Movers & Shakers - "Opinion | Softbank Will Succeed Even If Its WeWork Investment Doesn't"
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A client asked recently for my view on Japanese conglomerate SoftBank Group Corp (OTC: SFTBY) and its substantial investment in WeWork, whose CEO evidently has sold WeWork stock to buy properties in New York City and California that he has leased back to WeWork. The question on my client's mind is whether this transaction is a conflict of interest.
Truth be told, my firm is not as big a fan of WeWork as we are of Softbank's Chairman and CEO, Masayoshi Son. WeWork, to us, is a real estate company that borrows long-term by buying office real estate or entering into office leases and lends short-term by breaking large office spaces into small offices and leasing them out fully furnished for periods ranging from days to months.
My firm spent a lot of time analyzing WeWork's competitor Regus a few years ago—Regus actually pioneered their business model. The conclusion we came to was that the only number which matters for this business is utilization (the percent of real estate leased). If WeWork is able to lease out 90% of its space, it will be a highly profitable enterprise. If the utilization drops to, let's say, 60%, then it will start losing money and implode. This is a classic high-fixed-cost business with variable and cyclical revenues.
In contrast, Son looks at WeWork as the future of the collaborative workplace. We have our doubts. Softbank's Vision Fund invested a few billion into WeWork, valuing it as high as $40 billion. Then came the Wall Street Journal story about WeWork CEO Adam Neumann buying properties in New York City and California and leasing them back to WeWork.
Here's our view: By buying Softbank's shares we effectively hired Son — a brilliant investor — on the cheap to make capital allocation decisions for us. Wwe are paying a 50% discount for Softbank's shares relative to our estimate of their value.
Do we agree with, or even understand, every capital allocation decision he makes? In a word, no. But Son has a unique view of the world and has built an enormously successful company from scratch by getting a lot more things right than wrong.
Does Son make mistakes? Of course. Do all his bets play out? Absolutely not. Investing in private or public companies is not an exact science. It's a messy, nonlinear, probabilistic endeavor. We analyze Softbank and Son the same way we would want to be analyzed as money managers. We are asking the same question that our clients should be asking about every decision we make, namely:
1. Does Son follow a deliberate decision-making process?
Son thinks about the future, identifies inevitable future areas of transformational growth and then finds the best ways to bet on that future. In the 1980s it was personal computers, in the 1990s it was the internet, and in the 2000s it was wireless internet, smart phones, and ecomerce. Today, it is the Singularity: computers becoming smarter than humans.
Vision Fund is a way for Softbank shareholders to bet on the future. It is basically a $100 billion private equity fund run by Son. But instead of paying Son typical hedge-fund fees (2% management fee and 20% from profits) – you as a Softbank shareholder collect those fees.
Softbank put in $25 billion of capital, and $75 billion came in the form of common and preferred equity from the likes of Qualcomm, Inc. (NASDAQ: QCOM), Apple Inc. (NASDAQ: AAPL), and the Saudi Wealth Fund.
Here is the best part: In our analysis of Softbank, due to the company's undemanding valuation, we have the luxury of ignoring the value of Vision Fund. In the fourth quarter of 2018 Softbank took its largest nonpublic asset, a Japanese telecom business, public at a very attractive valuation. Today we can value all of Softbank's holdings by using public prices. If we add up the value of Softbank's stake in Softbank Telecom, Alibaba Group Holding Ltd (NYSE: BABA), Yahoo! Japan, Sprint Corp (NYSE: S), and Arm Holdings (at the price Softbank took it private), we get a value price somewhere around $70-80 per share.
This analysis completely ignores the value of Vision Fund. We really don't know what it is worth. But we guesstimate that if it achieves an 8% rate of return over the next 10 years, it may create as much value as what we are paying for SoftBank's stock today.
2. Are Son's incentives aligned with ours?
You need a lot less integrity from a manager when he eats from the same dish as you. Son owns 20% of Softbank shares, and thus his incentives are completely aligned with ours.
3. Is Son transparent in his decision making? And Does he admit mistakes when he makes them?
We have been listening to Son's investment calls for years, and we have watched dozens of interviews with him. Yes, some of his remarks are boastful, but that doesn't make them any less true. At the same time, he admitted that he made a multibillion-dollar mistake in first buying Sprint. (Son thought he would be allowed to merge Sprint with T-Mobile. The merger was initially blocked under the Obama administration, but now stands a good chance of being approved.) Then in 2018 he apologized for botching negotiations with T-Mobile Inc (NASDAQ: TMUS), which cost Softbank billions.
Accordingly, in the grand scheme of things, Softbank's investment in WeWork won't matter that much.
If you are new to SoftBank, read my analysis: Buying Warren Buffett, Richard Branson and Steve Jobs at a Discount.
Vitaliy Katsenelson is the CEO at Investment Management Associates, which is anything but your average investment firm.
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