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What Drove SoftBank’s Vision Fund Up Is Dragging It Down


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What Drove SoftBank’s Vision Fund Up Is Dragging It Down

https://www.wsj.com/articles/what-drove-softbanks-vision-fund-up-is-dragging-it-down-11569243411?mod=article_inline&mod=hp_lead_pos3

Investors’ sudden skepticism toward pricey, profitless tech companies is threatening

SoftBank Group
Corp.


9984 0.17%

’s Vision Fund, which may take a hit on some of its high-profile investments.

The bungled initial public offering of WeWork’s parent, We Co., is the first big blow to the fund. Executives of the shared-office-space provider and investment bankers advising the deal expect We’s valuation to drop to as little as one-third of its last private-market valuation of $47 billion or possibly lower, The Wall Street Journal reported. Last week, the company postponed its IPO, which is now expected after mid-October at the earliest.

SoftBank and the Vision Fund own nearly one-third of We, reflecting the company’s strategy of making big bets. Any valuation below about $25 billion for the company would force SoftBank to reduce the value of its investment in it, according to an estimate by analysts at Sanford C. Bernstein & Co.

How the company values We and its other struggling investments at the end of the quarter will be a test of its credibility. If We were public, the number would be clear. Since it probably won’t be, the fund will have some discretion putting a price on its stake, though investors would be skeptical about any valuation near $47 billion.

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Where do you see Softbank in the coming months? Join the conversation below.

The downturn highlights the risks SoftBank has piled up: The fund effectively borrowed money to make risky investments; it raised and spent its cash in record time, deep into the longest bull market in history; and it took huge stakes in unprofitable companies, making it hard to unload them if their businesses or the market turn down.

Those decisions made the fund a kingmaker, allowing it to anoint companies including We,

Uber Technologies
Inc.

and its Chinese rival Didi Chuxing Technology Co. as industry leaders by writing them huge checks. Until recently, that strategy paid off, with the fund reporting a annualized return of 29% since its inception in 2017 through the end of March. But what made the fund soar in a bull market is pulling it down during a weak one.

The disappointment of We follows the weak IPO of Uber, whose shares are down 28% from their offering price, and

Slack Technologies
Inc.,

whose stock tumbled more than 30% since the end of the latest quarter when SoftBank last had to value the Vision Fund’s investments.

Even shares of cancer-test company

Guardant Health
Inc.,

which nearly quadrupled from their IPO price, are now trading below where they were at the end of June, potentially requiring them to be marked down.

By financing much of its assets with what is essentially debt, the Vision Fund has increased its risk. Roughly 40% of the Vision Fund’s capital—$40 billion—is in the form of preferred stock, which promises a return of 7% a year, just like debt. It is unusual for a fund to include preferred shares. SoftBank has retained proceeds from asset sales to ensure it can pay the coupon.

The lure of regular payouts allowed the fund to raise money at a faster pace and in bigger chunks than any fund before it. It attracted Saudi Arabia’s Public Investment Fund and Abu Dhabi’s Mubadala Investment Co., which contributed more than half of the fund’s nearly $100 billion in capital.

That structure meant that holders of the fund’s roughly $60 billion in common equity—SoftBank and its employees have roughly half of that—get big returns on the way up, but the potential for big losses on the way down.

That is because the coupon payments—in theory as much as $2.8 billion a year—need to be made whether or not the fund makes money. And since owners of preferred stock are first in line when the fund cashes out of its holdings, any gains from investments go toward paying that $40 billion before equity holders get any. After all those payouts, the fund would need to generate around $12 billion in cash every year to produce a 20% return, an analysis by the Journal showed.

As of June 30, the fund had earned $6.4 billion in realized gains since its inception. Of that, $2.5 billion went to pay back investors and $1.6 billion went to make coupon payments on the preferred stock, according to a company presentation and Journal calculations.

