The two Sons shake on $45bn
Masayoshi Son faced a dilemma in
October: should the Japanese businessman go to an investment conference in
Riyadh, Saudi Arabia? The guy running that conference had promised Son’s Vision
Fund $45bn – that’s not a misprint, that’s forty-five thousand million US
dollars – so not showing up would look more than a little ungrateful. He was
also the Crown Prince of Saudi Arabia, next in line for the Saudi throne, and a
person not known for taking lightly any lack of due respect. Yet the same guy
had just been implicated in the murder and dismemberment of a journalist he did
not like. While you and I would let this go as being just one of those things,
the media and the political class of some powerful countries had shown
themselves to be unhappy with the event. If Son attended the conference it
could put his investment company SoftBank, and its Vision Fund, in an
unfavourable light.
It was all so unfair. Nobody of
any importance had complained about Crown Prince Mohammad bin Salman’s exploits
in Yemen that were killing off a whole population! Why make a fuss about a
minor journalist being disappeared in the Saudi Consulate in Istanbul? It was
evidently all a matter of big power politics, and who was allowed to do what to
whom and when. But the dilemma was nonetheless real for Masayoshi Son, given
the risk of negative publicity for his investments in projects for the
tech-wonderland future. After much consideration, he decided on a diplomatic
compromise. He travelled to Riyadh to talk to the oil oligarch, but did not
attend the conference itself.
Most people will not have heard
of the Vision Fund, or of SoftBank, not least because both names sound like
they were suggested by a bored publicist suffering business cliché indigestion
on a dull afternoon. But it is worth paying them attention for the light they
throw upon today’s imperialist world economy and how innovation becomes
entrapped by a parasitic machine. SoftBank itself does not rank highly in the
list of global corporations, with a stockmarket capitalisation of just $82bn at end-October. Yet its Vision Fund is the
world’s largest ‘venture capitalist’. It specialises in investments in the
technology sector and is reported to have investment funds available of nearly
$100bn – of which more below.
The rising Son
In 1981, Masayoshi Son founded
SoftBank in Japan, but for many years the company was almost unknown outside
the country. It began as a distributor of packaged software, also getting into
computer magazine publishing and running business events. By 1998, it had
become big enough to have its shares listed on the First Section of the Tokyo
Stock Exchange, and in 1999 it became a pure holding company aiming to expand
its presence in other areas of the Internet and mobile technology sector. From
the mid-1990s, SoftBank did a number of very profitable deals in Japan with US
web services provider Yahoo, including one with Yahoo Japan of around $9bn which
gave SoftBank 43% of the company. It also bought Vodafone’s Japanese mobile
operation for $15bn in 2006 and, from the late 1990s, it began to make its
first significant deals outside Japan.
SoftBank’s most successful
investment has been in Alibaba of China. In 2000, SoftBank advanced a mere $20m
for a 29% stake in Jack Ma’s fledgling company, plus a modest later investment.
The value of this holding soared to $60bn when Alibaba went public in 2014, and
is now valued at around $100bn. Other major SoftBank investments have been in
2012, when it invested $23bn in Sprint, the fourth largest mobile network
operator in the US, in 2016 with the $31bn takeover of ARM Holdings, a UK-based
chip designer for smartphones, and in 2017 with the $9bn or so put into the US
ride-hailing company Uber for a 15% stake.
None of these have gone anywhere
near as well for SoftBank as Alibaba. For example, Sprint, 83%
owned by SoftBank, after losing market share and subscribers is now in the
process of being rescued by a merger with T-Mobile US, owned by Deutsche
Telekom. If that goes ahead, SoftBank will own 27% of the new business.
There have been many
reorganisations and name changes of companies in the SoftBank group. Its
portfolio of holdings has also increased dramatically in recent years, with
investments ranging from a complete or near-complete takeover of another
company to deals that involve SoftBank owning perhaps only 5-10% of its shares.
The prices SoftBank paid for these have not always been clear, since it has
often been part of a consortium of other funds that have bid for a stake in the
particular venture.
Given SoftBank’s promoted image,
a natural assumption is that all of its investments are in the ‘technology’
sphere. This would suggest e-commerce, mobile communications, online
services and so forth. But often the investments extend into other areas that have little or
no connection with these and may be just an online application to contact a
service. Although the latter is a pervasive feature of the economy today, it is
not so far removed from telephoning a company to make a booking, rather than
being a sign of ‘hi tech’. Notable in this respect is WeWork, a US company
leasing out office space in which SoftBank (and its Vision Fund arm) has already
invested more than $4bn, and the $300m invested in the US-based Wag, a dog
walking service! I will not mention SoftBank’s investment in a Japanese
baseball team, the Fukuoka SoftBank Hawks.
