SoftBank's Vision Fund : Why the owner of Oyo, Uber and Paytm is in trouble

SoftBank has changed the rules of venture capital investing in recent years thanks to its massive $100 billion Vision Fund. Mr. Masayoshi Son, the chief executive of SoftBank, has turned the VC industry upside down by writing giant checks to companies around the world raising their valuations to astronomical levels. As has been the case with Uber, WeWork and Oyo, many of the Vision Fund portfolio companies have been facing significant headwinds even prior to the advent of the coronavirus pandemic. Things have only got worse in the last couple of months. Earlier this week, Softbank took a $17 billion investment loss on account of the plunging value of its Vision Fund portfolio companies.

In this article, we critically evaluate the underlying reasons why SoftBank's Vision Fund currently finds itself in such deep trouble.

Using Capital as a Weapon : SoftBank has focused majority of its investments on capital intensive, low-margin, mature businesses. Mr. Masayoshi Son seems to believe that the Vision Fund’s massive capital investments can be used as a weapon to gain sustainable competitive advantage. But this thinking is flawed for mainly two reasons:

1. In virtually every category in which SoftBank is heavily invested—real estate, ride-sharing, meal delivery, hotels, construction—SoftBank is facing well-capitalized and resilient competition. In a world awash in capital, none of SoftBank’s funded ventures has achieved anything close to monopoly pricing power. This has contributed to escalating losses across Mr. Son’s portfolio.
2. By investing too much, too soon in unproven ventures, SoftBank compels its portfolio companies to rapidly scale businesses that still have unproven or deeply flawed business models (e.g. WeWork and Uber), inadequate core business processes (e.g. Brandless, Wag) or weak defenses against competitive threats (Slack). Prematurely picking winners with massive bets heightens the risk of the company's eventual failure.

Portfolio Concentration : Vision Fund is vulnerable because a handful of huge investments have an outsize role in determining the fund’s returns - the top-seven portfolio companies account for about half of its invested capital. These include companies such as Uber, Chinese ride-hailing company Didi Chuxing, hospitality unicorn Oyo and WeWork, companies which have been struggling even prior to the advent of the coronavirus pandemic.

Lack of diligence: It has compounded the problems for SoftBank. Adam Neumann famously persuaded Mr. Son to invest in WeWork at a valuation of $20 billion during a 12-minute walk around the office before signing the deal on an iPad in the back of a cab. Add to that a stunning lack of corporate governance at portfolio companies and you have a combustible mixture.

Liquidity : Surprisingly, for a $100 billion fund, liquidity might be a big issue going forward. SoftBank is the largest shareholder for the majority of companies in the Vision Fund. That means it will be asked for follow-on investments for which Mr. Son has dedicated about $20 billion of the $100 billion. Many have expressed concern whether $20 billion was enough reserve capital for a fund with a 14-year lifespan.

To add to the fund’s misery, the $40 billion that was invested in the Vision Fund by the sovereign funds of Saudi Arabia and Abu Dhabi carry a debt like annual interest rate of 7%. That’s $3 billion that must be paid out every year, no matter how the underlying portfolio performs. As a result, the fund may not be able to backstop its cash-burning companies with follow-up investments. Cash intended for that purpose might have to go toward paying interest to the preferred stock holders. And this is precisely the reason why SoftBank is keen to raise Vision Fund 2. It needs fresh funds to keep investing in its portfolio companies.

Aggressive Accounting : SoftBank’s controversial accounting practices is another key challenge. The Vision Fund booked profits on startups as their valuations rose, even if the gains were only on paper and no shares were sold. WeWork and Oyo both contributed to profits early on in the fund’s lifetime. SoftBank declared during their last annual results that the Vision Fund had delivered an Internal Rate of Return (IRR) of 45% on the equity portion. Now, IRR is a nebulous concept and there is no standard way of calculating it. However, in simple terms, IRR indicates how much the investment value is up over a period of time compounded annually. The challenge for SoftBank is that the IRR is almost certain to be much lower for the current year - given the loss in the investment values of portfolio companies. As a result, investors will be difficult to find. And all plans for raising Vision Fund 2 will need to be suspended for now. This is likely to compound cash flow concerns of portfolio companies.

Final thoughts....

Lest one forget, the Vision Fund has also made some successful bets though they are few and far in between. It sold Indian e-commerce firm Flipkart to Walmart for a $1.5 billion profit. Cancer-test company Guardant Health had a strong IPO though the value of the shares have tumbled in recent months. There are others such as Grab and ByteDance ( owner of the wildly popular app TikTok) that could witness a strong exit in the future.

There are other positive signs for Vision Fund investors. Recently, SoftBank pulled back from a $3 billion commitment to buy shares from WeWork ex-CEO Adam Neumann and other early investors arguing conditions of the deal were not met. It withheld a cash installment from direct-to-consumer retailer Brandless, which then shuttered. It also allowed satellite internet startup OneWeb to file for bankruptcy even after previously investing about $2 billion - all pointing towards heightened discipline and course correction at SoftBank.

Many have argued that it is too soon to judge the performance of a fund that has a 14-year lifespan. It has only been about 3 years since the fund was launched. Mr. Son too has advised his investors to have some perspective.

"Look at a shadow…even within 24 hours, the length of your shadow differs dramatically, even though your height in 24 hours is unchanged. People get scared or overconfident looking at the length of the shadow."

Mr. Son lost almost everything during the dotcom bubble. At one point in time, the value of SoftBank stock had fallen by 99% !! However, Mr Son came back strongly from the setback. His $20 million investment in Alibaba (made in 2005) is worth a staggering $140 billion today. Mr. Son's supporters and investors will be hoping that he can once again recreate that magic at Vision Fund.

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