Hard Truths For Japan's Softbank

The broadband bet looks solid, but investors want to see profits

Masayoshi Son has often been criticized for being long on vision but short on delivery. In the mid-1990s, his Softbank Corp. focused on computer-magazine publishing, trade shows, and software distribution -- with mixed results. Then, as the Internet started to take off, he spent more than $3 billion buying stakes in some 800 Net-related companies. "Masa" soon was playing the Nippon dot-com guru to the hilt -- posing in samurai costume, shuttling between Silicon Valley and his Tokyo headquarters, giving inspirational talks at mass lovefests with Japan's first generation of Netrepreneurs.

Like cherry blossoms in spring, though, it was over all too soon. His portfolio included winners, such as portal Yahoo! (YHOO ), but also plenty of flameouts, such as online retailer Webvan Group. When the Net bubble burst, Softbank's share price and earnings collapsed along with the rest of the sector.

End of story? Nope, just the prelude to Softbank 3.0. Son -- now sporting an adult-looking suit and tie -- is feeling feisty again. Softbank's stock, which had been flat-lining for years, is five times higher than at its nadir in November, 2002, and up 48% since January. Yahoo! Japan -- Softbank owns a big chunk of the company -- is roaring ahead, reporting an 83% surge in quarterly profits from online retail services and auctions. Softbank is sitting on $5 billion in cash and unrealized gains of $17 billion on its portfolio of stocks such as Yahoo, Yahoo Japan, and telecom-gear maker UTStarcom (UTSI ). A finance unit, built around online broker E*Trade Financial Corp. (ET ), is making solid money, too.

Finally, Son has, in his brash way, defied Japan's established telecoms to create perhaps the slickest consumer-broadband service in the world. Yahoo! BB, Son's high-speed Internet unit, offers users service at some 10 megabits per second -- and he expects to double that in coming years, which would allow high-quality video streaming over the Net. The Japanese love Yahoo! BB: Some 4.3 million have signed up at $20 to $30 per month. With the addition of the broadband customers of Japan Telecom Co. -- the country's No. 3 fixed-line provider, which Son just bought for $3.1 billion -- Softbank should have the biggest broadband network in Japan by yearend, edging ahead of giant Nippon Telegraph & Telephone Corp. (NTT ) "Sooner or later, everything is going to migrate to broadband," says Son, Softbank's CEO.

Investors, though, want to know when Softbank will migrate to sustainable profits. There's no doubt that Son is back in the game. But some of the doubts the market has about the Japanese visionary remain. The company has lost nearly $2 billion over the last two years -- pretty stiff even by Son's grand standards. Some of that is from write-offs on failed Net investments, but the lion's share is from the cost of creating a broadband empire. Softbank has been burning through $100 million a month building Yahoo BB's network and trying to woo subscribers to it. The stock's rebound could be in jeopardy if the company posts another major loss this year, and the shares have already given back some of their gains since Son laid out billions for Japan Telecom. "It's going to be a difficult situation for Softbank if profits don't happen" soon, says Naoki Fujiwara, a fund manager at Shinkin Asset Management Co.


Son's response: "Our stock is really undervalued." From his vantage point, Softbank -- despite its still-capacious sprawl of 177 subsidiaries and nine business segments, ranging from e-commerce to consulting -- has a clear strategic thrust these days based on broadband. Yahoo BB, Japan Telecom, and E*Trade Japan form the core of that strategy.

What about that little profit problem? Son insists that if Yahoo BB were content simply to serve the subscribers it now has, the broadband unit would have $900 million in positive cash flow. But he insists the company can eventually be much more profitable by expanding its subscriber base, so he's continuing to spend and expects to have 6 million customers by fall, 2005. Once he gets subscribers in the door with his superfast service, he says, he'll be able to tease more money out of them by offering add-ons such as Internet phones, wireless networking equipment, live sports programming, and music downloads.

Son's other big earnings vehicle will be Japan Telecom. When the deal to buy JT closes in November, Softbank will get 600,000 new residential broadband accounts. Another big contribution will be the $780 million in cash flow JT generated last year, which should improve Softbank's profit picture, notes Mizuho Securities Co. analyst Atsuo Takahashi.

It is JT's 170,000 corporate clients, though, that really interest Son. His plan: Turn stodgy Japan Inc. on to all kinds of cool Net-based services. Son wants to merge JT's 12,000 kilometers of fiber-optic cable with Softbank's more modest fiber network to offer corporate clients high-speed data communications. Then he plans to use that network to provide Japan Inc. with Internet-based phone service that will help companies slash their calling fees and maintenance costs. Megabanks UFJ Holdings and Mizuho Financial Group have already adopted Internet telephony, and in June, Tokyo Gas, Japan's biggest natural-gas utility, replaced its 20,000 phone lines with a system that routes calls over the Net. Problem is, all three companies looked to Softbank's rivals for those phones. Son wants a piece of that action -- and there's likely to be plenty of it. By 2007, Japan is expected to have 28 million Net phones, up from 5.3 million today, according to Yano Research Institute Ltd., a Tokyo think tank.

The final leg of Son's plan counts on the continued success of Softbank's e-finance unit. Fortunes at the group, which includes a 35% stake in E*Trade Japan, two other regional brokerages, and a tie-up with fund-researcher Morningstar, have been lifted by the turnaround in Tokyo's markets and a surprising surge in online stock trading by individual investors. Today the unit has some $17 billion in assets under management, and it turned a $54 million profit in the fiscal year ended in March after losing the same amount the year before. To keep that business growing, Softbank on July 5 announced plans to buy midsize broker Ace Securities Co. for roughly $73 million.

Son's real task, though, is getting Softbank itself into the black. Because of its high losses and $1.3 billion in short-term debt, Softbank can't get an investment-grade credit rating. Some real earnings might change that -- and Son vows to create them. He says the broadband unit will be profitable on an operating basis in the second half of this year, and that next year Softbank will benefit from some $460 million in cost savings from the merger with JT. That, he says, could swing Softbank into a profit in the fiscal year ending in March, 2006.

Confident as he is, Son can't help but be a little defensive. Hasn't he flipped and flopped over the years? No, he insists: "My strategy has been focused and steady." Focused, he says, on what comes next in the digital realm. And plenty of observers still admire his guts and vision. "Son has always thought big and taken big bets on the next big thing," says Neil Katkov, an analyst at telecom researcher Celent Communications. At some point, though, those bets have to pay off. For Son and his latest strategic plan, it's show time.

By Brian Bremner in Tokyo

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