The Son book of investing

The two twenty-somethings were nervous, sitting in the posh Gurugram house. Their host was Nikesh Arora, then president of SoftBank, the Tokyo-headquartered multinational. SoftBank is also one of the world’s largest investors in technology and new economy companies, and Arora was among its key people. The two young men were awed at the prospect of meeting him. So, when the sofa they were sitting on began to vibrate a bit, each thought the other was trembling with nerves.

Turns out they felt the tremors of an earthquake that shook the region in the summer of 2015.

But back then, Ritesh Agarwal and Abhinav Sinha weren’t thinking of earthquakes. They were thinking of a different kind of tectonic shift, of moving their startup OYO into the big league. They needed SoftBank’s help for that. Apart from the immensity of the deal for them, Agarwal’s nerves were stretched more at the prospect of meeting a man he had long admired: Masayoshi Son, chairman and CEO of SoftBank Group. “His ability to look at the world from the minutest execution level, all the way to a bird’s eye view is fascinating,” says Agarwal.

It’s startup history that a few months after this meeting, SoftBank led a Rs 630 crore funding round in OYO, paving the way for the startup to grow its business from a budget hotel aggregator to an asset-management firm which manages properties across guest houses, second homes, hotels, and more.

OYO is one in a long list of investments. Since 2014, SoftBank has invested over $7 billion in India in high-growth startups in e-commerce, ride-hailing apps, budget hotel aggregation and asset managing, grocery delivery services, and payment platforms, among others. In the last one year alone, it invested an eye-popping $4.3 billion (Rs 27,163 crore) in diverse companies here. SoftBank has placed major bets on Ola, Flipkart, and Paytm, says Alok Sama, chief strategy officer, SoftBank Group.

Industry observers say SoftBank’s large cheques are coming at a time when startups are evolving from creating a new business (like e-commerce and digital payments) to expanding the market. The capital, hence, is crucial as it gives the firms an opportunity to continue building the business and expand.

“While no one can guarantee what will happen in future, in 10-12 years SoftBank will end up playing a big shaping role in the whole tech, Internet ecosystem around the world, including India,” says Mukesh Bansal, founder, Cure.fit, a healthcare and wellness startup, and one of the most successful entrepreneurs in the country.

Two years before SoftBank was set up, music star Kenny Rogers won the “best country vocal performance, male” award for the song The Gambler. Masayoshi Son was then 22 years old, and a total unknown. But the lyrics of that song could have been about the Son the world knows today. “You’ve got to know when to hold ’em, know when to show them, know when to walk away, know when to run,” could well be from Son’s playbook of investing.

SoftBank group started off as a computer software distributor, hence its name. (Software is referred to as “soft” in Japan, and the name, according to the company’s site, literally means “a bank of software”.) Son, meanwhile, wanted far more than to head a distribution company, and began putting together the elements of the SoftBank we know today. Son did not meet us for this story, but there is much we learn from him from the team at SoftBank as well as the investments he has made. He took risks, there were failures, and he still gambled. There are enough media reports that discuss how Son lost $70 billion in the dotcom crash, but there are as many that laud his successes.

Son’s investment in Alibaba is by now the stuff of business history. Some 18 years ago, Son backed the then fledgling Chinese Internet company to the tune of $20 million, which gave him close to 30% in Alibaba. That stake today is worth almost $140 billion, but back then, his shareholders were worried. In a note to investors in July last year, Son recalled SoftBank’s journey. In 2004, he writes, shareholders were up in arms at what they considered his ambitious plans.

In a note to shareholders last year, Son recalls some of that. “I spoke about my vision as follows: ‘You may think I’m boasting—but please listen. I want us to grow to such scale that we count our net sales in trillions by my forties, and operating income in trillions by my sixties. That’s the kind of scale I am determined to achieve.’ I was 46. It was an outrageous statement considering our situation at the time; and yet, in fiscal 2016, we achieved net sales of ¥8.9 trillion, up 0.2% year on year, operating income of ¥1.0 trillion, up 12.9%, and net income, or net income attributable to owners of the parent, of ¥1.4 trillion, up 200.8%.”

The risk-taking wasn’t confined to Japan alone. In India, Son gambled on good ideas, such as housing. com. Then there was the $200 million investment in InMobi in 2011; that was then the largest investment in the mobile Internet space.

There were also early investments in Ola and Snapdeal. Not all these have been roaring successes. Take Housing.com. The Mumbai- based firm was started in 2012 by Rahul Yadav and nine others, and raised $100 million from SoftBank in 2014. Things started going downhill in 2015 when the real estate market slumped. Soon, disagreements started emerging over the focus and direction of the company, which led to a public spat between the investors and Yadav. While Yadav left the firm, Housing.com never got back its mojo. In January 2017, PropTiger, a real estate portal backed by News- Corp, said Housing.com will merge with it in an all-stock deal.

The SoftBank of today seems a far different beast. “I would not expect an investor like SoftBank to go beyond the top two or three players in each sector of their interest,” says Sanjeev Krishan, private equity and deals leader, PwC India. “I would also not expect them to take any contrarian bets,” he says. And so we have the big-ticket deals: Paytm, Ola, Flipkart...