Already, some of SoftBank’s plans for extracting cash to pay the Vision Fund’s investors are starting to look overly optimistic. SoftBank Chief Executive

Masayoshi Son

—the mastermind behind the fund—said he is counting on five or six IPOs from its portfolio during the fiscal year ending March 2020, and another 10 the following year. But many of the Vision Fund’s companies are still burning through cash and losing money, something that the public markets may not view favorably, as We’s attempt to list has shown.

The fund can borrow more if it needs to generate cash quickly. In August, it said it had secured an unusual three-year loan facility, backed by its shares in Uber and Guardant. The loan lets it borrow up to $4 billion to return cash to its investors. Having some form of leverage isn’t unusual for a large fund, but it isn’t common practice to use stakes in public companies as collateral on loans.

Risky Borrowing

SoftBank’s Vision Fund is unusual because its capital is a mix of equity and debt-like preferred equity. This makes the fund risky because it must make regular payments even though its investments are volatile. Most funds like it only raise equity.

Saudi Arabia’s Public Investment Fund

Preferred Equity

$27.5 billion

Abu Dhabi’s Mubadala Investment Co.

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SoftBank and its employees

SoftBank’s Vision Fund is unusual because its capital is a mix of equity and debt-like preferred equity. This makes the fund risky because it must make regular payments even though its investments are volatile. Most funds like it only raise equity.

Saudi Arabia’s Public Investment Fund

Preferred Equity

$27.5 billion

Abu Dhabi’s Mubadala Investment Co.

SoftBank and its employees

SoftBank’s Vision Fund is unusual because its capital is a mix of equity and debt-like preferred equity. This makes the fund risky because it must make regular payments even though its investments are volatile. Most funds like it only raise equity.

Saudi Arabia’s Public Investment Fund

Preferred Equity

$27.5 billion

Abu Dhabi’s Mubadala Investment Co.

SoftBank and its employees

SoftBank’s Vision Fund is unusual because its capital is a mix of equity and debt-like preferred equity. This makes the fund risky because it must make regular payments even though its investments are volatile. Most funds like it only raise equity.

Saudi Arabia’s Public Investment Fund

Preferred Equity

$27.5 billion

Abu Dhabi’s Mubadala Investment Co.

SoftBank and its employees

If the fund had invested when markets were cheap, it might have benefited from a rebound. Instead, in the 11th year of the longest bull market in history, the fund said it has invested close to $85 billion of the nearly $100 billion it raised in 2017. Three of those investments—Uber, We and Didi—account for nearly 30% of the Vision Fund’s portfolio by value, estimates research firm Astris Advisory.

SoftBank’s $33 billion stake in the fund, which accounts for more than half of the equity in the fund, also relies on borrowed money. SoftBank itself has more than $160 billion in debt, and the company extended about $8 billion in loans to Vision Fund employees to invest in the fund, the Journal reported.

There is new urgency to the success of the Vision Fund. SoftBank is raising money for a second fund, and says it has expressions of interest totaling $108 billion. So far the only confirmed commitment is from SoftBank, which will invest $38 billion and lend up to $20 billion to the fund’s employees for their investments, the Journal reported.

SoftBank also is counting on cash generated by the first fund to cover its investment in the second Vision Fund. To do that, the first Vision Fund would have to generate $9.5 billion a year for SoftBank for four years—on top of the money needed to pay returns on the preferred shares, estimates analyst David Gibson at Astris.

That could be difficult since the fund’s returns will likely be lumpy and the bulk of cash distributions may come years from now. SoftBank also could sell assets, such as a portion of its $120 billion stake in Chinese e-commerce company

Alibaba Group Holding
Ltd.

, to fund its investment.

Investors have grown skeptical of SoftBank’s ability to handle this balancing act. The company’s shares are down nearly 25% from their recent peak in April.

SHARE YOUR THOUGHTS

Where do you see SoftBank in the coming months? Join the conversation below.

Write to Miriam Gottfried at Miriam.Gottfried@wsj.com and Phred Dvorak at phred.dvorak@wsj.com

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