Since my pre-IPO postal service on WeWork, where I valued the fellowship ahead of its as well as then imminent offering, much has happened. The company’s IPO collapsed nether the weight of its ain pricing contradictions, as well as afterwards a near-death experience, Softbank emerged every bit the savior, investing an additional $ 8 billion inwards the company, as well as taking a much larger stake inwards its equity. As the WeWork story continues to unfold, I am finding myself to a greater extent than interested inwards Softbank than inwards WeWork, largely because its actions cutting to the pump of thus many questions inwards investing, from how sunk costs tin impact investing decisions, to the feedback effects from mark-to-market accounting, as well as finally on the larger query of whether smart coin is actually smart or exactly lucky.
WeWork: The IPO Aftermath
It has been only a few weeks since I valued WeWork for its IPO, but it seems much longer, but because of how much has changed since then. As a reminder, I valued WeWork at most $10 billion pre-money, as well as $13.75 billion amongst the anticipated proceeds of $3.5 billion added on. I also argued that this was a fellowship on a knife’s edge, a growth machine amongst immense operating as well as fiscal leverage, where misstep could really rapidly tip them into bankruptcy, amongst a tabular array illustrating how rapidly the equity slips into negative territory, if the operating assumptions change:
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Soon afterwards my post, the Blue Planet shifted nether WeWork, every bit a combination of arrogance (on the portion of VCs, bankers as well as founders) as well as delineate of piece of work organization model risks caught upward amongst the company, as well as the IPO was delayed, albeit reluctantly past times the company. That action, though, left the fellowship inwards a cash crunch, since it had been counting on the IPO to select inwards $3 billion inwards uppercase to embrace its near-term needs. In conjunction amongst a loss of trust inwards the travel past times management of the company, created a vicious cycle amongst the really existent possibility that the fellowship would implode. As WeWork sought rescue packages, Softbank offered a lifeline, amongst 3 components to it:
- Equity Buyout: Influenza A virus subtype H5N1 tender offering of $3 billion inwards equity to purchase out of existing stockholders inwards the delineate of piece of work solid to growth its part of the equity ownership to 80%. In an strange twist, Softbank contended that, afterwards the financing, “it volition non agree a bulk of the voting rights… as well as does non command the company… WeWork volition non endure a subsidiary of Softbank. WeWork volition endure an associate of Softbank”. I am non certain whether this is a truthful confession of lack of command or a ploy to hold from consolidating WeWork (and its debt load) into Softbank's financials.
- Added Capital: Softbank would provide fresh debt financing of $5 billion ($1.1 billion inwards secured notes, $2.2 billion inwards unsecured notes as well as $1.75 billion every bit a delineate of credit) as well as an acceleration of a $1.5 billion equity investment it had been planning to brand into WeWork inwards 2020, giving WeWork respite, at to the lowest degree inwards the curt term, from its cash constraints.
- Neutering Adam Neumann (at a cost): The offering also includes a severing of Adam Neumann’s leadership of the company, inwards homecoming for which he volition have $1 billion inwards cash, $500 1000000 every bit a loan to repay a JP Morgan credit delineate as well as $185 1000000 for a four-year seat every bit a consultant. I assume that the consulting fee is to a greater extent than akin to a restraining order, preventing him from coming inside sighting distance of whatever WeWork business office or building.
Since that bargain was position together, the storyline has shifted, amongst Softbank straight off playing the Pb work inwards this morality play, amongst multiple questions emerging:
- What motivated Softbank to invest thus much to a greater extent than inwards a fellowship where it had already lost billions? Some are disputation that Softbank had no choice, given the magnitude of what they had invested inwards WeWork, as well as others are countering that they were throwing expert coin afterwards bad.
- With mark-to-market rules inwards effect at Softbank, how volition accountants reverberate the WeWork disaster on Softbank’s books? I mean value that fair-value accounting is neither fair nor is it most value, but the WeWork write downward that Softbank had to have got is a expert fourth dimension to utter over how fair-value accounting tin have got a feedback effect on corporate determination making.
- Is Masa Son a visionary genius or an egomaniac inwards require of checks as well as balances? Influenza A virus subtype H5N1 twelvemonth ago, in that location were many who viewed Masa Son, amongst his 300-year plans as well as access to hundreds of billions of dollars inwards capital, was a human being ahead of his time, epitomizing smart money. Today, the consensus persuasion seems to endure that he is an impulsive as well as emotional investor, non to endure trusted inwards his investment judgments. The truth, every bit is oft the case, lies somewhere inwards the middle.
