Breakingviews - Vision Fund may be Hotel California for investors

LONDON (Reuters Breakingviews) - Saudi Arabia and Abu Dhabi are involved in a high-stakes game of double or quits. The kingdom and its Gulf ally’s wealth funds jointly put up $60 billion of the near-$100 billion pledged to SoftBank Group’s giant Vision Fund. Now they have to decide whether to participate in the sequel planned by Masayoshi Son, the Japanese group’s founder. Walking away could undermine confidence in the vehicle’s current batch of startups.

Japan's SoftBank Group Corp Chief Executive Masayoshi Son bows his head after his presentation at a news conference in Tokyo, Japan, November 5, 2018. REUTERS/Kim Kyung-Hoon

The first mega-fund has used up much of its firepower. By the end of March, it had paid $60 billion for stakes in 69 companies ranging from ride-hailing service Uber Technologies to dog-walking app Wag Labs. That’s a staggering $620 million a week since the first major fundraising less than two years ago. The outlay is higher now: Vision Fund boss Rajeev Misra said last month he had allocated $80 billion to 80 companies. Venture funds typically hold back some spare capital to make additional investments in successful portfolio companies, so the first vehicle is probably close to its limit for new commitments.

That adds impetus for Son to launch Vision Fund 2. He claimed on Wednesday that most of the first fund’s investors want to participate. The key question is whether the Japanese entrepreneur gets more cash from Saudi Arabia’s Public Investment Fund (PIF) and Abu Dhabi’s Mubadala Investment Company. The two pledged $45 billion and $15 billion, respectively, the first time, but neither has decided whether to invest again, people familiar with their thinking say.

Based on performance, doubling down seems a simple decision. SoftBank reckons the fund’s investments had risen 20% compared with the purchase price by March, excluding two stakes it has already sold at a profit. The fund’s equity had generated a 45% internal rate of return (IRR) so far, SoftBank calculates, more than twice the average performance for venture capital vehicles, based on Pitchbook data. About 40% of the fund’s capital is in debt-like preferred shares which pay a 7% annual coupon. Including these, the IRR is still a chunky 29%.

Right now these are mostly paper profits, based on SoftBank’s own valuations. They don’t necessarily reflect what stock market investors or other buyers would pay. For example, SoftBank transferred a one-quarter stake in Arm into the fund at an $8.2 billion valuation. That implies a $33 billion price tag for the UK chip designer, or 18 times trailing revenue. Fellow chipmaker NVIDIA is valued at just 8 times.

The Vision Fund also marked up its holding in Uber in anticipation of an initial public offering. But those shares are now 3% below the IPO price. The shaky performance has dented hopes for other Vision Fund portfolio companies hoping to go public this year, like business-messaging app Slack and shared-office provider WeWork. Cashing out will also be harder if technology stocks dip again, as they did in the final quarter of 2018. The Vision Fund’s leveraged structure, which amplifies gains for equity holders when prices are rising, would magnify losses in a downturn.

Nor do the Saudi or Emirati wealth funds have a bottomless pit of money, even though their combined’ assets are worth $550 billion, according to Sovereign Wealth Fund Institute (SWFI) data. They’re interested to know how a new fund could be structured to protect against a market correction, people familiar with the matter told Breakingviews. Moreover, tying up more money in technology startups carries an opportunity cost. Mubadala has investments spanning aerospace and healthcare. Saudi’s ambitious economic reforms envisage expensive initiatives to stimulate tourism. PIF’s commitments to the first Vision Fund already represent 14% of its assets.

Yet sitting out the next round would create other problems. The Vision Fund’s investment logic rests partly on its firepower, which allows portfolio companies to outspend competitors, finance expansion and dominate their markets. Uber Chief Executive Dara Khosrowshahi labelled it SoftBank’s “capital cannon”. The strategy unravels, however, if the ammunition runs out. Walking away could be seen as a sign that the Gulf pair have less confidence in Son, and that the current crop of startups can’t keep drawing from a deep well of petrodollars. That might harm the valuations of companies in the first Vision Fund, many of which are still burning cash.

Son could fill the gap by selling a chunk of SoftBank’s separately-listed Japanese telecom unit SoftBank Corp. Reducing its two-thirds stake to 30% would raise $20 billion, assuming a 10% discount to the market price. The company could also borrow against holdings like its 29% stake in Chinese e-commerce giant Alibaba, currently worth $124 billion.

Even then, however, Son would need big globs of external capital to get close to the size of the first Vision Fund. That explains recent overtures to wealth funds in Oman and Malaysia, based on recent news reports. Signing them up would have the added benefit of making Son less dependent on Saudi money, which has been tainted by last year’s brutal murder of journalist Jamal Khashoggi. Even so, the Omani and Malaysian funds have total assets of less than $40 billion, using SWFI data. Devoting 10% of their combined portfolios wouldn’t move the needle much.

So Son probably needs continued Saudi and Emirati support. The Gulf duo, for their part, need to show at least token backing for the Vision Fund sequel to avoid undermining their current investment. Call it the venture capital equivalent of the Eagles’ song “Hotel California”: you can check out, but you can never leave.


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