Cheap capital and SoftBank's audacious Vision Fund 2

Assif Shameen

SINGAPORE (Aug 26): Over the next week or so, bonds issued by governments and companies in Europe and Japan that trade with negative yields will cross the US$17 trillion ($23.5 trillion) mark, or five times the combined size of all the economies in Southeast Asia and 28% of the total outstanding debt worldwide. Governments and companies are essentially getting paid to borrow money, as investors are increasingly desperate for a safe haven for their cash.

In a world awash with cheap money, few investors have made more audacious bets than Masayoshi Son, the billionaire Japanese investor and founder of Japanese tech conglomerate SoftBank Group. In recent weeks, Son has been criss-crossing the globe, meeting CEOs of banks, sovereign wealth funds and cash-rich companies who are eager to invest alongside him in a new US$108 billion investment vehicle dubbed Vision Fund 2. His bet is that instead of paying debt-laden governments and companies to look after their money, investors will give him money to make big, outsized bets in technology, particularly in key areas such as artificial intelligence (AI), Internet of Things, cloud services, software, social media, fintech and the sharing economy. The goal: to identify and grab stakes in companies capable of dominating their respective industries.

Son’s Vision Fund, dubbed the “kingmaker” of unicorns — private companies with billion-dollar valuations — is looking to add to its portfolio of companies, which includes ride hailing giant Uber Technologies, its Chinese counterpart Didi Chuxing, Southeast Asian lookalike Grab, as well as TikTok and Toutiao owner Bytedance, South Korean e-commerce giant Coupang, India’s top payment systems firm Paytm, UK chip design behemoth ARM Holdings and co-working firm WeWork, which is seeking an IPO in October in what could be one of the most controversial listings in years.

Son’s story is the stuff of legends. Scion of Korean immigrants in Japan, he founded a software distributor in 1981 and, in 1995, started a US$10 million fund to invest in internet disruption. SoftBank bought 5% of Yahoo for US$2 million that year. At its peak in 2000, Yahoo’s market capitalisation was over US$130 billion and SoftBank’s $2 million had ballooned to US$6.5 billion. At the height of the dotcom bubble in March 2000, for three days, Son’s net worth surpassed US$70 billion, making him the world’s richest man. When the bubble burst, his net worth shrank 99%, leaving him barely a paper billionaire.

Around that time, Amazon.com founder Jeff Bezos offered to sell him a 30% stake in his firm for US$130 million. Son could only manage to scrape together US$100 million, so the deal collapsed. Had it gone through, that stake would have been worth US$270 billion today. Yet the indefatigable Son was back four years later when he invested US$20 million in Alibaba Group Holding. Its current stake in Alibaba, plus realised gains from the sale of a portion, add up to a whopping US$135 billion.

Three years after Son raised US$97 billion from Saudi Arabia’s Public Investment Fund and Abu Dhabi’s Mubadala Investment as well as iPhone maker Apple, chip giant Qualcomm and the world’s largest contract manufacturer Taiwan’s Foxconn group, SoftBank is seeking to raise US$108 billion for Vision Fund 2. SoftBank itself will provide US$38 billion in capital or assets while the remaining US$70 billion will come from software powerhouse Microsoft, Apple, Asia-focused Standard Chartered Bank, investment banking powerhouse Goldman Sachs, the Kazakhstan government and an array of Japanese banks and Taiwanese insurance firms. A stake of nearly 19% in the new fund has been earmarked for SoftBank and Vision Fund’s executives, who will be able to borrow up to US$20 billion to buy stakes in the fund. Son himself could borrow up to US$15 billion for a personal stake in the new fund.

Compared with the nearly US$100 billion deployed by Vision Fund over the past two years, the rest of the venture capital industry in the US invested US$130 billion last year.

Why invest?

Vision Fund’s investors have their own reasons for backing the SoftBank founder’s newest venture capital and private-equity vehicle. Microsoft is keen to invest in the fund because SoftBank is ready to encourage its portfolio companies to transition away from rival Amazon Web Services, which dominates the cloud infrastructure business, to Microsoft’s own fledgling cloud platform, Azure. Goldman Sachs is investing in the fund because it will open the door to more corporate advisory work with Vision Fund’s investee firms and give it a leg up over competitors when the unicorns that the fund is hatching are ready for public listing. Standard Chartered is keen to lend to Vision Fund companies that are years away from an IPO and need capital to grow. Japanese financial institutions — Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group Mizuho Financial Group, Daiwa Securities Group, Dai-ichi Life Holdings, Sumitomo Mitsui Trust Holdings — and Taiwanese insurers are all eager to get better returns in a negative yield environment.

