Fallout of Softbank’s big reality check

SoftBank wanted to hire as many as six such senior executives. These executives would be in addition to the investment team that the company was simultaneously setting up in India. Most of the executives approached, however, turned down the chance to work with SoftBank, said several people familiar with the matter.

“From what I saw, there was a lot of confusion internally about who was taking calls on India," said one of the executives, who held talks with SoftBank and decided against joining the Vision Fund. “It was not clear how much influence the operating partners they were looking to hire would have. You didn’t want to end up in a place where you’re advising one of the companies to cut burn, and then a month later, SoftBank cuts a cheque of $1 billion to the same company."

Nearly a year later, this executive and others are relieved that they did not join the Vision Fund. Last week, the Vision Fund, for which SoftBank reports results separately, posted an operating loss of $9 billion for the July-September period, primarily on account of a crash in the valuation of WeWork Companies Inc., the American office rental startup that is battling for survival.

WeWork, Uber fallout

The Vision Fund and SoftBank had pumped in more than $10 billion into WeWork, whose valuation touched a peak of $47 billion earlier this year. But WeWork’s loss-making business model and suspect corporate governance policies put off potential public market investors, forcing the firm to suspend its proposed initial public offering (IPO) in September. SoftBank was forced to arrange for financing of $9-10 billion last month to bail out WeWork at a valuation of less than $8 billion.

SoftBank founder Masayoshi Son, who was a cheerleader for WeWork, issued a rare apology last week, saying at the earnings press conference in Tokyo that his judgement was “poor" vis-à-vis WeWork.

Son, however, vowed to persist with his high-risk investment strategy of pumping billions of dollars in internet and technology firms. He said that the second Vision Fund was on track to close soon. According to media reports, SoftBank is still trying to raise around $100 billion for this fund, just like the first.

But the WeWork debacle, along with the disappointing public market debuts of other SoftBank-backed firms such as Uber Technologies Inc. and Slack Technologies Inc., has prompted a reckoning for the Japanese company that many investors said was a long time coming. This is expected to have an impact on startups globally, including those in India. Mint spoke to a dozen venture capitalists (VCs) and entrepreneurs to understand the potential fallout.

The SoftBank Model

By pouring tens of billions of dollars into loss-making internet firms and pushing their valuations to outrageously high levels, SoftBank had led a startup investment boom globally over the past five years, prompting comparisons with the dot-com bubble of the late 1990s.

Those comparisons seem especially relevant for Son, as he had invested in dozens of internet firms during that period. The 62-year-old billionaire was driven to the edge of bankruptcy in the wake of the dot-com bust that started in 2000, though Son and SoftBank survived after bold deal-making in the telecom business and have thrived in recent years.

SoftBank’s revival and its latest investment spree have, in fact, much to do with the success of one of its dot-com investments: Alibaba Group Holding Ltd. In 2014, the Chinese internet giant went public at a record-high valuation of more than $200 billion. SoftBank, which held a third of Alibaba’s shares, reaped the rewards of the IPO and began pouring large quantities of cash into new internet firms across the world.

Internet startups in India have been among the biggest recipients of SoftBank’s largesse. In October 2014, while announcing a large investment in e-commerce firm Snapdeal, Son pledged to invest $10 billion over a decade in India. Less than five years later, SoftBank has already fulfilled that promise, a clear indicator of the company’s freewheeling investment strategy.

A SoftBank spokesperson confirmed that it had already invested $10 billion in India but declined to comment on other queries from Mint.

The India portfolio

SoftBank is a large investor in nine Indian unicorns, out of the 20 internet firms that became unicorns in the past five years, according to Mint research (See graphic). With the exception of Paytm, the rest of the eight startups became unicorns only after SoftBank entered the fray.

That said, SoftBank’s performance has been inconsistent. Among its early investments, a $1 billion bet on Snapdeal and a smaller punt on Housing.com failed spectacularly. Other bets on InMobi and Hike Pvt. Ltd have also disappointed as these firms have consistently lagged growth expectations.

Its India strategy was driven by Nikesh Arora, who was once anointed by Son as his successor. Arora, a former Google executive, left SoftBank in 2016 under a cloud, temporarily causing uncertainty about the company’s India plans. But a year after Arora’s exit, SoftBank launched the Vision Fund and started investing aggressively again.

What has helped SoftBank redeem its India record is its $2.5 billion investment in e-commerce firm Flipkart Internet Pvt. Ltd, which was sold to the world’s largest retailer Walmart Inc. of the US in May 2018. SoftBank netted $4 billion from the sale, less than a year after it had invested in Flipkart.

In its current India portfolio, SoftBank’s most valuable holdings are: Oyo (Oravel Stays Pvt. Ltd), Ola (ANI Technologies Pvt. Ltd) and Paytm (One97 Communications Ltd). SoftBank’s holdings in two of these firms, Oyo and Paytm, are large enough to be considered significant for the overall Vision Fund. It has invested more than $3 billion in these firms.

