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How will SoftBank decrease its Alibaba stake without selling shares?

Aria Thomas

Aug 11, 2022 10:56

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By reducing its investment in Alibaba Group Holding from 23.7% to 14.2%, SoftBank Group Corp hopes to gain $34.1 billion.


However, the Japanese titan would not instantly sell its shares on the market. It utilizes "prepaid forward contracts," a complex derivative extensively employed by investors.


How these agreements function:

WHAT ARE FUTURE-PAYMENT CONTRACTS?

A prepaid forward contract is a type of derivative contract that enables investors to hedge equity investment risk.

HOW DOES IT WORKS?

The contract contains a floor price and a ceiling price, limiting the exposure of investors to the set price range.


Investors can either pay financial institutions in cash or physically deliver the shares to complete transactions.


"The investor is safeguarded against loss if the price of the shares falls below the floor. Alternately, if the company's growth exceeds the cap, the investor is not entitled to any of the upside." This was claimed by David Martinez, an associate at the legal firm Clifford Chance.

Exist other advantages to prepaid forward contracts?

According to Gareth Old, a partner at Clifford Chance, investors who wish to monetize holdings without selling the stocks utilize prepaid forward contracts often. Financial institutions advance the funds using the range's floor price and a discount rate.


Moreover, with prepaid forward contracts, investors only pay taxes on capital gains when the contract is finalized.

WHY HAS SOFTBANK DECIDED TO PREPAY THE CONTRACTS BY DELIVERING ALIBABA'S SHARES?

Due to the challenging market conditions, SoftBank has decided to transfer 242 million Alibaba shares to financial institutions instead of selling them directly.


SoftBank also indicated that the physical settlement will alleviate concerns over future cash outflows, reduce contract-related fees, and bolster its defenses against the market decline.


The Japanese company anticipates earning $34 billion in unrealized profits and settlement proceeds.


Bo Pei, senior equity research analyst at U.S. Tiger Securities, stated, "It is evident that they want cash." "The IT industry as a whole has decreased by 30% to 40%. SoftBank has always made substantial investments in these industries, but they now demand finance."

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