This article first appeared in The Edge Malaysia Weekly on September 23, 2019 - September 29, 2019
THE overriding concern in Silicon Valley in recent months has been the overvaluation of start-ups funded by venture capital. In every tech cycle, there have been periods in which investors in both private and public markets have chased too few deals, invariably leading to bubblelicious valuations. What is different in the current tech cycle is that just one late-stage investor in the private markets — Japan’s tech and telecom giant SoftBank Group and its US$100 billion (S$137.4 billion) Vision Fund — has been blamed for a lot of the excesses, particularly the way it has used capital as a weapon to choke off competitors.
While capital has traditionally been used as oxygen to nurture young companies and help them survive and thrive, it can also be strategically used as a weapon. Having turned a US$20 million investment in Chinese e-commerce giant Alibaba Group Holding into realised and unrealised gains of nearly US$140 billion, SoftBank founder Masayoshi Son believes there are internet companies in every sector of the economy that have the potential to morph into global-scale semi-monopolies such as online retail behemoth Amazon.com, social media powerhouse Facebook and search engine giant Google.
To be sure, there is nothing wrong with tech venture capitalists’ (VCs) picking winners, showering them with a ton of capital to give them a leg-up against challengers. But when capital is used as a weapon to kill or ward off competitors, it can also mask the problems of the chosen companies. The recent travails of ride-hailing giant Uber and co-working firm WeWork are a case in point. As they have soaked up billions of dollars in VC funds, it is still unclear whether WeWork and Uber have a viable business model, let alone are destined to rule the world like Amazon or Google.
Big challenge worldwide
SoftBank’s use of “capital as a weapon” is one of the biggest challenges corporate boards around the world have ever had to face, Bill Gurley, a general partner at Benchmark, a VC firm in Menlo Park, California, noted recently. Price competition fuelled by SoftBank’s investments is “one of the toughest things a board has ever had to analyse”, he said. Gurley should know. Benchmark is the second biggest investor in Uber and WeWork behind Softbank.
Even tougher is the lesson that Uber and Grab have learnt — that while a huge capital injection by a cash-flush tech investor such as Softbank can be helpful, it is not necessarily a game changer. The money they raised has not given them an edge against competitors such as Lyft or Go-Jek, nor has it provided them with a clearer pathway to profits. Instead, they have been forced to expand into meal delivery, freight and, in the case of Grab, into becoming a SuperApp to keep up with their pace of growth, which in turn has forced them to raise even more capital — ironically pushing their eventual profitability even further out.
On Sept 15, WeWork’s parent The We Company announced it was delaying its planned IPO after investment bankers cautioned the firm against charging ahead amid tepid investor demand.
Companies delay or call off their IPOs all the time. So, why does WeWork’s decision matter? For one thing, it could derail Softbank’s US$108 billion Vision Fund 2, for which it had already received commitments of more than US$80 billion from top Japanese banks, Microsoft, Apple and other large global companies. For another, it could choke off funding for key sectors, including ride hailing and food delivery, not just in the US, where it would affect Uber and its competitor in meal delivery DoorDash, but also reverberate around the world where SoftBank has funded similar firms such as Grab China’s Didi Chuxing and India’s Ola Cabs, another Uber competitor in which SoftBank is the largest shareholder.
If WeWork collapses or is forced to drastically scale down operations to stay afloat, the repercussions for the tech industry in general and SoftBank investee companies could be huge. Some Silicon Valley insiders have gone so far as to call WeWork a “systemic risk”, arguing that its collapse could trigger the fall of less viable firms as their funding is choked off, while others believe that reverberations will mostly be felt through a sharp decline in tech valuations across the board.
SoftBank has so far invested US$10.7 billion in WeWork, with the last round in early January valuing the co-sharing firm at US$47 billion (of that, US$7.5 billion is in the holding company and the remainder in its subsidiaries and joint ventures). In April, WeWork’s charismatic founder and CEO Adam Neumann told journalists and investment bankers that he expected the co-working outfit to do an IPO that would value it at more than US$60 billion. That was first cut to between US$25 billion and US$30 billion in late July, to between US$18 billion and US$20 billion two weeks ago, to between US$10 billion and US$12 billion more recently. Indeed bankers reportedly told Neumann that there was just no appetite for WeWork shares at anything higher than the US$12 billion valuation.