Last week, the Vision Fund said it had invested about $76 billion in 90 firms as of 30 September 2019. It valued those stakes at about $78 billion, excluding exits. Of the $78 billion, large contributions came from Oyo and Paytm (its stake in Ola is held by the parent entity, not by the Vision Fund).

Oyo and Paytm

According to SoftBank’s presentation, the fair value of its consumer investments was $15.8 billion at the end of the September quarter. Anywhere between 20% and 33% of that can be attributed to its holdings in Oyo. SoftBank owns about 48% of the hotels firm that was valued at $10 billion in its funding round last month. Before this round, Oyo raised $1 billion from SoftBank and others at a valuation of $5 billion in September 2018. It is unclear if the Vision Fund marked up its Oyo stake after the latest round.

SoftBank’s presentation shows that the fair value of its fintech investments was $4.5 billion as of 30 September. At least half of that was on account of its 19-20% holding in Paytm, which last raised funds at a valuation of nearly $11 billion in August 2018. Paytm said its valuation jumped to $15 billion this August when some of its employees cashed out their shares in a secondary sale to unnamed New York-based investors. It is unclear if SoftBank marked up the value of its holdings in Paytm after this share sale.

As with its other portfolio firms, SoftBank has helped push up the valuations of Oyo and Paytm to record highs. Now, the two firms have to prove that they can become profitable in the future. That won’t be easy.

Paytm is locked in a market share war with Google Pay and Walmart-owned PhonePe Pvt. Ltd in digital payments. Once the clear market leader, Paytm has fallen behind its two rivals in UPI transactions. Paytm is trying to become a comprehensive financial services firm to grow and to improve margins, but it has been struggling to expand its payments bank and other businesses. A person familiar with the matter said that for months, SoftBank has been pressing Paytm to cut its spending faster and find new revenue streams.

Oyo has been on a wild expansion spree in domestic and international markets such as the US, UK and China. As with WeWork, Oyo’s strategy, backed by SoftBank, was to grab market share at all costs and worry about cutting losses later. That approach is no longer sustainable.

In July, Oyo founder Ritesh Agarwal announced that he will invest $2 billion to purchase the company’s shares from some of its early investors and invest more capital in the hospitality firm to triple his stake to about 30%. Agarwal’s purchase was to be funded by loans backed by Son, the SoftBank founder. But in the wake of the WeWork IPO failure, Son has recused himself from decisions about future investments in Oyo, The Wall Street Journal reported last week.

The wider impact

Even before the WeWork fiasco, SoftBank had slowed its pace of investments in India this year. While the company has been the biggest backer of Indian startups, it has avoided some fast-growing segments.

SoftBank had considered investing in food delivery firms Zomato Media Pvt. Ltd and Swiggy (Bundl Technologies Pvt. Ltd), but eventually the fund decided that it would only make an investment if the two firms merged, said two people familiar with the matter. However, the two firms declined, they added.

SoftBank had also discussed an investment in business-to-business e-commerce firm Udaan, but passed up on the firm.

Mint reported on 10 November that though SoftBank has been considering making large investments in eyewear retailer Lenskart Solutions Pvt. Ltd and regional language news app Dailyhunt (Verse Innovation Pvt. Ltd) for more than six months, the deals haven’t yet materialized. Earlier, being turned down by SoftBank would be worrying for any unicorn as the Japanese company had become the default choice for any startup looking for large amounts of capital. But now, SoftBank’s image as an all-powerful investor has taken a battering, say investors and entrepreneurs.

“Whenever SoftBank invested in a company, it would tend to scare off rivals. After WeWork, the aura of invincibility around SoftBank and their portfolio companies has reduced. Now there’s a feeling that Softbank’s strategy is dubious and that even if you’re up against one of their companies it is possible to win by following an alternative approach," said a partner at a venture capital firm, who declined to be named.

Many investors now expect a funding downturn to take hold soon. In this period VCs are expected to do fewer deals, valuations could decline across the board and investor pressure on portfolio firms will lead to M&As, say investors. “It’s not only SoftBank companies where valuations are unsustainable, it is a broader wave. Now that it’s become clear that you can’t keep burning money to buy revenues, I think many consumer internet unicorns will have to take a hit on valuation," said another VC, who also declined to be named.

Apart from making direct investments into Indian startups, SoftBank has also been the biggest source of exits for Indian VCs over the past three years. It had bought shares worth hundreds of millions of dollars in Flipkart, Paytm and others. These exits may reduce, too, if SoftBank is forced to cut its India investments.

The intensity of the expected downturn in startup funding will depend, to an extent, on the size of the second SoftBank Vision Fund. That will only become clear over the coming months.