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Softbank Embraces Junk as Sprint Boosts Debt: Corporate Finance

Softbank Corp. (9984), the first supplier of Apple Inc. (AAPL)’s iPhones and iPads to Japanese buyers, expects its credit rating to be cut to junk as the country’s biggest purchase of a foreign company more than doubles borrowing.

The extra yield over government debt that investors demand to hold Softbank’s 1.1 percent bonds due 2016 jumped fourfold to 1.65 percentage points after the company said Oct. 12 it’s in talks to buy a 70 percent stake in Sprint Nextel Corp. (S) for $20.1 billion, according to Japan Securities Dealers Association prices on Bloomberg. Relative yields on Softbank’s global peers narrowed in that period.

Softbank will increase its net debt to 3.9 trillion yen ($49 billion) with the takeover of the third-biggest U.S. wireless carrier. Moody’s Investors Service said it may lower the Tokyo-based company’s rating, currently on the cusp of speculative grade, by at least one level because “the addition of new debt is unlikely to offset the initial benefits” of the acquisition.

“Our ratings will be lowered, but they will recover,” Yoshimitsu Goto, Softbank’s head of finance, said in an interview in his Tokyo office on Oct. 26. “We do these deals assuming our cash flow and corporate value will rise. Our credit ratings will go even higher as repayment proceeds.”

Overseas Expansion

Softbank’s purchase of the stake in Sprint Nextel will help the 31-year-old Japanese company expand beyond its home market while giving its loss-making U.S. counterpart more financial backing as it upgrades the infrastructure of its networks.

The acquisition will make Softbank the fifth most-indebted publicly traded company in Japan, according to data compiled by Bloomberg. Toyota Motor Corp. ranks highest in the data, which exclude banks and insurers, with 9.1 trillion yen of net debt.

Softbank’s deal will be financed by loans, and banks already have committed 1.6 trillion yen in bridge financing secured by shares in the U.S. company. The bank debt may be refinanced in the bond market later, Goto said.

Moody’s placed Softbank’s Baa3 rating on review for a possible downgrade on Oct. 15 because of the amount of debt Japan’s third-largest mobile phone company is taking on. In terms of Softbank’s business, Moody’s said the takeover presented “uncertain operating synergies” because both companies will continue to operate in their home markets and use different technology.

Softbank Penalized

Downgrading Softbank would penalize the Japanese company compared with the rating firms’ treatment of its European rivals, according to Mana Nakazora, the chief credit analyst at BNP Paribas SA in Tokyo, who based her assessment on telecommunications companies’ leverage ratios.

The ratio of Softbank’s net debt to earnings before interest, tax, depreciation and amortization will deteriorate as a result of the merger to 2.7 times from 1.4 now, Nakazora estimated.

That’s still better than Telefonica SA (TEF), Spain’s biggest telecoms provider, at 3.1 times and with a Moody’s rating of Baa2, she said. Telecom Italia SpA (TIT), Italy’s main phone company, already has a debt-to-Ebitda ratio of 2.7 times and is rated Baa2, according to Nakazora. Even so, a Softbank downgrade is inevitable, she said.

Standard & Poor’s placed Softbank’s BBB rating, two levels above junk, on “CreditWatch Negative” on Oct. 16, citing “the debt-financed acquisition cost and weaker cash flow generation of Sprint Nextel.” The New York-based firm said it expects to downgrade Softbank to the BB category, or its three highest speculative-grade ratings, when the takeover is completed, probably in mid-2013.

‘Upgraded Again’

Japan Credit Rating Agency Ltd. in Tokyo ranks Softbank at A, five levels above junk.

“After a few years, Softbank will be upgraded again,” said Nobumasa Mizutani, the chief investment adviser at Japan Credit Advisory Co., a hedge-fund advisory firm in Tokyo.

The yield premium on Softbank’s 45 billion yen of 2016 bonds widened to 165 basis points on Oct. 19, the most since they were issued in January 2011, JSDA prices on Bloomberg show. The spread was 43 basis points on Oct. 11, before the Tokyo- based company confirmed the merger talks, and has since fallen back to 158 basis points.