Lining up large cheques—$1.4 billion in Paytm and $2.6 billion in Flipkart—the Japanese investor has taken backing of businesses in the Indian tech world to new heights. These are by far the biggest cheques written for consumer tech firms in India. Before the latest funding by SoftBank, the largest funding round by Paytm was worth $200 million, raised from China’s Alibaba Group Holding and venture capital investor SAIF Partners. It’s similar with Flipkart as well.

Even the most active traditional large investor such as TPG or KKR (non-real estate) in India hardly ever goes beyond investing $500 million at a time in a firm. But that’s also because their fund mandates are vastly different, explains Rajiv Maliwal, founder and managing partner, Sabre Partners, a PE firm in Singapore. “Their mandate,” he says, “is to invest in late stage, and not early stage or the venture capital stage. Secondly, the DNA is very different. For traditional investors, if they make five investments, four of them better do well (generate returns within an investment horizon). However, for SoftBank, Tiger Global and others like them, they can do 15 deals and even if five do very well, they are in a good position (in terms of overall returns).” He adds that “traditional investors may have just missed the bus. Most such funds have not changed their strategy; they don’t want to take early or growth stage risks. They have not hired people or acquired the skills needed for such investments.”

Sanjay Nayar, country head and CEO, KKR India, shares his investment thesis. “We like to see a real business model with actual cash flows, because cash flows ultimately lead to valuations. If you do not have sustainable cash flows and real profits, over time it is difficult for valuations to continue,” he says, adding that the investment firm is currently evaluating some investment opportunities in this space.

With its latest $100-billion Vision Fund, SoftBank is expected to be the biggest backer of tech firms in India. India is home to 10 unicorns—startups that are valued at over $1 billion—and SoftBank has invested in half of them: Ola, Flipkart, InMobi, Hike, and Paytm.

The Softbank of today does not see its role as merely that of a purveyor of large cheques. Again, that goes back to Son’s vision. “We want to form a coalition of like-minded people, comrades, entrepreneurs... we want to form a group, everyone to work together to create a revolution,” he said at SoftBank World 2017, an annual conference, held in July last year. That’s the philosophical Son, the one who has evolved ideas on the intersection of technology with human bodies. OYO’s Agarwal adds that Son thinks about the world in a time frame of 300 years from now and how companies will endure during this time period. Son’s idea of how businesses and customers’ needs will evolve is probably what has led SoftBank to invest in India.

While SoftBank, for whatever reason, could not turn Housing.com around, it did manage with grocery service provider, Grofers. Founded in 2013 by Saurabh Kumar and Albinder Dhindsa, the on-demand hyperlocal grocery delivery service ran into trouble. It raised $165 million from investors such as Apoletto Managers, Tiger Global, and Sequoia Capital, besides SoftBank. With a huge cash pile in the bank, the startup went on an expansion spree at a break-neck speed. By 2016, the founders realised they had bitten off more than they could chew, and they began the process of rationalisation. Grofers exited nine cities, sacked dozens of employees, and began the process of changing its business model to an inventory-led one.

And SoftBank’s role? “We are going through a transition and SoftBank has been very patient,” says Dhindsa. “They understand market shifts and are okay to take a step back in the short term if it makes sense in the long term.” For SoftBank, it seems like being patient is a good business call. In the past year, Grofers has cut costs, led by decisions such as moving from bikes to vans for deliveries, opened over 20 warehouses for faster delivery, and has tied up with several brands for exclusive launches on its platform in lieu of a fee.

K. Ganesh, partner, GrowthStory, which promotes and runs startups such as Portea Medical, BigBasket, and BlueStone, says SoftBank is one of the few investors who are in a position where they can control the destiny of a firm. “A $100 billion fund gives them huge power to dictate the luck of a company, industry and sector,” he explains. Ganesh points out that SoftBank is able to take parallel bets by investing in competitors such as Flipkart and Snapdeal and Ola and Uber on the back of its large fund. “SoftBank is betting on a sector and industry. There is an opportunity to win or consolidate. Their bets are hedged.”

Being long-term focussed is definitely SoftBank’s value proposition. While most investors tend to have an investment horizon of 5-8 years, with the $100 billion Vision Fund, SoftBank has 14 years to return capital to its backers.

Anything very powerful can be dangerous or can be an asset depending on how you harness that power, says a Bengaluru-based marquee entrepreneur, requesting anonymity.

“SoftBank’s ability to give such large cheques and draw a long-term conviction on a business can be a massive edge to the firm as long as the promoter is also ready to use the money smartly. The danger is if you raise a lot of capital and burn it on unproductive things, it will catch you sooner or later as we have seen in a couple of cases,” he adds.

In 2015, Son had committed to a minimum $10 billion investment in 10 years in India. Sama says SoftBank continues to be as bullish. Given the pace of commitments, he expects to hit this target well ahead of schedule. While SoftBank may have clarity on what it expects from its Indian portfolio, experts say it has paid steep premiums in its bet to take equity exposures.