- Since Softbank is a belongings company, deriving a chunk of its value from its perceived powerfulness to abide by start-ups as well as immature companies as well as convert them into large wins, how volition its value alter every bit a outcome of its WeWork missteps? To reply this question, I volition hold off at how Softbank’s marketplace seat capitalization has changed over time, peculiarly about the WeWork fiasco, as well as examine the consequences for its Vision fund plans.
Sunk Cost or Corporate Rescue!
In the years that WeWork was a mortal company, Softbank was, past times far, the largest investor inwards the company. In August 2019, when the IPO was showtime announced, Softbank had non only been its largest uppercase provider, investing $7.5 billion inwards the company, but had also supplied the most recent circular of capital, at a pricing of $47 billion. That lead-in, though, raises questions most the motives behind its determination to invest an extra $ 8 billion to hold WeWork afloat.
- It’s a corporate rescue: There are some who would debate that Softbank had no choice, since without an infusion of capital, WeWork was on a pathway to beingness worth naught as well as that past times investing its capital, Softbank would avoid that worst-case scenario. In fact, if you lot believe Softbank, amongst the infusion, WeWork has a pre-money value of $8 billion, amongst the infusion, as well as piece that is a steep write downward from the $47 billion pricing, it is nevertheless meliorate than nothing.
- Good coin chasing bad: The sunk cost principle, position simply, states that when you lot brand an investment decision, your selection should endure driven past times its incremental effects as well as non past times how much you lot have got already expended leading upward to that decision. In practice, though, investors seem to abandon this principle, trying to brand upward for past times mistakes past times making novel ones. In the context of Softbank’s novel WeWork investment, this would imply that Softbank is investing $ 8 billion inwards WeWork, non because it believes that it tin generate to a greater extent than than that amount inwards incremental value from hereafter cash flows, but because it had invested $7.5 billion inwards the past.
So, how do you lot resolve this question? As I meet it, the Softbank rescue of WeWork may have got helped it avoid a nigh term liquidity meltdown, but it has non addressed whatever of the underlying issues that I noted amongst the company’s delineate of piece of work organization model. In fact, it has taken a highly levered fellowship whose only pathway to survival was exponential growth as well as made it an fifty-fifty to a greater extent than levered fellowship amongst constrained growth. In fact, Softbank has been remarkably vague most the economical rationale for the added investment as well as their story does non agree upward to scrutiny. I do realize that Masa Son claims that “(t)he logic is simple. Time volition resolve . . . and nosotros volition meet a sudden V-shaped recovery,” inwards WeWork, but I don’t meet the logic, fourth dimension lone cannot resolve a $30 billion debt job as well as in that location are plenty costs inwards non-core businesses to cutting to yield a quick recovery. At to the lowest degree from my perspective, Softbank’s investment inwards WeWork is expert coin chasing bad, a classic instance of how sunk costs tin skew decisions. To those who would counter that Softbank has a lot of coin to lose as well as smart people working for it, annotation that the to a greater extent than coin you lot have got to lose as well as the smarter people mean value they are, the to a greater extent than hard it becomes to acknowledge to past times mistakes, exacerbating the sunk cost problem. In fact, straight off that Softbank volition have got to a greater extent than than $15 billion invested inwards WeWork, they have got made the sunk cost job worse, going forward.
Accounting Fair Value
I empathize the allure of fair value accounting to accountants. It provides them amongst a agency to update the remainder sheet, to reverberate existent Blue Planet changes as well as developments, as well as brand it to a greater extent than useful to investors. The fact that it also creates work for accountants all over the Blue Planet is a bonus, at to the lowest degree from their perspective. I mean value that the accounting response to Softbank’s WeWork error illustrates why fair value accounting is an oxymoron, to a greater extent than probable to do harm than good:
- It is toll accounting, non value accounting: In Softbank’s latest earnings report, nosotros saw the showtime installment of accounting hurting from the WeWork mistake, amongst Softbank writing downward its WeWork investment past times $4.6 billion as well as reporting a hefty loss for the quarter. The ground for the write-down, though, was non a reassessment of WeWork’s value, but a reaction to the driblet inwards the pricing of the company’s equity from the $47 billion earlier the IPO to $8 billion afterwards the IPO implosion.
- With Softbank supplying the pricing: If you lot are dubious most the work of pricing inwards accounting revaluations, you lot should fifty-fifty to a greater extent than skeptical inwards this case, since Softbank was setting the pricing, at both the $47 billion pre-IPO, as well as the $8 billion, post-collapse. As I noted inwards the in conclusion section, in that location is naught tangible that I tin meet inwards whatever of Softbank’s numerous press releases to dorsum these numbers. In fact, if WeWork had non been exposed inwards its world offering, my gauge is that Softbank would have got likely invested to a greater extent than uppercase inwards the company, marked upward the pricing to some number higher than $47 billion as well as that nosotros would non endure having this conversation.
