Gavin Baker+ Your Authors @GavinSBaker Husband, Becky Painter. CIO, Atreides Management. Former PM, Fidelity OTC fund. No investment advice, views all my own. Nov. 05, 2019 6 min read + Your Authors

1) Masa is brilliant & have to respect the track record, but I am curious to compare the marks on Didi/Grab across public mutual funds and the Vision fund.

VF travails with WeWork & Uber well understood but Didi/Grab marks and the Sprint outcome might be pivotal for Softbank/VF.

2) Applying the valuations for public ride sharing comps to Didi and Grab would result in large writedowns, which is what mutual funds required to accurately price their funds have likely done. Comparable writedowns might put the Vision Fund in negative IRR territory.

3) *Very* rough Vision Fund numbs: Down $5 to $7b on WeWork on $10b invested. Down $1b on Uber on $8b invested. Likely down $2ishb on Didi and Grab on $15b invested. ARM is a big wildcard given the rise of RISC-V. So down $10ish billion on $33b invested pre ARM pain.

4) This puts enormous pressure on the rest of the VF portfolio to deliver exceptional returns - think GH type outcomes w/in VF to date (or for the paper losses to reverse), especially given that VF owns an unusual amount of common stock and has an unusual structure itself.

5) My understanding is that VF often invested a small $ amount in primary stock at a high valuation with preferences/ratchets, but then invested a larger $ amount in the same company in common stock at a much lower valuation via employee/early shareholder buyouts.

6) This lowered their average cost (i.e. invested relatively small $ in WeWork at $47b and Uber at $70b), but leaves them with an unusual amount of common stock with minimal anti-dilution protection, liquidation prefs, etc. which makes them vulnerable in downside scenarios.

7) This means that all else equal Vision Fund marks should be lower than the mutual fund marks, which generally own preferred stock at the top of the liq stack. Taking extra risk by owning common stock is on brand for Masa, who is *really* bold.

8) Masa has personally leveraged his stake in Softbank. Softbank is leveraged. Both Softbank and Masa invested in the VF common stock rather than its preferred stock, which pays out at 7% annually. Payout, not a hurdle. Leverage on leverage on leverage.

Plans w/in plans. 😀

9) An overall IRR for the Vision Fund below the 7% preferred rate of return would mean a severely negative rate of return on the Vision Fund common stock in most scenarios. A negative IRR for the Vision Fund overall likely wipes out the Vision Fund common stock entirely.

10) A 7% rate of return for KSA and other VF preferred stock investors would be acceptable for them and they might be left with large stakes in a variety of high quality startups that will likely stand the test of time, however overvalued they might have been or be.

11) But no idea how this all plays out for Softbank. As noted earlier, Masa is brilliant w/ a great track record and has pulled rabbits out of hats before so I would not count them out but they are in a tough spot – esp. with all of this happening during fund raising for VF2

12) Announced VF 2 investors are in the Softbank ecosystem (Japanese banks, Apple, etc.) and will likely invest, but it’s not clear to me that Masa and Softbank will be able to invest and they are the linchpin for VF 2. Irony is that VF2 returns would likely be quite good!

13) Masa/Softbank investing in Vision Fund 2 are somewhat dependent on the outcome of Sprint, as a merger with T-Mobile would improve the Softbank balance sheet and make it easier for them to invest in VF2. Funny that the fate of so many startups rests on a telecom merger.

14) BTW – great job by the Softbank PR department. Loved the articles that noted their $400m WeWork IPO ratchet. Over $12b invested to own 80% of a company valued at sub $8b as a way to control a mark.

15) Implications for the venture ecosystem are negative over the next year and positive over the next 5 years. Negative near term especially for later stage co’s burning lots of cash, which was a logicalish strategy in VF world. “Don’t get to choose the field you play on,” etc.

16) It’s unclear how many of these companies will be able to raise at up valuations or flat valuations, which may result in lots of premature IPOs as being converted to common is preferable to being crammed down depending on voting % vs. preference % of ownership.

17) This will create a lot of near term pain, but also create immense opportunities either in public markets or for later stage venture/growth investors (VF2, esp. if allowed to invest in VF1 co’s). There are some awesome co’s in the Vision Fund portfolio

18) This will be good for public equities that compete with large, venture funded competitors who are burning lots of cash and now need to get profitable really fast. Likely see this begin to manifest in 1H 2020 as reality sets in and ecosystem moves beyond denial to acceptance.

19) And all of this will be positive over the next 5 years. So many startups learned the wrong lesson from Amazon and Salesforce and thought it was ok to lose enormous amounts of money at scale or even worse, scale their way into positive unit economics.

20) Reality is that Amazon and Salesforce internally financed their growth and generally adhered to my “$1 of free cash flow” principle which meant their futures were not dependent on the kindness of strangers (markets) to finance their operations and growth.

21) The Vision Fund and its weaponization of capital (although not always to its benefit given its funding of so many competing co’s in ride sharing/food delivery – the capital cannon was sometimes a circular firing squad) amplified all of these negative dynamics.

22) esp. as the Vision Fund's size forced it to find cash hungry startups.

Sidenote: The VF always made me think of the aphorism that if you owe $Xm the bank owns you, but if you owe $100xm you own the bank. Just unclear who the bank is in this analogy!

23) Can’t say this strategy is not time tested; Julius Caesar used the same strategy to win election as Pontifex Maximus; telling his mother the morning of the election that he would either return as Pontifex Maximus or not at all. Go big or go home.

24) Anyways, I think there will be lots of good potential opportunities in 2020 for investors, which will sow the seeds for future returns. And capital scarcity works to the advantage of both good entrepreneurs and good investors. Exciting times.

25) These dynamics are why I think VF2 returns might be better than VF1 along with Masa's historic resilience & lessons learned from VF1. But the future is ever uncertain.

Anyways, a return to unit economics and generating cash at scale will be great for the venture ecosystem.

You can follow @GavinSBaker.


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