In some deals, according to the people involved, SoftBank has invested at more expensive terms than required as it became desperate to get exposure in the firm, its growth story and the sector, exerting its main weapon–the enormous cheque book.

E-commerce is one such space, says an investment banker, who has worked with SoftBank on a deal. “For investors at large there was a fear of being left out; the market was exploding, India was a place to be. For someone who has not grown through an investment cycle in India and is rather going through the perception of the market size, he may have one particular view about the opportunity, which is often inflated,” he says, requesting anonymity.

Oversizing the market and having ballooned perceptions of market opportunities has been a reality in India. Investors have paid as much as five times more for a growth story after they missed the initial investment opportunity.

This is probably one reason why they can’t find exits, as finding investors for the next round (and pushing up the valuation) is hard; valuations of several of SoftBank’s portfolio firms in India such as Paytm (valued at $7 billion in latest round) are seen as quite high. The other option is the public offering route, which is a long way off.

The Securities and Exchange Board of India (Sebi), the capital markets regulator, stipulates that one of the conditions for an IPO is a profit record of more than three years; according to a government notification, the company should declare a minimum of Rs 15 crore as average pre-tax operating profit in at least three of the immediately preceding five years. Most consumer tech firms in India are yet to post anything resembling profits.

While consolidation is an option, getting a large enough, deep-pocketed suitor is easier said than done. Getting two large firms to join hands is not easy due to a variety of reasons including regulations regarding competition, willingness amongst promoters and management, to say nothing of diligence issues. But that said, consolidation seems to be on SoftBank’s mind.

In August, Snapdeal, which is run by Jasper Infotech, ended negotiations for a proposed sale with Flipkart. The discussions were initiated by SoftBank, Snapdeal’s largest investor. Had the transaction materialised, it would have been the largest buyout in the Indian startup space. Snapdeal has now decided to follow an independent path, which it calls Snapdeal 2.0, a simplistic, watered-down version of a marketplace.

The failure to close the proposed transaction is seen as a setback for SoftBank. It is believed that through the transaction, SoftBank was aiming to consolidate its holdings in India—by selling Snapdeal to Flipkart, and FreeCharge (which was acquired by Snapdeal) to Paytm. But then, as we know, the transactions fell through.

Not that this has deterred the Japanese giant. “SoftBank’s investment criteria remain unchanged: it looks for disruptive business models targeting huge addressable markets. The notion of ‘leapfrogging’ is an essential part our Indian investment thesis,” Sama wrote in response to an emailed questionnaire. He explained it thus: “SoftBank’s bet is that India never approaches car ownership thresholds experienced in the West, but rather migrates straight to a shared transportation model. Similarly, India will never likely have scaled organised retail in the form of physical department stores, but will gravitate directly toward mobile e-commerce. In finance, credit card penetration rates will likely never approach those seen in the West, but we will move straight to a tech-enabled digital finance model.”

These mega trends have led SoftBank to place major bets on Ola, Flipkart, and Paytm, he said. “Along with Oyo and Hike, both of whom have developed a uniquely local offering, these investments are the cornerstone of our Indian digital investment strategy,” Sama added.

Given the scale at which it operates, SoftBank tends not to invest at the venture stage but rather at a growth stage. But there’s still one pertinent question that needs answering: Can capital alone guarantee success for SoftBank? One has to see SoftBank beyond its cheque sizes, says a former financial head of a SoftBank investee firm, requesting anonymity. According to him, as SoftBank is a telecom firm, their understanding of handling volumes is very strong.

“Volumes matter in e-commerce and a partner who has seen this has a lot of learning that they can share. For us, their learnings led us to automated returns, quick and committed delivery, and an overall better experience for customers. Some succeeded, some failed,” he says, adding that his company was registering a cash burn of nearly Rs 120 crore every month in 2015-16, which came down to Rs 60 crore a month by the end of 2016.

At the time, SoftBank’s Arora also advised them to use analytics to understand a customer’s social and buying behaviour to offer discounts. “None of the earlier investors who backed the company ever asked about the utilisation of the capital. They only asked about the growth,” the financial head says, adding that after SoftBank came it all changed. “They have a huge team of analysts and observations are data driven. So SoftBank was one investor that was actively involved in day to day activities...not on petty things but on analytics, acquisitions, how to monetise etc.”

Experts say SoftBank is unique in its approach in India. “India has seen a slew of global investors but very few have the funding capabilities, focus and intention to invest in India’s new age companies as SoftBank has,” says a Delhi-based investment banker, who did not wish to be named.

Companies can fail for a variety of reasons (as seen in the case of Housing.com) including the lack of market adoption, incessant cash burn, growth saturation, wrong strategic decisions, and severe competition. SoftBank’s large funding rounds alone cannot assure a sustainable and fast growing business.

Ganesh begs to differ. SoftBank is making smart moves, he says. “They own a sector. What’s the disadvantage? Nothing! People have to buy, eat, and move. That’s a strategy. From now to the next three years more, people will buy things, commute and eat,” he adds.

And that’s probably what is driving Son’s vision.

(The article was originally published in the February 2018 issue of the magazine. )