- Too little, every bit good late: As is ever the instance amongst accounting write-downs as well as impairments, in that location was really piddling intelligence inwards the announcement. In fact, given that the write downward was based upon pricing, non value, the marketplace seat knew that a write off was coming as well as about how much the write off would be, which explains why fifty-fifty multi-billion write offs as well as impairments commonly have got no toll effect, when announced. Incidentally, the accountants volition offering you lot intrinsic valuations (DCF) to dorsum upward their assessments, but I would non attach to much weight to them, since they are what I telephone telephone “kabuki valuations”, where the analysts decide, based on the pricing, what they would similar to acquire every bit value, as well as and then contrary engineer the inputs to deliver that number.
- With unsafe feedback effects: If all fair value accounting did was create these write downs as well as impairments that don’t faze investors, I could alive amongst the consequences as well as process the costs incurred inwards the procedure every bit a jobs invention for accountants. Unfortunately, companies nevertheless seem to mean value that these accounting charges are intelligence that moves markets as well as have got actions to minimize them. In fact, a cynic mightiness debate that 1 motivation for Softbank’s rescue of WeWork was to minimize the write downward from its mistake.
I am non a fan of fair value accounting, partly because it is a delayed reaction to a pricing alter as well as is non a value reassessment, as well as partly because companies are oft tempted to have got costly actions to brand their accounting numbers hold off better.
Smart Money, Stupid Money!
I hope that this entire episode volition position to ease the notion of smart money, i.e., that in that location are investors who have got access to to a greater extent than information than nosotros do, have got meliorate analytical tools than the ease of us as well as work those advantages to brand to a greater extent than coin than the ease of us. In fact, it is this proffer that leads us to assume that anyone who makes a lot of coin must endure smart, as well as past times that measure, Masa Son would have got been classified every bit a smart investor, as well as wealthy investors funneled billions of dollars into Softbank Vision funds, on that basis. I am non going to debate that the WeWork misadventure makes Masa Son a stupid investor, but it does let out the fact that he is human, capable of letting his ego acquire ahead of expert feel as well as that at to the lowest degree some of his success over fourth dimension has to endure attributed beingness inwards the correct house at the correct time.
So, if investors cannot endure classified into smart as well as stupid, what is a meliorate suspension down? One would endure to grouping them into lucky as well as unlucky investors, but that implies a consummate give upward to the forces of randomness that I am non yet willing to make. I mean value that investors are meliorate grouped into humble as well as arrogant, amongst humble investors recognizing that success, when it comes, is every bit much a portion of luck every bit it is of skill, as well as failure, when it every bit good arrives, is portion of investing as well as an occasion for learning. Arrogant investors claim every investing win every bit a sign of their science as well as persuasion every loss every bit an affront, doubling downward on their mistakes. If I had to pick someone to handle my money, the lineament that I would value the most inwards making that selection is humility, since humble investors are less probable to overpromise as well as overcommit. I mean value of the really human activity of demanding obscene fees for investment services is an human activity of arrogance, 1 ground that I abide by it hard to empathize why hedge funds are allowed to acquire away amongst taking 2% of your wealth as well as 20% of your upside.
Leading into the WeWork IPO, the query of where Masa Son cruel on the humility continuum was tardily to answer. Anyone who makes 3 hundred twelvemonth plans as well as things that bigger is ever meliorate has a God complex, as well as success feeds that arrogance. I would similar to believe that the WeWork setback has chastened Mr. Son, as well as inwards his remarks to shareholders this week, he said the correct things, stating that he had “made a bad investment decision, as well as was deeply remorseful”, speaking of WeWork. However, he as well as then undercut his message past times non only claiming that the pathway to net for WeWork would endure uncomplicated (it is not) but also asserting that his Vision fund was nevertheless meliorate than other venture capitalists inwards seeking out as well as finding promising companies. inwards my view, Masa Son needs a few to a greater extent than reminders most humility from the market, since neither his words nor his actions dot that he has learned whatever lessons.
Softbank: The WeWork Effect
WeWork may have got been Masa Son’s mistake, but the vehicle that he used to brand the investment was Softbank, through the fellowship as well as its Vision fund. As WeWork has unraveled, it is non surprising that Softbank has taken a meaning hitting inwards the market.
