TOKYO, JAPAN - NOVEMBER 06: SoftBank Group Corp. Chairman and Chief Executive Officer Masayoshi Son ... [+] arrives for a press conference on November 6, 2019 in Tokyo, Japan. SoftBank reported its second-quarter earnings result posting a 704 billion yen ($6.46 billion) loss for the July-September period. (Photo by Tomohiro Ohsumi/Getty Images)
Softbank's rescue ofWeWork, an American commercial real estate company founded in 2010, avoided a near term liquidity meltdown. However, the holding company has not addressed any of the structural concerns in WeWork's business model. WeWork has a high level of debt in its balance sheet. The high degree of debt subjected the business to a great deal of risk. Hence the firm's only route to survival was exponential growth. Now Softbank, with its bailout offer, has added even more debt in WeWork's balance sheet. This action can further restraint WeWork's growth.
It has been a few weeks sinceWeWork IPO collapsedunder the weight of its pricing inconsistencies. WeWork was a growth machine with tremendous operating and financial leverage, where a blunder could very quickly tip them into insolvency. After WeWork filed to go public in August, investorsrailed againstits unproven business model, mounting losses, limited governance, and its founder Adam Neumann's questionable conduct. As a result, the company discontinued its IPO, and Neumann stepped down. This setback left the company in acash crunch, as WeWork was relying on the IPO to provide $3 billion in capital to cover its near-term needs. After the IPO failure, Softbank emerged as the protector, funding an additional $8 billion in the company, and exercising a much more significant stake in its equity.Softbank offered a lifeline, with three provisions to it:
Corporate Redemption or Sunk cost fallacy
Softbank is the biggest investor in WeWork and financed $7.5 billion in the company during the IPO. The holding company had also funded the most recent round of capital, at a pricing of $47 billion. Softbank had no alternative since, without an infusion of capital, WeWork was worth nothing.
In the connection of Softbank's WeWork investment, the holding company is financing $8 billion in WeWork, not because it thinks that it can earn more than that amount in incremental value from future cash flows, but because it had financed $7.5 billion in the past. That looks like a classic case of throwing good money after bad. Softbank is making a typical rookie error by yielding to the sunk cost fallacy and assuming that the additional investments will finally recover previous losses.
Accounting Fair Value
Fair value accounting provides accountants with a way to update the balance sheet, to reflect real-world changes and developments, and make it more valuable to investors. In Softbank's latest earnings report,the company had written down its WeWork investment by $4.6 billionand reported a hefty loss for the quarter. The write-down was a reaction to the drop in the pricing of the WeWork's equity from the $47 billion before the IPO to $8 billion after the IPO implosion. Softbank was fixing the pricing, at both the $47 billion pre-IPO, and the $8 billion, post-collapse. There is nothing concrete in any of Softbank's copious press releases to verify these numbers. Hence the fair value accounting in WeWork's case is a delayed response to a pricing adjustment and is not a value reassessment.
Softbank: The WeWork Effect
Softbank is a holding company for investments in other companies, and many of Softbank's most recent ventures have been in growing, private businesses like WeWork. The holding company's investment approach is to issue enormous funds into its target companies that they were practically overflowing in the capital; this would provide the companies, to overwhelm their competitors and achieve supremacy in their markets. Softbank finance enterprises that provide goods and services for lower than their cost. The holding company's strategy was that in the future, they would be able to raise prices to cover their losses. The problem with this strategy is that, often, a time arrives when building a company out of selling the products at a loss no longer works. In the case of Amazon, the strategy worked, and the company now holds a de-facto monopoly on online retail, but for WeWork, the approach was a disaster.
Softbank prices their investments in its financials based on recent VC funding rounds. As WeWork venture has unwound, Softbank has lost more than $15 billion in value since its IPO announcement. After WeWork's debacle, investors are cautious about trusting VC pricing. Softbank was the largest investor at both the WeWork and Uber two of the most high-profile private companies in recent years that also had notable issues with the founder's management and governance. The holding firm's standing as a company skilled at selecting the winners of the disruption game has been maligned, at least for the moment and perhaps irreparably. The easiest way to measure how investor perceptions have changed is to compare the market capitalization of Softbank to its book value, a significant proportion of which indicates its holdings, marked to market. The price to book ratio has experienced a sharp correction, with the market capitalization at 123% of the book value of equity in November 2019. The holding company is trading at a deep discount to its net assets, which include a $ 110 billion stake in Chinese e-commerce giant Alibaba. WeWork fiasco casts severe doubt on Softbank's investment strategy and on its hopes for raising a second $100 billion technology investment fund.
Read more:
Why Weworks Collapse Is A Moment Of Reckoning For Softbank - Forbes
