprint Corp., has a weak position in the highly competitive U.S. telecommunications market, but we believe its profitability will rise gradually through cost reductions and improvements in network quality. As a result, we think SoftBank will increase overall profits, albeit gradually. In addition, SoftBank has good business diversity, including as a leading internet business. Accordingly, we continue to assess SoftBank's business risk profile as satisfactory.

SoftBank's fund business has been accelerating investments and the company has poured in far more capital than we had assumed. We believe adjusted debt to EBITDA for SoftBank (on a consolidated basis and excluding its captive finance business and its fund business; the same applies to all financial metrics hereafter) as of March 31, 2018, will worsen to about 5.0x from 4.4x the previous year, taking into account bridge investments SoftBank plans to transfer to the fund business. We do not expect the fund business' pace of investments to change next fiscal year and beyond. Therefore, unless SoftBank lessens the burden that its contributions to the fund business produce, for example by selling assets, debt to EBITDA is likely to hover around 5x for the next one to two years, in our view. We continue to assess SoftBank's financial risk profile as aggressive, but we see narrowing room to maintain this assessment. Our rating on SoftBank incorporates our view that it can lessen its debt burden with the sale of noncore assets bearing large unrealized capital gains. Such noncore assets include its stake in China-based e-commerce company Alibaba Group Holding Ltd.

We believe SoftBank will extend a degree of some form of support to the fund business if it comes under financial stress because the business is highly important to the company's growth strategy, it shares the same brand and name with the company, and it makes huge investments. These factors lead us to incorporate the fund business into our rating on SoftBank. To do so, we analyzed the fund business separately from the company's other existing businesses because it is an essentially different business. We then combined the analytical results for the other existing businesses with those for the fund. We determined the weighting between the fund and other businesses according to the debt of each: debt excluding the fund business for other existing businesses, and the fund business' debt plus third-party interests in the business. We adjusted downward the proportion of the fund business' debt to account for its nonrecourse and equity-like characteristics.

SoftBank's fund business carries more risk than its existing communications and internet businesses, in our view. This is because the fund business focuses on unlisted stocks with low liquidity. In addition, some third-party interests call for fixed distributions, making them debt-like in nature. We expect the total amount of third-party interests in the business, which makes rapid investments, to reach JPY / CNY6 trillion in the next two years or so. The fund business is likely to continue making additional investments, given its importance to SoftBank's growth strategy. If the high-risk business' weight in SoftBank's business portfolio increases, it is likely to negatively affect our ratings on the company. Furthermore, the business has the potential to impair SoftBank's assets. Therefore, if the value of any of the business' investments declines, SoftBank's capitalization could deteriorate, in turn potentially hurting its refinancing efforts.

We assess SoftBank's liquidity as adequate and expect its liquidity sources to remain about 1.2x its uses over the next 12 months. The company's debt is huge, but we believe it secures ample cash and cash equivalents. It also maintains solid business relationships with financial institutions, can sell assets as needed, and has room to cut capital expenditures. We believe these factors support its liquidity.

Our base-case scenario for SoftBank assumes the following:
  • In 2018 and 2019, Japan's real GDP will grow 1.2% annually; in the U.S., it will grow 2.6% and 1.9% respectively.
  • Revenue will stay flat in fiscals 2017 and 2018, primarily because of maturation of the domestic market and price competition in the U.S.
  • Profitability will slip slightly in fiscal 2017 because of investments in the domestic mobile communications business to acquire and retain subscribers, and it will improve a little in fiscal 2018 thanks to benefits from these investments and cost reductions, mainly at Sprint.
  • Capital expenditures will remain high over the next one to two years, primarily to strengthen Sprint's network.
  • Total investment will be about JPY / CNY1.6 trillion in fiscal 2017, including in SoftBank's fund business and bridge investments it plans to transfer to the fund business; investment will total about JPY / CNY700 billion in fiscal 2018, mainly contributions to the fund business.
  • The fund business will use all available committed capital in the next two years or so.
This scenario does not take into account the planned public listing of SoftBank's domestic telecommunications business subsidiary or the large amount of proceeds it might receive from the listing.
Under this scenario, we expect the following key financial metrics for SoftBank:
  • An EBITDA margin of about 32% in fiscal 2017 and about 33% in fiscal 2018;
  • Debt to EBITDA of about 5x in fiscals 2017 and 2018; and
  • Funds from operations to debt of 13%-15% in fiscals 2017 and 2018.

The negative outlook reflects our view that consolidated financial metrics such as debt/EBITDA are likely to deteriorate and remain at such levels for a prolonged period because of SoftBank's aggressive financial policy to allow accelerated investments in its fund business. Further, the fund business itself is riskier than SoftBank's existing businesses, and the company is likely to continue large investments through the fund in the long term.

We would downgrade SoftBank in the next 12 months or so if we were to believe its debt to EBITDA was likely to exceed 5x and unlikely to recover, as a result of further accelerated investments in its fund business, a delay in collection of bridge investments, or a larger deterioration in Sprint's FOCF than we expect. A downgrade is also likely if we believe it will excessively pursue its growth strategy under a highly aggressive financial policy even if its debt to EBITDA remains below 5x as a result of asset disposals.

Conversely, we would change the outlook back to stable if the company reduced debt materially through asset disposals or a public listing of its domestic telecom subsidiary and kept its debt to EBITDA sufficiently below 5x on a prolonged basis even after incorporating the possibility of more acquisitions or investments for growth.

Our issue rating on SoftBank's long-term senior unsecured bonds--a portion of which we rate--is equal to the long-term corporate credit rating on the company. This is because the ratio of the issuer's total secured debt plus its subsidiaries' debt to the issuer's total debt (priority debt ratio) stands below 50%, the threshold for us to consider notching down the issue rating. We rate SoftBank's subordinated debt 'B+', three notches below the long-term corporate credit rating, to reflect the issuer's option to defer interest payments as well as the subordination of the securities.

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