Elements of this remind me
of the dotcom equity market bubble of the late 1990s. One anecdote from that
time was that a laundry company saw its share price soar once it had changed
its name to laundry.com or something similar. SoftBank is not the laundry
company, but its share price had also boomed in that market bubble, to around
¥19,000 in early 2000, but by November 2002 it had slumped to just ¥300.
Happily for Mr Son and his shareholders, SoftBank’s equity price has since
risen and was at around ¥9,000 by end-October. But the vulnerability of the
company to changing fashions is seen in the 20% drop through that month, partly
prompted by the declining fortunes of another ‘son’, Mohammad bin Salman. Such
volatility is not uncommon in the markets for financial securities, but an
examination of SoftBank’s accounts, and the new Vision Fund, shows that there
is a lot going on behind the headlines.
No, not this robot dog, a real dog!
---
Assets, debt liabilities,
income
SoftBank’s annual report for the
year to end-March 2018 gives the basic picture for its assets, liabilities and
income that still holds today. Two features stand out. Firstly, the company’s
cash revenues have derived mainly from its telecom operations in Japan and the
US; secondly, it has a lot of debt.
The telecom operations have the
advantage of generating an inflow of cash, with regular subscriber payments and
sales of mobile phones, and in the annual 2018 report these accounted for just
over 70% of net sales and over 90% of adjusted earnings before interest, tax
payments, etc, for the group as a whole. This cash comes in handy for
SoftBank’s appetite to invest in other companies, but most of SoftBank’s
requirements are instead met by its loans from banks or its issue of bonds.
This has led Softbank to accumulate an unusually high level of debt, amounting
to $160.4bn by the end of March 2018.
Financial markets focus on a
measure of how much interest-bearing debt that the company has outstanding and
compare that to the equity investment of the company’s owners in the company
itself. This ‘debt-equity ratio’ is one indicator of a company’s ability to pay
back its debt liabilities if its operations get into trouble. Outstanding debt
levels and also the debt-equity ratio will be different for different kinds of
company, but industrial and commercial companies rarely have a debt-equity
ratio above 1 or 100%. In other words, their outstanding debt is not greater
than how much equity the owners have invested in the company.
The debt-equity ratio is not
necessarily high for companies in the tech sector. Even startups usually get
funds from equity investors, rather than depending much, if at all, on
long-term bank loans and issues of bonds. For example, in 2017
Alphabet-Google’s debt-equity ratio was less than 3% while Amazon’s, although
higher, was still below the 100% level at 89%. In 2015, the year before
SoftBank took it over, ARM Holdings had no outstanding debt at all. By stark
contrast, SoftBank’s own debt-equity ratio in March 2018 was 271%, and a still
high 220% counting only the long-term debt of $130.1bn.
This level of debt is a problem
for SoftBank because the funds have been used to invest in a wide range of tech
(and not so tech) companies, as already noted. As their market value changes,
so will the value of these assets on SoftBank’s books, which makes the company
very vulnerable to a change in financial market sentiment on the outlook for
these ventures. Meanwhile, the debt remains until it is paid off, and until
then it has to be serviced. In the year to March 2018, SoftBank’s net income
from continuing operations was $11.7bn, but this figure had been reduced by the
interest paid on its debt of $5.1bn.
How could SoftBank continue to
expand its investment in tech companies when it already had high levels of
debt? One way was to sell off some existing assets as a means to raise cash. An
example earlier this year was the $4bn sale of its holding in Flipkart of India
to the US giant retailer Wal-Mart, registering a gain of some $1.5bn. Back in
April, SoftBank also used its stake in Alibaba as collateral for a bank loan of
$8bn. Furthermore, there is a plan for the public sale of some shares in
SoftBank’s mobile business in Japan, hoping to get as much as $30bn, although
that hope is undermined by Japan’s regulator forcing mobile companies to cut
their charges by as much as 40%. But the real scope for expansion lies with the
venture noted at the beginning of this article: the Vision Fund.
Double Vision: $28bn becomes
$72bn
SoftBank’s Vision Fund was set
up in 2017 after being announced the previous year. It is included in
SoftBank’s reports as a division that aims to target ‘long-term investments in
companies and foundational platform businesses that seek to enable the next age
of innovation’. While there are many other hyperbolic statements with which the
Fund describes itself, and details of its structure can be confusing, I would
recommend keeping the following points in mind to clarify what is going on.