Of the US$97 billion capital invested in Vision Fund 1, SoftBank’s total stake in the fund was US$13.5 billion as at end-June. That includes the transfer of US$12.7 billion in assets — in which SoftBank is itself invested — to the fund. As such, the effective capital commitment by SoftBank is only US$800 million. How those transfers were done is another story. Take, for example, chip design giant ARM, whose processors and system-on-a-chip infrastructure and software power iPhones, iPads as well as an array of Android phones and tablets, which SoftBank bought in 2016 for £23.4 billion. SoftBank shuffled ARM stakes between its own subsidiaries and the Vision Fund, which now owns 25% of ARM. The shuffling resulted in SoftBank’s paying no taxes in Japan last year. Without the tax credits and relief, it would have paid 31% tax on US$9.4 billion. 

Vision Fund’s third-largest stake — or US$3 billion — currently is in WeWork. (SoftBank itself has US$6 billion invested in the company.) Of SoftBank’s investment in WeWork, US$2 billion is equity, US$1 billion convertible notes and the remaining US$3 billion warrants. Late last year, Vision Fund’s two big investors — Saudi Arabian and Abu Dhabi wealth funds — balked at the prospect of investing another US$16 billion in the co-working company, which would have given SoftBank a majority stake, buying out WeWork founder Adam Neumann’s other investors. So, SoftBank was forced to deploy US$2 billion itself, valuing the co-working company at $47 billion.

Why is SoftBank launching Vision Fund 2 so soon after the launch of Vision Fund 1 in early 2017? For one thing, cumulative investment by Vision Fund 1 totalled US$71.4 billion in 81 companies through end-June 2019. Those companies are now worth US$82.2 billion, not counting realised gains from stakes that Vision Fund has already sold. Assuming that the maiden fund continues to invest at the same pace as it did over the last two quarters, it will have invested more than 90% of committed capital by year-end and almost all of the money by March 2020.

SoftBank receives outsized returns relative to the equity it has put in the Vision Fund. SoftBank not only manages the fund but is also one of the largest investors in it. As a general partner of the venture-capital fund, it receives a 1% management fee plus a performance fee of 20% of all returns greater than 8%. In addition, as a limited partner, or investor in the fund, SoftBank receives 47% of all returns based on the proportion of the capital it has committed.

Lessons from Vision Fund 1

So, how profitable has Vision Fund 1 been so far? According to data provided in the last quarterly filing, it generated pre-tax profits of ¥212.3 billion (US$2 billion) in its recently concluded June 2019 financial quarter, while unrealised gains on the fund’s investments reached US$5.67 billion. Vision Fund 1 generated a 45% internal rate of return for investors in its common shares, or 29% when debt-like preferred shares are included. But, the fund’s unrealised losses on investments such as loss-making Uber reached US$1.83 billion in the last quarter and they are continuing to pile up. Uber was listed in May but has seen its stock plunge 24% since end-June. Slack Technologies, a firm in which Vision Fund had a stake worth US$1.4 billion in June, is down 19% since.

Vision Fund’s exits from its investments have had mixed results. The fund recorded a US$2.1 billion loss on the sale of its Nvidia Corp stake. Nvidia shares soared after SoftBank acquired the stake more than two years ago but tanked 57% from their peak last September. SoftBank also booked a US$1.91 billion valuation gain from its stake in Guardant Health, which was listed last October, and a US$1.45 billion gain in Oyo, a giant Indian hospitality firm that owns budget hotels.

Having learnt some tough lessons from the first fund, Son is doing a few things differently with the second. For one, he is eager to forge genuine partnerships between the fund companies and SoftBank’s own investee companies. Next month, executives from WeWork to Grab and Korea’s Coupang, Uber to ARM Holdings and India’s Paytm will gather in Los Angeles to talk about how they can work together. Uber and Grab might explore renting space from WeWork, while others could use Slack’s messaging software or Paytm’s payment services. Son’s idea is to create an “ecosystem” of companies that can collaborate to accelerate growth.

SoftBank and Vision Fund 1 have fundamentally changed the way venture capital has worked traditionally in Silicon Valley by pouring huge amounts of funds into late-stage firms such as Uber and Slack, which have then gone on to delay their listing because they do not need capital. Now, with the advent of Vision Fund, 2 other venture-capital firms are also raising large sums and everyone is chasing the same deals, which has created a bubble in valuations.

Son has vowed to raise a new US$100 billion Vision Fund every two to three years. If low interest rates are the New Normal, it would be no surprise if the size of the next Vision Fund is boosted to US$200 billion or Son announces that he would rather start a new fund every year than wait two to three years. When there is so much cash sloshing around and the cost of capital is close to zero, it pays to have the sort of audacity that the SoftBank founder is famous for.

Assif Shameen is a technology writer based in North America

This story appears in The Edge Singapore (Issue 896, week of Aug 26) which is on sale now. Subscribe here