Softbank is one of Japan’s three major comprehensive telecoms. The others are Nippon Telegraph & Telephone Corp. (NTT; AA/Stable/A-1+) and KDDI Corp. (not rated). Softbank has established a business of some considerable scale in both fixed-line telecom and broadband markets and it vies with KDDI for second place in Japan’s mobile communications market segment. We think the three major carriers’ domination of Japan’s telecommunications market prevents competition from overheating to some degree. However, in our view, competition in the market has intensified, fueled by swift industry migration to smartphones and high-speed communications, including the Long Term Evolution (LTE) standard. The launch of the iPhone 5, which both Softbank and KDDI offer, in Japan in September 2012 is likely to stoke further competition, which may shrink the telecoms’ profit margins, in our view.
Softbank aims to increase earnings in its mobile communications business, wholly owned subsidiary Softbank Mobile Corp. (not rated), which generated about two-thirds of its consolidated EBITDA in fiscal 2011 (ended March 31, 2012). Despite greater competition, clever marketing has raised Softbank’s mobile subscriptions and market share. Softbank has the fewest mobile subscribers of the three dominant carriers but has narrowed the gap with second-ranked KDDI. Softbank’s churn rate is just over 1%, slightly higher than that of its domestic peers. However, we believe its efforts to improve network quality will strengthen its ability to secure subscribers in the next two to three years; Softbank is improving its network quality, using the 900Mhz radio frequency band that the Ministry of Internal Affairs and Communications allocated to it in February 2012. We believe the strong corporate segment of Softbank’s fixed-line business together with cost reductions will help it continue its earnings growth. Furthermore, strong brand recognition and steady revenue from Internet advertising enable its Internet business, Yahoo! JAPAN, to contribute to overall earnings.
Softbank on Oct. 2, 2012, announced a plan to consolidate Japan’s fourth-ranked telecom, eAccess Ltd. (BB+/Watch Dev/--). The consolidation would benefit Softbank significantly, in our opinion. EAccess’ 1.7GHz core band for LTE would expand Softbank’s LTE service bandwidth and differentiate its service in the growing mobile broadband market from that of its rivals, in our view. We also think planned consolidation of eAccess is unlikely to substantially worsen the ratio of Softbank’s consolidated debt to EBITDA (adjusted for lease and pension obligations and other debt like liabilities) because Softbank plan to consolidate eAccess via a stock swap. Also, eAccess carries less debt than Softbank.
Standard & Poor’s Ratings Services placed its ‘BBB’ long-term corporate credit rating on Softbank on CreditWatch with negative implications on Oct. 12, 2012, to reflect the company’s discussions with Sprint Nextel Corp. (B+/Watch Pos/--) about investing in the third-largest U.S. wireless carrier. We kept the rating on CreditWatch with negative implications on Oct. 16, 2012, after Softbank announced it would acquire Sprint Nextel. If it proceeds, the acquisition would undermine Softbank’s financial risk profile because of the cost of debt financing the deal and because of Sprint Nextel’s weaker cash flow, in our view.
In our preliminary assessment, an investment in Sprint Nextel would not create meaningful combined benefits, because Softbank and Sprint Nextel operate in different geographic markets. As well as the increased financial burden of the potential acquisition, Softbank is investing in a massive and rapid enhancement of its communications network, such as its 900Mhz band and LTE networks. As a result, its free operating cash flow will likely remain under pressure for at least the next few years. Accordingly, we think the transaction would materially undermine Softbank’s “intermediate” financial risk profile.
We regard Softbank’s liquidity as adequate. We expect its sources of liquidity to exceed 1.2x uses over the next year. These liquidity sources include more thanJPY750 billion in cash and cash equivalents and approximately JPY700 billion in funds from operations (FFO). Liquidity uses over the same period include about JPY725 billion in annual debt repayments; its required capital expenditures; and about JPY44 billion in dividend payments. The company has approximately JPY180 billion in unused committed credit facilities with both domestic and overseas banks, good access to capital markets, and solid relationships with financial institutions, including Mizuho Financial Group Inc. (A/Negative/--), all of which support its liquidity. At this time, it is difficult to incorporate the precise effect of the planned acquisitions into Softbank’s liquidity. We intend to analyze the impact the Sprint Nextel transaction and accompanying financing may have on Softbank’s liquidity and reflect our views in our liquidity assessment.
We expect to resolve the CreditWatch status when the Sprint Nextel transaction closes, which we believe is most likely to be in mid-2013. If the transaction goes ahead, we are likely to lower the corporate credit rating on Softbank to the ‘BB’ category.
We expect to provide more clarity on the ultimate ratings outcome in the event the companies provide more information on financial policy and strategic direction. At this stage, we would be likely to downgrade Softbank because of the combined entity’s weaker financial risk profile, execution risk associated with this transaction, and Softbank’s aggressive growth strategy. To resolve the CreditWatch, we would assess Sprint Nextel’s position in Softbank’s global strategy, integration and execution risks associated with Softbank group entering the U.S. market, combined business benefits of the merger for both companies over the medium term, Sprint Nextel’s funding requirements, and Softbank’s financial policy and willingness to provide extraordinary financial support to Sprint Nextel.