Note that Softbank has lost to a greater extent than than $15 billion inwards value since August 14, when the WeWork IPO was announced, as well as much of that loss tin endure attributed to the unraveling of the IPO, as well as how investor perceptions of Masa Son’s investing skills have got changed since.
The knocking downward of Softbank’s value past times the marketplace seat may strike some of you lot every bit excessive, but in that location is ground that Softbank’s WeWork investment has ripple effects. Softbank may endure built about a telecom company, but similar Berkshire Hathaway, the fellowship that Masa Son is rumored to admire as well as aspire to be, it is a belongings fellowship for investments inwards other companies. In fact, its most valuable belongings remains an early on investment inwards Alibaba, straight off worth tens of billions dollars. While Alibaba is publicly traded as well as its pricing is observable, many of Softbank’s most recent investments have got been inwards young, mortal companies similar WeWork. With these investments, the pricing attached to them past times Softbank, inwards its financials, comes from recent VC funding rounds as well as their valuations reverberate trust inwards Softbank’s capacity to pick winners as well as the WeWork meltdown hurts on both counts. First, investors are to a greater extent than wary most trusting VC pricing, peculiarly if Softbank has been a Pb investor inwards funding rounds, since that is how you lot arrived at the $47 billion pricing for WeWork inwards the showtime place. Second, the notion of Masa Son every bit an investing savant, skilled at picking the winners of the disruption game, has been damaged, at to the lowest degree for the 2d as well as peradventure irreparably. The easiest agency to stair out how investor perceptions have got changed is to compare the marketplace seat capitalization of Softbank to its mass value, a meaning proportion of which reflects its holdings, marked to market:
The knocking downward of Softbank’s value past times the marketplace seat may strike some of you lot every bit excessive, but in that location is ground that Softbank’s WeWork investment has ripple effects. Softbank may endure built about a telecom company, but similar Berkshire Hathaway, the fellowship that Masa Son is rumored to admire as well as aspire to be, it is a belongings fellowship for investments inwards other companies. In fact, its most valuable belongings remains an early on investment inwards Alibaba, straight off worth tens of billions dollars. While Alibaba is publicly traded as well as its pricing is observable, many of Softbank’s most recent investments have got been inwards young, mortal companies similar WeWork. With these investments, the pricing attached to them past times Softbank, inwards its financials, comes from recent VC funding rounds as well as their valuations reverberate trust inwards Softbank’s capacity to pick winners as well as the WeWork meltdown hurts on both counts. First, investors are to a greater extent than wary most trusting VC pricing, peculiarly if Softbank has been a Pb investor inwards funding rounds, since that is how you lot arrived at the $47 billion pricing for WeWork inwards the showtime place. Second, the notion of Masa Son every bit an investing savant, skilled at picking the winners of the disruption game, has been damaged, at to the lowest degree for the 2d as well as peradventure irreparably. The easiest agency to stair out how investor perceptions have got changed is to compare the marketplace seat capitalization of Softbank to its mass value, a meaning proportion of which reflects its holdings, marked to market:
Investors have got been wary of Softbank’s investing skills, fifty-fifty earlier the WeWork IPO, but the write offs on Uber as well as WeWork has made them fifty-fifty to a greater extent than skeptical, every bit the toll to mass ratio continues its march towards parity, amongst the marketplace seat capitalization at 123% of the mass value of equity inwards Nov 2019. In fact, if you lot focus exactly on Softbank’s non-consolidated holdings, world as well as private, annotation that the marketplace seat capitalization of Softbank straight off stands at 73% of the value of exactly these holdings, most of which are marked to market. Put simply, when you lot purchase Softbank, you lot are getting Uber as well as Alibaba at a discount on their traded marketplace seat prices, but earlier you lot position your coin downward on what looks similar a slap-up deal, in that location are 2 considerations that may impact your decision. The showtime is that the fellowship has a vast amount of debt on its remainder canvas that has to endure serviced, potentially putting your equity at risk, as well as the 2d is that you lot are getting Softbank (and Masa Son) every bit the custodian of the investments. If you lot have got lost faith inwards Masa Son’s investing judgments (in people as well as inwards companies), you lot may persuasion the 27% discount that the marketplace seat is attaching to Softbank’s holdings every bit alone justifiable as well as steer away from the stock. In contrast, if you lot experience that WeWork was an aberration inwards an otherwise stellar investment picking record, you lot should charge upward on Softbank stock. As for me, I don’t invention to ain Softbank! I don't similar grandiosity as well as Masa Son seems to have got been soaked inwards it.
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