Credibility of SoftBank called into question

SoftBank has been known for being a big money player. Their investment fund, the Vision Fund, worth of $100 billion is made of mostly money from the Middle Eastern governments. They have poured money into startups around the world, including big names such as ByteDance, WeWork, Uber, Slack, Flipkart and Brandless, as well as established companies such as Sprint in the US.

By all means, being able to the tune of $100 billion is a massive undertaking. It shows the trust of investors in Son, the founder and CEO of SoftBank, and his team. However, three years after the money was raised, there have been concerning signs of SoftBank’s investment strategy and execution.

SoftBank’s most infamous flop is WeWork. After pouring $9 billion into the startup, the Japanese firm had to see WeWork’s IPO scrapped, its CEO and founder ousted and to plan another $10 billion bailout at a valuation that is significantly lower than what Son and his team expected (per WSJ). It’s mind-blowing that billions of dollars were invested with what seemed to be insufficient scrutiny and due diligence

SoftBank executives were alarmed by what they found looking deeper into the company’s financials, people familiar with the matter said.

Source: WSJ

In addition to WeWork, other high profile investments such as Uber and Slack haven’t met expectation either. Uber had to scale back its valudation upon going public and since being on the stock market, neither Uber nor Slack has been trading above its initial price

Source: Financial Times

Six years ago, SoftBank bought a controlling stake in Sprint. This paragraph below from CNBC summarized how the move is six years later

SoftBank successfully engineered a sale of Sprint for $6.62 per share to T-Mobile in 2018. (State attorneys general are in court attempting to quash the deal on grounds that it will unacceptably decrease competition.) But SoftBank acquired its majority stake in Sprint for $7.65 a share in 2013. When SoftBank bought Sprint, it was the third-largest U.S. wireless carrier by subscribers. When SoftBank sold, Sprint was a distant fourth behind VerizonAT&T and T-Mobile.

But Sprint’s annual revenue has shrunk since SoftBank took over, from $35.3 billion in 2012 to $33.6 billion in the latest fiscal year. Recently, subscriber numbers have been dropping, and the company recorded a $1.9 billion loss last year. Still, Claure made over $40 million in compensation from 2015 through 2017, primarily because of stock awards that resulted from keeping the shares above $8 per share, which was only marginally higher than the price SoftBank paid in 2013.

Sprint even acknowledged in April it didn’t have a sustainable path forward in a filing to the Federal Communications Commission, asking for the regulator to approve its sale.

“Sprint is in a very difficult situation that is only getting worse,” the company said in the letter. “Sprint is losing customers — which then reduces revenues and cash flow — further limiting its ability to invest in its network and service its debt. Simply put, Sprint is not on a sustainable competitive path.”

Source: CNBC

Furthermore, troubles have surfaced at other startups that SoftBank invested in. Fair, an online car-leasing startup, announced that it would lay off 40% of its workforce this week. Wag, an on-demand dog walking firm, laid off more than 50 employees this year already. Brandless saw declining revenue by 54% compared to the same period last year and planned to cut marketing budget.

On the other side of all the problems that hit SoftBank lately, the Japanese firm does have success in the form of its investments in Alibaba and Flipkart. Plus, its capital allowed ideas and founders to come into life. Nonetheless, the struggles at companies listed above do call into question its hype, strategy, execution and credibility. When you want to raise an unprecedented amount of money and invest in an unprecedented fashion, you are put under unprecedented scrutiny and expectations.

Book: Super Pumped: The Battle For Uber

Having a lot of time on my hands during bus and train rides to Chicago and back, I decided to read this book. It turned out to be a really interesting and good book about Uber’s history and the list of events that led to where it is now. The growth at all cost mentality and the toxic culture both catapulted Uber into the stratosphere of startup valuation and cost the ride sharing company millions of dollars and a litany of problems. Uber was drowned in so many scandals that it was mind-blowing to see how the governance allowed that to happen. The part in which Benchmark and its allies did everything they could to oust Kalanick was fascinating. If you are interested in one of the most interesting startups of recent times, then I highly recommend it

At the end of the week, Uber’s finance team added it all up. The entire “X to the x” celebration cost Uber more than $25 million in cash – more than twice the amount of Uber’s Series A round of venture capital funding.

The reality was much less noble. As Uber’s insurance costs grew exponentially, the “Safe Rides Fee” was devised to add $1 of pure margin to each trip, according to employees who worked on the addition. That meant for each trip taken in the United States, Uber took in an extra dollar in case. The drivers, of course, got no share of the extra buck. That number added up to hundreds of millions of dollars over years of operation, a sizeable new line of income. After the money was collected, it was never earmarked specifically for improving safety.

