Unicorn Valuation Rout Casts Dark Clouds Over SoftBank Group's Vision Funds

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About: SoftBank Group Corp. (SFTBF), SFTBY, Includes: UBER, WORK
by: Christoph Liu
Summary

The We Company (formerly known as "WeWork") might cancel its planned IPO.

One of the parties urging for a cancellation is SoftBank Group Corp., the largest shareholder in The We Company.

The rationale behind this is that only this way the high valuation - currently about $47 billion - might be preserved, thus preventing a considerable paper loss for SoftBank/the VisionFund.

However, WeWork is not the only important portfolio company which's valuation is under pressure.

A failure of the Vision Fund to meet expectations endangers SoftBank's long term strategy of transforming into an investment company.

SoftBank Group Corp. (OTCPK:SFTBF;OTCPK:SFTBY) and its Vision Fund face the risk of paper gains turning to paper losses following the loss in valuation of recently listed portfolio companies and potentially upcoming decreases in valuation of yet private ones.

I already alluded to that risk some months ago, after Uber Technologies Inc.'s (UBER) rather disappointing post IPO performance. Uber shares continued trading downwards since resulting in SoftBank being in the loss zone on its investment in the company.

Now SoftBank is reportedly urging The We Company (formerly known as "WeWork") to postpone its IPO -which was initially scheduled for as early as this year - in order to prevent its valuation from declining.

Paper Gains Might Turn Into Losses Quickly

SoftBank reported impressive profits from the Vision Fund. The fund accounted for profits of ¥397.6 billion, nearly 60 percent of the company's total operating income of ¥688.8 billion, in the quarter ended June 30th. This does, however, unrealized valuation gains of ¥408.5 billion. And unfortunately such gains may turn into losses fairly quickly if valuations decline.

The We Company could become the source of such decline in the nearer future. The latest funding round valued the company at $47 billion. However the funding was led by SoftBank meaning the sky-high valuation is in no small part the result of SoftBank's own investment. In other words: the company itself decided at which level to value the asset which it already owned a good portion of thus in essence creating its own profit out of the air. Yet said profit exists only on paper until the moment when someone else is willing to pay that very same price. As it turns out the public market is not. Thus SoftBank's eagerness to cancel the listing for the time being.

Now if The We Company cancels its IPO a new problem would immediately arise. Without the proceedings it would need to turn to other sources for further funding. After all the business is still far away from profitability. There are hence but two ways to obtain the necessary capital. Either the company has to borrow money - which would of course put considerable pressure on the balance sheet. The alternative would be another private funding round. But it might turn out to be a rather difficult endeavor to come up with investors willing to provide the necessary amount at a valuation that the public market evidently considers heavily overvalued. So at the end of the day SoftBank would probably be forced to provide the funding itself if it seeks to uphold the valuation level.

And the We Company is not the only such problem. While the investment in Slack Technologies Inc. (WORK) still accounts for considerable gains, the stock has fallen further and further since its listing. And of course Uber as of the time of writing trades at a price at which SoftBank is already several hundred millions underwater on its investment. Since those companies are public by now, SoftBank is unable to simply establish a valuation it deems appropriate through an investment round. Theoretically it could purchase stocks on the open market until such price level would be reached. Yet this would face some obstacles in reality. Suffice it here to say, that such measures are highly unlikely.

Neither should go unnoticed that besides the high profile names that are already public or at are or were at one point in the process of going public, the Vision Fund portfolio contains a host of other private companies. Since most of the companies do not report their financials, it cannot be ruled out that there might be imminent decreases in valuation in other cases as well once a listing happens.

For all the reasons pointed out above the Vision Funds - paper - profits might before long give way to sizable losses.

Vision Fund II Might Come Into Jeopardy

The Vision Fund and its brethren both existing and planned are the centerpiece of SoftBank's long term strategy. Therefore trouble for the Vision Fund equals trouble for the mother company.

Doubts about the funds ability to achieve expected returns could negatively affect the inception of the planned even larger (about $108 billion in volume compared with the first fund's less than $100 billion) Vision Fund II. And of course a profitable Vision Fund would certainly help to come up with the $38 billion that SoftBank plans to contribute itself.

It appears questionable to me whether investors would be willing to provide a combined $70 billion for a second fund if the first fails to meet expectations. Among the potential investors are Apple Inc. (AAPL), Microsoft Corp. (MSFT), several Japanese banks and insurance companies National Investment Corporation of National Bank of Kazakhstan, Foxconn Technology Group, Standard Chartered (OTCPK:SCBFF), and yet unnamed Taiwanese "major participants" according to SoftBank. Reportedly, Emirati sovereign wealth fund Mubadala which has already been a contributor to the first fund is considering an investment as well. Some of those institutions might reconsider their commitment if the first Vision Fund underperforms.

Conclusion

The deterioration of the valuations of high priced yet unprofitable unicorn companies seriously endangers the performance of SoftBank Group Corp.'s Vision Fund. It might potentially have a negative effect on investors willingness (and SoftBank's ability) to contribute to a similar but even larger Vision Fund II. This might be devastating for SoftBank which is in the process of transforming itself into an investment company.

A listing of the first Vision Fund - if indeed it ever has been entertained in a serious fashion - would probably be off the table as well. Instead, rather than unlocking value through a separate listing, the company might be forced to contribute further funds in order to preserve valuations of private portfolio company.

All in all, my formerly neutral outlook for SoftBank turns more negative given the recent developments regarding "unicorn" valuations and the negative consequences that may very well arise for the company.

Disclosure: I am/we are long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: All research contained in this article was done with utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his or her own due diligence and research.

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