On Wednesday evening local time, SoftBank Group made an announcement that it will reduce its position in Alibaba by settling prepaid forward contracts, confirming last week’s media reports on the matter. As of press time, Alibaba’s U.S. shares are down 1.7% pre-market. In short, SoftBank’s announcement means that **the board of directors has approved the early settlement of a number of prepaid forward contracts involving up to 242 million Alibaba ADRs (American Depositary Receipts), involving a number of financial institutions as counterparties.
A prepaid forward contract is a trading strategy that allows a large holder to receive a lump sum of cash from a counterparty in advance for a single share, typically 70% to 80% of the market value of the stock at that time, with an option associated with that share as to whether or not to sell the stock at maturity or the ultimate number of shares to be sold. If the option is not to sell the shares at the time of delivery, the cash initially received and the corresponding cost of capital will be returned.
The actual settlement will begin in mid-August and is expected to close by the end of September this year. ** SoftBank said it does not expect the settlement of these contracts to result in financial institutions selling additional Alibaba shares directly into the market.
The announcement shows that the deal is expected to bring SoftBank 4.6 trillion yen (about $34 billion) in cash.
The key point is that SoftBank said that after the completion of the deal, the group’s stake in Alibaba will account for 14.6% of the latter’s overall shares outstanding, down from 23.7% at the end of June, which also means that SoftBank’s Alibaba position in the hands of Alibaba will no longer be able to be consolidated under the equity method after falling below 20% shareholding.
Early delivery Cash out defense
It is important to briefly explain that prepaid forward contracts help SoftBank to quickly raise cash from its stock positions without paying immediate taxes on capital gains, while retaining the possibility of continuing to hold shares or settling in cash in the future. According to past records, SoftBank has been raising funds through the sale of derivatives related to Ali shares since at least 2016.
While this operation is a bit more complicated than selling shares directly, it has the benefit of avoiding a sharp short-term impact on the underlying company’s stock price.
According to previous media reports, SoftBank has a two-year deadline for the final delivery of most of its Ali prepaid forward contracts, so this early delivery is more or less a market surprise.
In this regard, SoftBank also explained in today’s announcement that by settling these contracts in advance, SoftBank Group was able to settle its concerns about future cash outflows, while reducing the financial expenses associated with these contracts, helping the company to enhance its ability to defend against the current tough market conditions.
SoftBank stressed that the two companies have built a strong relationship since it first invested in Ali in 2000 and will maintain a friendly relationship after this transaction, despite changes in the way accounting statements are calculated.