When Uber cut rates in 2015, rather than worry about the effects lower income would have on drivers, Kalanick was giddy. To Travis, lowering prices meant raising demand. Growth would explode again, and growth – not the concerns of his drivers – was Travis’ top priority.

It didn’t matter to Kalanick that drivers were logging more trips and picking up more people – basically doing twice the work – to make the same amount of money. It didn’t matter that drivers were commuting absurd distances to busy cities like San Francisco – often from places two hours away, but occasionally as many as six hours away – sleeping in their cars overnight on side streets and empty parking lots for the chance at more rides per hour. It didn’t matter than San Francisco lacked sufficient public bathrooms for drivers, forcing them to find coffee shop bathrooms, or, more often make do elsewhere. And it certainly didn’t matter that drivers pulling dayslong shifts were overworked and under-slept.

Most importantly for Son, SoftBank would purchase those shares at a steep discount from Uber’s valuation earlier in the year. Son and Khosrowshahi settled on a purchase price of $33 per share, pegging Uber’s valuation at about $48 billion – a steal for SoftBank. That meant that the scandals of the previous twelve months had knocked about $20 billion off Uber’s private market value.

To keep the price propped up on paper, the investors did some sleight-of-hand maneuvering. SoftBank would purchase $1.25 billion in additional, newly issued shares at Uber’s previous existing valuation of $68.5 billion. The premise was absurd; the secondary market clearly valued Uber’s shares at far lower than they were before Uber’s 2017 from hell. Yet in the eyes of the market, the maneuver worked; Uber’s valuation would remain at $68.5 billion.

One particularly raucous evening, a bunch of Uber Thailand employees, were up late drinking and snorting coke, a semiregular occurrence at that office. One female Uber employee with the group had decided she didn’t want to do drugs with her colleagues, and tried to abstain. Before she could leave, her manager grabbed the woman and shook her, bruising her. Then he grabbed the back of her head and shoved her face-first into the pile of cocaine on the table, forcing her to snort the drugs in front of them.

The New York office was largely defined by its machismo, sexism and aggression. Sao Paolo saw angry managers throwing coffee cups across the room or screaming at employees when they weren’t happy with results.

WeWork – Is its story credible?

In business, I find that all companies strive to tell a compelling story and work to back it up. Apple wants us to believe that it is a luxury brand and it is here to make our life and world better. Uber wants to be the Amazon of transportation and changes the world with its services. On a higher level, a lot of companies sell the story of their operational losses on the promise of future growth and profitability. Each firm tells its story in a different way. Each tries to differentiate themselves from the herd. Whether a company succeeds is a matter of producing evidence to back up the story.

Want consumers and investors to believe in a growth narrative in exchange for present losses?

  • What is your economies of scale?
  • How is your revenue growth?
  • How does your expense compare to revenue?
  • How are this year’s numbers compared to last year’s?
  • How big is the Total Addressable Market?
  • What is it that you do makes your company better than competitors?
  • What are some success stories from your customers?
  • What is the credibility of your team?
  • What is your plan for innovation?
  • How is your free cash flow?
  • So on and so forth

The more pieces of evidence are presented to back up the story, the more likely the story can stand the scrutinizing eyes of investors, analysts and the public. In this sense, I don’t buy the story of WeWork.

It’s tricky to put a definition on WeWork, but essentially, it rents or owns a real estate and allows individuals or companies to use the space in exchange for some fees. It has grown significantly fast since its inception and is about to go public soon this year.

WeWork now has 466,000 members working out of 485 locations in more than 100 cities in 28 countries. Its revenue has grown from $75 million in 2014 to $1.8 billion last year. Three years ago, it had 1,000 employees; today, it has 12,000 and is adding 100 every week. It has installed 22 million square feet of the glass partitions that have defined an era of workplace aesthetics, and last fall, it became Manhattan’s largest tenant. (In Central London, it is second only to the British government.) In the wake of Uber’s (disappointing) debut on the New York Stock Exchange, the We Company is now America’s most highly valued start-up, at $47 billion — at least for the moment.

Source: New Yorker

On the less sexy side, WeWork lost a staggering amount of $1.9 billion in 2018, even more than Uber, and $700 million alone the first quarter of 2019 (Business Insider). The economics of the model can pose trouble, particularly in times of an economic downturn. If an economic crisis forces knowledge workers and companies to retreat from renting out WeWork space, the company will be saddled with fixed costs which are their leases or related to owning buildings. Regus had a similar model to WeWork in 2000s, became the darling of Wall Street and went bankrupt shortly after.