The logic behind the fund’s
existence is the limit on expansion that SoftBank faced with its high level of
debt. Otherwise there would have been little reason for SoftBank to make big
efforts to attract outside investors. Related to this, an important aspect of
the Fund is that it has now given Masayoshi Son huge resources from these
outside investors over which he has complete control. Meanwhile, SoftBank has
not limited itself from undertaking any investments it likes outside of the
Vision Fund set up.
…
SoftBank’s investment in the
Vision Fund is reported as $28bn, with the other, external investors providing
$72bn, to make up the $100bn when all funds are committed. That makes a good
headline, but all is not what it seems. Not simply because most funds are
committed rather than having yet been allocated, and the number does not yet
quite add up to $100bn anyway. Let us assume that all the commitments will turn
up. Instead, the main issue to puncture the headline bubble is that more than
$15bn of the capital, and perhaps as much as $25bn or so, is not a pile
of new cash waiting to be invested. It simply represents the value of existing
investments held by SoftBank that the company has transferred from its
main accounts to sit now under the Vision Fund heading.
At end-September 2018, the value
of Vision Fund investments was $35.8bn, with an acquisition cost recorded at
$28.1bn. A big chunk of this, represented by acquisition cost, consists of
previous investments made by SoftBank. For example, a little over $8bn for 25%
of SoftBank’s ownership of ARM Holdings, $5bn from its stake in Nvidia, a
couple of billion from its stake in WeWork and some smaller investments,
including in Wag. SoftBank’s $9bn holding of Uber will also be transferred to
the Vision Fund, but this had not happened by end-September.
These SoftBank ‘investments’ in
the Vision Fund are not new cash that it can use to invest in other things. So
its firepower is significantly less than the $100bn number promoted in the
headlines, although it is still clearly a big number. The key point, however,
is that by establishing the Vision Fund, SoftBank can get control of up to
around $70bn more from the funds committed by other investors.
Under refurbishment: Vision Fund London office
Vision investors, debt and
equity
SoftBank’s 28% of the Vision
Fund would appear to give a higher weight to the external investors, who have 72%.
But there is another complication: whether the investors have an equity stake
in the fund or whether they buy the ‘preferred’ units of the Vision Fund that
will pay them an annual coupon, as if they owned a debt security. According to
a
Financial Times report in June, the Vision Fund set up is where the
external investors have 62% of debt and 38% of an equity stake in the Fund for
every billion they put in. SoftBank therefore has a majority equity stake in
the Vision Fund, given that all its 28% investment is for equity.
External investors in the Vision
Fund are of two kinds, and each has a different motivation that I will give
myself the freedom to speculate upon.
The first kind is the Gulf
investors with $60bn of commitments: $45bn from the politically-devalued Crown
Prince, allocated from Saudi Arabia’s Public Investment Fund, and another $15bn
from Abu Dhabi’s Mubadala Investment Company. These are funds that aim to boost
the wealth of the already rich Gulf states by investing in something other than
the low-yielding government bonds issued by the major powers.
It is not difficult for the Gulf
investors in this venture to feel they are smart money capitalists when all
they have to do is get a better return than on US Treasuries. The Vision Fund
will have looked an attractive option, one full of a high tech optimism that
helps obscure the reactionary reality back home, and doing so with a promised
high return – for details of which see the next section.
The second kind of external
investor is a group of four companies not new to the world of tech exploitation
– Apple, Qualcomm, Foxconn and Sharp . They will offer $5bn in total to the
Fund. For them, the amount is trivial, but it may give a reasonable return and
it will also give them a valuable overview and early insight into developments
that could impact their businesses.
‘Eat yourself’ returns and
SoftBank upside
So what is the return for
investors in the Vision Fund? These investors, and SoftBank itself, get paid in
different ways, and this highlights that it is called the Vision Fund for a
good reason.
Those who have equity stakes in
the fund get the relevant portion of the returns from the portfolio of
investments made, but that is after money has been deducted to pay for the
annual 7% coupon on the Vision Fund debt securities purchased by external
investors. While this 7% coupon looks attractive compared to other debt
securities in the financial markets today, it may have escaped the external
investors’ attention that this coupon payment will also reduce the return they
will get from their equity stake. If the Vision Fund debt component amounts to
$44.6bn (62% of the external $72bn), then around $3bn per annum will be
deducted from the profits made on Vision Fund assets to deliver the external
investors their coupon payments. They look to be protected from any downside in
the equity and revenue performance by their fixed 7% coupon, but that leaves
the tricky question of who will pay them the coupon money if the Fund’s return
is insufficient.