The extra yield on notes offered by global telecoms companies tightened eight basis points since Oct. 12 to 145, according to Bank of America Merrill Lynch index data.

Software Distributor

Softbank President Masayoshi Son, Japan’s second-richest man, founded the company in 1981 as a distributor of computer software. By 2006, he had transformed it into a fully fledged phone-service provider similar to Nippon Telegraph & Telephone Corp. (9432) by acquiring Japan Telecom Co. and the Japanese unit of Vodafone Group Plc. (VOD)

“With today’s announcement, I’m prepared to see the ratings of Softbank lowered,” President Masayoshi Son said in a presentation on Oct. 15.

Softbank raised 1.45 trillion yen through the sale of asset-backed debt in September 2006 to fund its purchase of the Vodafone unit. The notes were repaid using cash flow generated by the unit.

Following the Vodafone merger, S&P and Japan Credit Rating placed Softbank on review for a cut, and Moody’s put it on watch for upgrade. In the end, none made any ratings change.

While Softbank then had lower ratings than the Vodafone unit, it’s now graded above Sprint Nextel, which is rated B1 by Moody’s, four levels into junk status, and an equivalent B+ at S&P. Moody’s placed the U.S. company’s rating on review for an upgrade because of the takeover while S&P put it on “CreditWatch Positive.”

Good, Bad

“A good-credit company is buying a bad-credit company,” Softbank’s Goto said.

The 3.9 trillion yen of debt that Softbank will have after the takeover compares with 7.3 trillion yen as of June 30 for Tokyo Electric Power Co. (9501), the owner of the nuclear reactors at Fukushima which were destroyed in the March 2011 earthquake and tsunami, and 1 trillion yen for Sharp Corp. (6753), the maker of Aquos TVs that’s facing back-to-back annual losses, according to data compiled by Bloomberg.

Tokyo-based Tepco is rated B1 by Moody’s, four levels below Softbank, and B+ by S&P, five steps lower than the phone company. Osaka-based Sharp is graded at BB+ by S&P, two levels below Softbank, and BBB by JCR, three steps lower.

Softbank’s Son said on April 26 he was abandoning the company’s zero net-debt target and that he will consider “a proper balance between growth strategy, reward for shareholders and cutting of net interest-bearing debt.”

Foreign Currency

Softbank’s Ebitda was 1 trillion yen in the year through March 31, according to data compiled by Bloomberg. The merger will increase net debt from 1.45 trillion yen, according to the Oct. 15 company presentation.

Within a year, the majority of Softbank’s borrowing for the takeover will be refinanced with domestic syndicated loans, and the remainder from bonds, Goto said. A smaller portion of the debt may be funded in the overseas markets, including in dollars and euros, he said.

“From a borrower’s point of view, Japan’s financial environment is globally very profitable,” Goto said. “The Japanese loans market is the most advantageous.”

The average rate for new loans by domestic banks declined 5.4 basis points to 0.989 percent in August, according to the latest data from the Bank of Japan. (8301) Margins for U.S. dollar- denominated loans signed in August globally averaged 357 basis points, while those for euro-denominated facilities were 444 basis points, according to data compiled by Bloomberg.

Relative Value

Increased revenue after the acquisition will help Softbank to raise its rating again, Goto said. The operator plans to repay the debt with its own cash flow, and won’t use that of Sprint Nextel, he said.

Softbank’s shares, after touching a 16-month high of 3,335 yen in Tokyo on Sept. 19, plunged to 2,200 yen on Oct. 15. The stock was at 2,540 yen at 2:02 p.m. today in Tokyo.

“We are going to explain the strategy we have taken to debt investors,” Goto said, adding that he plans to start meeting with bondholders twice as often as he does now.

To contact the reporters on this story: Yusuke Miyazawa in Tokyo at ymiyazawa3@bloomberg.net; Emi Urabe in Tokyo at eurabe@bloomberg.net

To contact the editor responsible for this story: Shelley Smith at ssmith118@bloomberg.net

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