SoftBank Group Corp (TYO:9984) (OTCMKTS:SFTBY) is unloading a sizable chunk of its stake in Alibaba Group Holding Ltd (NYSE:BABA) (HKG:9988), raking in over $34 billion by selling one-third of its stake in the Chinese e-commerce giant via transactions involving derivatives. SoftBank recorded record losses on its technology bets this year, so it’s looking for a way to support its upcoming cash outflows while slashing costs associated with the prepaid forward contracts.
In a statement, SoftBank clarified that the move will strengthen its “defense against the severe market environment.” The company sold some of its Alibaba stake only two days after dumping its Uber shares.
How SoftBank Is Selling Part Of Its Alibaba Stake
In a regulatory filing, the Japanese firm said it would slash its stake in Alibaba from 23.7% to 14.6% via the early settlement of some derivative contracts. The $34 billion SoftBank expects to gain from selling part of its Alibaba stake includes $17.8 billion from a revaluation of the stock.
Reuters explained how the transaction will work. SoftBank won’t sell its shares directly in the market but rather is using prepaid forward contracts, a derivatively primarily used by investors. Prepaid forward contracts allow an investor to hedge the risks associated with holding shares of the company.
The contract sets floor and cap prices, limiting the investor’s exposure to that particular price range. Investors can settle these contracts by paying cash to the financial institutions or handing over the actual shares. If the stock price falls below the floor, the contract protects the investor from that decline, but if it rises above the cap, the investor doesn’t enjoy those gains.
Investors who want to avoid selling their shares but still want to monetize them often use prepaid forward contracts. Financial institutions advance the money on those shares using the floor price of the range set in the contract with a discount rate applied.
Challenging Times For SoftBank And Alibaba
In SoftBank’s case, it’s handing over 242 million shares of Alibaba to financial institutions to settle the contracts early. The Japanese conglomerate clearly needs cash, given that it has historically been heavily invested in the technology sector, which has plummeted by 30% to 40% this year.
SoftBank reported a record $23 billion net loss for the second quarter as plunging tech valuations routed its Vision Fund investment arm. The firm plans to lay off some workers at its Vision Fund and has also exited other positions to raise cash, including Opendoor and Uber.
Meanwhile, Alibaba has shed approximately $600 billion from its market value since peaking in October 2020. Chinese authorities have been cracking down hard on the Chinese tech firm over the last year. The recent economic headwinds have further damaged its growth, forcing it to lay off workers and look for other ways to cut costs.
U.S.-listed and Hong Kong-listed shares of Alibaba both rose 4% on Thursday, while SoftBank shares traded over the counter in the U.S. and on the Tokyo Stock Exchange both rose less than 1%.
This article originally appeared on ValueWalk
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