In 2017, SoftBank Group Corp. (TSE:9984, Financial) shocked the investing world when it announced plans to raise a massive $100 billion venture capital fund. Dubbed the Vision Fund, it ended up fully subscribed, with billions of dollars pouring in from sovereign wealth funds and powerful tech investors alike. This summer, SoftBank CEO Masayoshi Son announced plans for a $108 billion Vision Fund 2; by July, it was boasting commitments from the likes of Microsoft Corp. (MSFT, Financial) and Apple Inc. (AAPL, Financial).
Alas, the success was not to last.
When it rains, it pours
2019 has seen the Vision Fund’s fortunes turn sour as major investments in tech companies like Slack Technologies Inc. (WORK, Financial) fell underwater following lackluster initial public offerings. Worst still, WeWork, the Vision Fund’s biggest investment, imploded on its way to going public; deep investor skepticism saw the co-working company’s planned valuation melt down from $47 billion to less than $20 billion before the IPO was eventually pulled altogether.
As we discussed in another research note this week, SoftBank’s paper gains on highflying startups could not last. However, while our reading of the situation was hardly kind to Mr. Son and SoftBank, it was comparatively charitable when set beside the opinions of a number of influential commentators in the investing community.
Calling out self-serving paper gains
Josh Wolfe, a respected science and technology-focused venture capitalist, offered a downright damning critique of the Vision Fund’s strategy during a Sept. 5 interview with Ritholtz Wealth:
“What’s crazy is that the money that they’re putting to work in some cases, they are pricing up their own investments...I have a slightly more nefarious view that a reason that SoftBank is doing this, understanding the motive is that they are doing this to be able to create paper assets and increases in paper valuations that can serve as collateral against indebtedness that is north of 140, $150 billion. So, by being able to invest in WeWork at $10 billion and then pricing it to 20, you showed that you had 100 percent gain in your $1 billion or $2 billion investment. And if you look at their earnings over the past one or two or three quarters, a significant portion of the profits that are reported is from these paper gains, illiquid.”
This reflects the problem we described previously, but is obviously a harsher view. While we are willing to remain more charitable with regard to SoftBank’s intentions, there can be no doubt about its results. When a company has the ability to effectively set the price of its assets, it naturally has an incentive to inflate the values of those assets as much as possible.
Don’t say the P-word
On Oct. 8, Axios published a report detailing the Vision Fund’s highly irregular structure, which guarantees a 7% annual coupon to its outside limited partners:
“SoftBank Vision Fund isn't just the largest private equity fund ever raised, at $100 billion. It's also one of the most complicated. All outside limited partners are promised a 7% annual coupon on their invested capital, which through June had come out to $1.6 billion. And some of that $1.6 billion has come from those same limited partners, in a bizarre bit of capital carousel. The result, from a practical perspective, is that SVF might not really invest $100 billion into outside tech companies…SoftBank created the coupon as a marketing tool, knowing it would be difficult to get investors to bite on such an out-sized fund. But it also assumed that the coupon could be entirely paid for via distributions — something that hasn't yet born out. Of the $1.6 billion in coupon payments-to-date, only $400 million has come from distributions (Flipkart and Nvidia).The rest has come from capital calls.
“The result: Outside LPs are basically paying themselves, SoftBank Group is paying them even more (on a percentage basis, since it only has traditional equity), and Vision Fund isn't really investing $100 billion.”
“Bizarre” seems far too light a descriptor for what SoftBank has done. Indeed, Francine McKenna, a reporter with a long track record of sniffing out corporate malfeasance and accounting chicanery, responded to the Axios report with a one-word question: “Ponzi?”
That is a serious accusation. As a closed-end fund, the Vision Fund cannot, by definition, be a Ponzi scheme, but that does not mean it is not doing some questionable things. Paying investors their own money back even as the Vision Fund’s paper gains evaporate on contact with financial reality is unsustainable.
Verdict
Just a few months ago, SoftBank thought it would ride its paper successes with the Vision Fund to another massive raise. Now, it appears that Vision Fund 2 is on life-support. With the original looking rather battered, many investors have begun to reconsider their commitments.
Real losses always trump paper profits. That is a lesson SoftBank is learning the hard way.
Disclosure: No positions.
Read more here:
- Bill Nygren: Fundamentals Are the Key to Value Investing
- Wall Street Analysts Divided as Earnings Season Looms
- Earnings Recessions: Imperfect but Important Indicators
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