The external investors will have
noticed that they are paying SoftBank a management fee of around 1% for the
privilege of running the Vision Fund, which could be up to $720m per annum.
SoftBank will also cream off 20% of any return on investment over 8%. In the
world of ‘venture capital’ investment funds, however, these conditions are, if
anything, low cost.
Overall, the Vision Fund gives
SoftBank a vast amount to finance future tech investments, and it gets around
some of the constraints posed by SoftBank’s high debt levels. If there are
difficulties paying the fixed 7% coupon, then that may be a Vision Fund problem
with its investors, not a SoftBank problem of default on its bond liabilities.
Another important point is that
the Vision Fund’s investments have delivered it very little in operating
profit. Its recorded ‘income’ from its assets is overwhelmingly made up from
capital gains on their market value, including unrealised gains. In the six
months to end-September 2018, the operating income from the Vision Fund was
around $5.5bn, but $1.5bn was from the gain on the sale of Flipkart and another
$4bn or so was from increases in the value of Nvidia and some other assets.
This points to problems that Mr Son’s venture will have in generating enough
income when the market turns down.
Parasitic vision
In an interview with
TechCrunch
in September,
a Vision Fund managing director set out the Fund’s investment policy. He
explained that it was a ‘late stage growth fund’. It did not aim to give early
advice to tech startups, but instead wanted to see how far they could become a
key player in the market. If they were happy with a company’s plans, they would
invest a minimum of $100m to finance its growth.
This reveals perhaps more than
he realised. Yes, the Vision Fund provides a tech company with funds, but only
after it has passed the difficult, uncertain, early stages of growth when
survival is at risk, and when it now looks like the only barrier to dramatic
expansion is a lack of funds. This is not so different from what a regular bank
would do, except that the Vision Fund will make sure that it has an equity
stake in what it hopes will be a rapidly growing business, rather than a bank
that simply sees good market prospects as giving it confidence that a loan will
be repaid. Far from being the daring investor backing ‘the next stage of
innovation’, the Vision Fund is more like a money capitalist bean counter that
will first ensure that all its boxes are ticked.
Another aspect of the Vision
Fund shows that it understands the nature of the imperialist world market
today, at least as it applies to the technology sector. The minimum $100m
investment is to finance a big increase in the scale of operations of its
chosen tech companies, both within their national sphere and
internationally. A key feature of businesses that have communications
technology as a core element is economies of scale. Here, much the same cost
infrastructure is needed to service tens of millions of customers as for tens of
thousands, except perhaps the need for a bigger computer server and some better
software. Costs per customer will tend to fall rapidly and net revenues can
rise sharply.
This is also something that
leads to monopolisation of markets. Companies that are backed with funds to
invest and expand when they have no operating profit and, like Uber, may be
running at a loss, can still invest to sideline competitors. SoftBank and the
Vision Fund are involved in this process. One example is the likelihood that
SoftBank will play a part in carving up the ride hailing market, given its
stake in Uber and in a number of other companies in that area, notably DiDi of
China, but also Ola in India and Grab in Singapore. Recent business media
reports suggest that these companies, which are often rivals in the same
markets as well as having stakes in each other, could decide to ‘cooperate’.
Tech in the machine
What we find today are
many examples of technical inventions and innovation, but all of these get
bound up in the monopoly machine of imperialist economics and finance. Rather
than communications technology being developed to benefit humanity, any good
outcomes that may result depend first upon whether the innovation can meet the
machine’s demands.
Paradoxes also abound,
highlighted especially by how some of the most reactionary regimes in the world
put up many billions of dollars to fund ‘progress’. One acute observer of the
tech world, Evgeny Morozov, speculated that the ‘disruptive innovation’ backed
by Saudi Arabia would include killer robots and the ability to smoothly dispose
of dissidents’ bodies. But one must not lose sight of how these regimes are
also part of the imperial money-go-round, with full backing from the US and the
UK.
The tens of billions
of dollars allocated to SoftBank’s Vision Fund are only a small sample of the
massive funds potentially available worldwide to address everything from
debilitating diseases, to malnutrition and environmental destruction. Instead
they are advanced with a beady-eyed parasitism to find the right profitable
niche in the market and monopolise it. Even then, the decisions on how the
world’s resources will be used rest with a small number of multi-billionaires
and the states that back them.
Tony Norfield, 5 November 2018
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