In addition, there are other signs that I think are troubling at the very least.

He is known for making bombastic pronouncements, like this one at an all-company event last year: “There are 150 million orphans in the world. We want to solve this problem and give them a new family: the WeWork family.” In L.A., Neumann told his employees that the newly formed We Company would now have three prongs — WeWork, WeLive, and WeGrow — with a single, grandiose mission: “to elevate the world’s consciousness.”

As Neumann recently told a person close to the company, he believes that WeWork’s size and scale could put it in a position to help deal with some of the world’s largest problems, like the refugee crisis, saying, “I need to have the biggest valuation I can, because when countries are shooting at each other, I want them to come to me.”

Source: New Yorker

What is the focus of WeWork now? Is it to be profitable in the real estate or coworking space? Or is it to change the world and help orphans? The potential “hands on multiple jars” approach is not a welcome sign in the times when the company loses a massive sum from operations every year.

The idea that countries need to come to WeWork to solve political and social conflicts seems more delusional than wildly ambitious.

In 2017, Neumann declared that WeWork’s “valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.” He has long maintained that categorizing WeWork as a real-estate concern is too limiting; it is a “community company” with huge ambitions. “We are here in order to change the world,” Neumann said that same year. “Nothing less than that interests me.”

Source: New Yorker

What does “it is based on our energy and spirituality than it is on a multiple of revenue” even mean?

It has lately been investing more in technology to better understand how people use its space, and Shiva Rajaraman, WeWork’s CTO, described a typical WeWork to me as “an Amazon warehouse with a lot more soul.” The company uses data to improve its management of conference rooms and analyze its customers’ interests to better plan community events. (Rajaraman said the company had found that WeWork members in Brooklyn and San Francisco enjoyed “urban gardening.”) The manager of a WeWork space in Flatiron told me that “one of our best learnings” since opening was that people liked sitting at several desks in the back of the room that were near the windows. This, he said, was something they hadn’t guessed, before admitting it “makes a lot of sense.”

Source: New Yorker

More demand for coffee in the morning and people preferring desks near the windows are new revelations? It doesn’t really sound like compelling evidence of great artificial intelligence or future revenue stream.

On a practical level, SoftBank’s cash infusion helped WeWork cover the increasing costs of its whirlwind expansion as the real-estate market got more expensive. It also began spending heavily to fill all the desks it was adding. Just a few weeks after SoftBank’s investment, Shlomo Silber, the owner of Bond Collective, a  New York–based co-working company, turned on his phone at the end of Rosh Hashanah to find dozens of his customers had forwarded an email from WeWork offering to buy them out of their leases and give them as much as a year of free rent. WeWork’s occupancy rate went up, but the deals made it difficult to determine the natural demand for its product. WeWork employees in multiple cities told me that savvy companies would take advantage of a few months of free rent in one WeWork, then wait for a new location to open so they could move and take advantage of another deal.

Source: New Yorker

A high valuation for a money-losing startup needs to come with robust proof of significant demand. If demand in this case is inflated, will the valuation still be reliable or justified?

Just before last Christmas, Masayoshi Son called Neumann with bad news: A plan for SoftBank to invest $16 billion into WeWork, including $4 billion it had already promised — and to become its majority shareholder — was dead. The stock market had tanked, and the Vision Fund’s investors, including Saudi Arabia, were hesitant to invest more in real estate. SoftBank ended up investing another $1 billion in WeWork, and buying another $1 billion of stock from employees and other investors. This was more money than Neumann’s smaller rivals had raised combined, but it was still a disappointment, and presented as such in the media. At the company summit in January, Neumann told employees that news coming from outside the company was often “fake or misinformed.” (In 2017, he told the Economic Club of New York he thought fake news was “a great term.”)

Source: New Yorker

When even your biggest advocate scaled back the support and confidence…

A lot more details can be found in the profile by New Yorker. Above are just notable pieces that I think can tell a lot about the company and its CEO. Kudos to WeWork for what they have done so far. Noone should deny the credit they deserve. As they already have 24% of their desks are occupied by companies with more than 100,000 employees (Wired), there is a reason to believe that WeWork will be able to stick around, even in tough times. However, the hype and the gigantic valuation, I think, are a bit excessive. The evidence isn’t convincing enough. The evidence for concern, so far, has been, though.