Why is Japanese investment firm SoftBank investing a further US$8 billion into WeWork, even though the office rental company is now valued at just US$8 billion, and buying out founder Adam Neumann at a further cost of US$1.7 billion? Forgetting SoftBank’s previous sunk investments in WeWork – which exceed US$10 billion – as a standalone deal this looks to be a bad one. Some question whether WeWork is even worth US$8 billion.
To many, this looks like throwing good money after bad. The prospects of an IPO in the next few years look remote, as confidence following the recent botched IPO has been destroyed. Indeed SoftBank is likely to have difficulty making subsequent IPOs in its portfolio of firms work after this blow to its valuation credibility.
So WeWork has become a long-term investment for SoftBank, with little prospect of any serious return. The real motive for saving it may well lie in the company’s plans to raise US$108 billion for its second Vision Fund. As with its first US$97 billion Vision Fund, SoftBank is trying to attract investors to trust it with investing in early stage, high growth companies. This next fund is touted to have a focus on artificial intelligence companies but the catastrophic write down on its WeWork investment has shaken confidence in it.
The WeWork saga follows SoftBank pouring US$20 billion from its first Vision Fund into high-risk ride hailing businesses Uber, Didi Chuxing, Grab and Ola. Ride hailing was always likely to be a low-margin business with low switching costs for drivers and customers and low entry barriers for competition. Didi Chuxing is haemorrhaging money in China and the path to profitability remains elusive for Grab in South-East Asia. Uber had a successful IPO but its shares have performed poorly since. As a result, India’s Ola, which looks like it might soon turn a profit, is delaying its IPO.
But with WeWork, SoftBank has managed to destroy its own reputation as a tech investor in one fell swoop. Three months ago it was attempting to sell WeWork to the IPO market at US$47 billion, now they are rescuing the business with a total valuation of US$8 billion. The rescue has taken another US$9.5 billion, bringing Softbank’s investment to over US$18 billion in WeWork.
Softbank now controls the business and appears to be holding around 80% of the shares. Neumann has been bought out of much of his equity and his super voting rights. Three months ago he was viewed as a major asset to the business, now he is a liability that needs a US$1.7 billion golden goodbye to remove.
Softbank were in a no-win situation. If they walked away, which would’ve been by far the cheaper option, then WeWork would probably have folded and Softbank would’ve lost all their investment, around US$10 billion. It would not have been a good look. The approach they have chosen to take is to invest further substantial sums. There is little real prospect of return but it does defer the bad news of write downs surrounding WeWork until a later date.
Various measures are in place to make WeWork viable and actually worth the current US$8 billion valuation. Bear in mind that WeWork is running losses of US$1.9 billion a year so this will be no mean feat. But top SoftBank executives are now calling the shots at WeWork. Major cost-cutting is on the cards and the workforce will bear the brunt – 4,000 jobs are already on the line.
Major strategic failings
SoftBank made a very big bet that WeWork (and Uber) are “winner takes all” industries – like Amazon was for online shopping. This gamble was based on the idea that they revolutionised their respective industries with their app design and technology.
But WeWork has major strategic failings in that it attempts to arbitrage long-term contracts with short-term rentals. Any recession or downturn is likely to put the model under strain. If the model is successful then competitors will follow, which will lower occupancy levels and push down profit margins.
It’s not clear that WeWork’s technology changes any of these traditional vulnerabilities of its business model. This argument over whether or not WeWork is primarily a tech company or a property company has been one that SoftBank has had with key Vision Fund backers from Saudi Arabia and Abu Dhabi (together, they contributed 60% of the first Vision Fund).
It looks as though SoftBank is hoping to prove them wrong by refusing to cut its losses with WeWork. But investors will remain very cautious about further Softbank investments unless its focus changes significantly. Perhaps artificial intelligence will succeed as the next carrot, as Softbank’s current approach has clearly run its course.