Japan’s Softbank Takes On Decidedly Old Form of Risk
Can Softbank Corp. turn debentures into ventures?
That’s the question analysts are pondering as they struggle to evaluate the Internet investment company’s latest move--last week’s agreement to acquire Japan’s failed Nippon Credit Bank.
While many details are sketchy, Softbank and its partners will pay $939 million for approximately 80% of NCB. Softbank will take close to 50%, with leasing company Orix and Tokio Marine and Fire Insurance Co. each receiving a little less than 15%. Several Western financial groups also may acquire minority stakes. A deal signing is set for July 9.
As is often the case with Softbank, the vision is bold, the upside huge and a well-grounded foundation not immediately apparent. Furthermore, while the company has thrived on a healthy appetite for risk, the nature of this risk is decidedly different.
Softbank’s competitive edge has always been its understanding of the new economy. With this deal, it saddles itself with a huge chunk of Japan’s old economy--in sharp contrast with AOL’s bid for Time-Warner--and a very sick part of Japan’s old economy that’s hit the wall.
Japan’s staid business community, which is always wary of brash upstarts, has been forced to take Softbank seriously because of early bets that paid off. By investing early in companies such as Yahoo, in which Softbank holds a 23% stake, and E-Trade, Softbank Chairman Masayoshi Son showed great foresight.
This was rewarded as Softbank’s value ballooned, allowing it to parlay it into related Asian investments, even as much of Japan’s old guard slipped further into the mud. Before a recent 70% swoon in its shares, Softbank exceeded AOL in market capitalization.
Softbank’s shares closed Friday in Tokyo at $180.66, down $6.55.
With the NCB acquisition, however, Softbank willingly enters a very different field in which it has no track record and little expertise. In doing so, it burdens itself with debts and old management in a low-margin, bricks-and-mortar banking industry where the government still holds great sway. These are all problems it has spent much of its short life avoiding.
“Mr. Son has an almost animal-like instinct for judging market trends, which made him very successful in the Internet and software sector,” says Morio Imai, an analyst with Sakura Bank. “But the banking business is different.”
NCB is the epitome of Japan’s old-style planned economy. As one of only three Japanese long-term credit banks, NCB was granted special government rights after World War II to raise money by selling two- and five-year debentures. Many were sold to rich individuals who liked the fact that in buying these large instruments they didn’t have to report their name to the tax authorities. In a no-brainer, NCB would then fund big industries favored by the bureaucrats such as steel, power generation and industrial real estate at guaranteed rates of return.
Betting on NCB Transformation
During Japan’s speculative bubble period, however, the bank’s special government status reportedly made its lending decisions very susceptible to political pressure. By the late 1990s NCB was awash in bad debt as the loan portfolio soured. It was nationalized in 1998, insolvent in all but name.
The government has taken at least $2.2 billion in bad debt off the books officially, leaving NCB with $37 billion in assets and $30 billion in liabilities. But many analysts believe billions in additional red ink will seep out of the bank’s vault in coming months.
But Son is apparently betting that a transformed NCB, when combined with Softbank’s stakes in various other Japanese Internet brokerage, insurance and retailer investments, will create a Japanese financial supermarket in cyberspace. “The value is in the banking license,” says Stephen McKeever, analyst with Lehman Bros.
Son, in characteristic fashion, was less than clear on his exact strategy at a meeting with reporters last week after the deal was announced. He said he’s interested in issuing loans to small and medium-size companies based on their ideas and cash flow, rather than simply their real estate collateral.
Some see the acquisition as a centerpiece in his bid to create an “Internet zaibatsu,” or conglomerate, modeled loosely on more traditional groups such as Mitsui and Mitsubishi. Yet any hope of using NCB’s capital to finance Softbank’s own investments could quickly run into trouble, even in Japan. Since recent financial sector reforms, reporting requirements and restrictions on insider dealings are much stricter as Japan tries to repair the damage of its past excess.
“The government would not be happy if Softbank used the bank as an instrument that only lent to Softbank-related businesses,” said Yushiro Ikuyo, banking analyst with Commerz Securities.
Others see a desire by Son to expand on his position as the leading figure of the Japanese Internet. Under this scenario, Softbank would use NCB to let a thousand venture flowers bloom in Japan, helping the country to rebuild and fight its way out of chronic depression.
“If his aim is to do that, socially it’s a good thing,” said Kota Nakako, Internet analyst with UBS Warburg. “But it won’t necessarily reward shareholders.”
‘Expensive Way to Buy . . . Some Respect’
Furthermore, Japan’s problem isn’t necessarily a lack of venture financing these days. Japan’s trade ministry is throwing billions of dollars into start-ups and many old-line industrial giants are creating in-house seed capital operations, while Western venture capitalists pick up the rest. The problem, say some analysts, is more the lack of good ideas under a system that has not encouraged risk-taking.
Still a third theory is that Softbank realizes it needs to get closer to the establishment, that its days as a successful maverick are numbered in a country where so many strings are pulled behind the curtain with this purchase representing a way to buy good will and respectability.
“The only thing that makes sense to us is that he’s trying to get close to the government. But there are cheaper banks to purchase out there,” said Luigi Limentani, Internet analyst with Nikko Salomon Smith Barney. “It’s an expensive way to buy yourself some respect.”
At the operation level there are a host of hurdles ahead. The extent of NCB’s bad loans may not be known for months. Softbank reportedly tried to strike a better deal with Japan’s Financial Reconstruction Commission to cap its exposure but wasn’t completely successful. That in turn prompted Softbank to consider more partners. Rumor has it that Lehman Bros., Chase Manhattan and UBS may be interested in a piece.
Also unclear is how much of a free hand Softbank will have in aggressively restructuring the bank, in a nation that still doesn’t officially allow layoffs. If it has agreed to go slowly, then trying to sharply reduce costs quickly could be difficult.
And without a staff shake-up, the management will have to teach old-line loan officers to recognize new economy opportunities--a major challenge, especially given the number of defections. “When things at the bank got worse, many of the good employees left,” said Soichiro Fukuda, analyst with the Industrial Bank of Japan.
Even if Softbank does have a free hand to put in place the people it wants, it’s unclear whether Japan has that many people with expertise both in banking and information industries, given that it’s been one of the last industrialized nations to get on the Internet bandwidth wagon.
Son has shown a preference for making investments and laying out the broad agenda, leaving others to manage. Yet a turnaround is a different proposition than buying into and supporting an existing business plan, a difference that can eat up huge amounts of senior management time.
In the end, though, if Softbank does pull it out, the company could dominate online financial transactions in the world’s second-largest economy. Success could also spur other banks and financial industries to emulate its strategy, giving rise to more robust and well-developed capital markets and a greater entrepreneurial culture in Japan. This, no doubt, is part of the Financial Reconstruction Commission’s hope in granting the bank to the group.
Softbank showed a consolidated pretax loss of $489 million on group sales of $3.99 billion for the fiscal year ended March 31, with a large part of that due to currency-related losses tied to its U.S. investments.