WeWork hard for the money
According to Crunchbase, a VC database, WeWork had raised US$12.8 billion by January this year. At end-June, WeWork had just US$2.47 billion in cash and equivalents. It also had operating cash burn of more than US$200 million and an investing cash burn of US$2.36 billion in the first half of the year. In recent quarters, WeWork’s losses have ballooned and are growing faster than its revenues. If the company bleeds as much in the second half of the year as it did in the first half, invests as much and raises no cash whatsoever, it would be broke before Christmas. That is before you add in all the IPO expenses, additional marketing expenses and Neumann’s vow to increase investments to quickly get scale and generate more revenues, so WeWork could actually run out of money sooner. That is why Neumann has been adamant that it will do its IPO as soon as possible and even spurned his biggest backer Son and SoftBank’s request to indefinitely postpone the IPO and consider raising money in the private markets.
WeWork — which operates in 111 cities, including Singapore and Kuala Lumpur, and is the largest office tenant in New York, San Francisco, Seattle, Washington, DC and London — needs up to US$10 billion more: US$3 billion to US$4 billion in new equity to gain access to more than US$6 billion of additional debt, most of which is contingent on the firm’s doing an IPO or raising as much money from the private market.
Having invested its last billion dollars in WeWork at a US$47 billion valuation, SoftBank has some downside protection for its investments. SoftBank has received warrants that allow it to put in as much as its original investments at IPO price. So, if WeWork does the IPO at US$10 billion valuation, SoftBank has the right to put up the whole US$3 billion at that low valuation to average down its investment and partake on any upside. Analysts say SoftBank has been contemplating putting in between US$750 million to US$1.5 billion in the IPO.
Chris Lane, an analyst for Bernstein & Co in Hong Kong, estimates Softbank’s weighted average investment value in WeWork at US$24 billion. So, if WeWork has an IPO valuation of US$12 billion, SoftBank would need to write down US$5.25 billion off its US$10.5 billion original investment. If it lists at US$10 billion, and the stock falls 20% after the listing, like Uber’s did, Softbank will need to write down US$7 billion, or two-thirds, of its original investment in WeWork.
The writedown in WeWork for Softbank will follow forced writedowns in other high-profile IPOs such as Uber, whose stock is down 26% since the listing in May. Indeed, SoftBank has had little luck with large investments since its huge payday at Alibaba. Most of SoftBank’s other investments, including Alibaba, have been minority stakes, with the exception of the No 4 US telco Sprint, in which it has a 80% stake; mobile phone distributor Brightstar; and British mobile chip design giant ARM Holdings, which Softbank bought outright, notes Atul Goyal, analyst for Jefferies & Co in Singapore.
“Sprint does not appear to have worked so far and SoftBank is giving up control in a pending deal with T-Mobile,” he says. SoftBank was also forced to write down large amounts on the Brightstar acquisition, Goyal says. ARM, which was profitable when Softbank bought it in early 2017, is now losing money. Softbank’s stated aim was to build ARM as a chip designer for the artificial intelligence-powered internet of things era and had committed large R&D investments to reach that goal.
WeWork’s rework will not work
So, will we or will we not see a WeWork IPO this year? Waiting an additional month or two is unlikely to change things for WeWork, just as dramatically slashing valuation and cosmetic revamping of governance have failed to move the needle. The structure of the company is such that its showing an additional quarter of losses will probably raise more questions than it might answer.
Without US$3 billion of new equity, WeWork cannot raise US$6 billion in debts and, without a S$9 billion infusion of new cash, WeWork’s entire plan to be a dominant global force in the co-working space will fall apart. WeWork would then be forced to drastically curtail its cash burn, cut costs, slash investments plans, eke out savings in refurbishing offices and spend less on marketing. Cost-cutting may make WeWork a little leaner, though not necessarily any more viable.
If WeWork’s saga shows anything, it is that the use of capital as a weapon can boomerang on large investors such as SoftBank. In the post WeWork-era, Silicon Valley is likely to go back to building tech companies the old way, using technology and innovation to gain a competitive edge rather than ever-larger chunks of capital.
Assif Shameen is a technology writer based in North America
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