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SoftBank Group's investment firepower has been a force in India, where there was traditionally little domestic risk capital. (Illustration by Eric Chow)
Cover Story

Fallout: SoftBank's next big crisis may be brewing in India

Overfunding and bloated valuations have destabilized the country's startups

NEW DELHI -- In 2014, Kunal Bahl and Rohit Bansal, the founders of Delhi-based e-commerce company Snapdeal, boarded a plane to Tokyo. Their company had just struggled through a transition from a Groupon-like discount voucher seller to a full online retail marketplace, and had nearly failed -- but Bahl and Bansal had managed to turn it around. They brought in $850 million from major investors, including sovereign wealth fund Temasek Holdings, Ratan Tata, the head of Tata Group, and U.S. chipmaker Intel. EBay even approached Snapdeal with a proposal to acquire the business.

Instead, Bahl and Bansal flew to Japan to meet the global tech sector's kingmaker -- Masayoshi Son, the founder and CEO of SoftBank Group. Even though Snapdeal had pulled in hundreds of millions, investment flows into India were still just a trickle. Chinese giants Alibaba Group Holding and Tencent Holdings were yet to enter the market at scale, and there were few local funds investing in technology. SoftBank was just starting to seek out deals in India, in an early display of its now-familiar playbook: offering to inject vast sums of money, and driving valuations higher than any other investor could offer young entrepreneurs.

Warned that Son had a short attention span, Snapdeal's founders brought only 10 slides to accompany their presentation. They had got through just three when Son cut off their pitch. "I have heard enough," he told them. "I will give you $1 billion for 49% of your company."

The amount was far more than the pair sought, or could even use. Ultimately, the two sides agreed on an infusion of $650 million for more than 30% of the company. "It was Snapdeal's first rodeo with so much capital," says one insider.

SoftBank's Vision Fund, with nearly $100 billion of capital, has become perhaps the most powerful funder in global technology. (Photo by Ken Kobayashi)

Dozens of entrepreneurs all over the world have had a similar experience. No investor has been more obliging than SoftBank's Son in writing massive checks to young companies, giving them the financial firepower to out-compete their rivals while pumping up their valuations. And that same pattern has played out in India, where, until recently, there was virtually no domestic risk capital, making SoftBank the biggest game in town. "SoftBank did put India on the global map," says Vinish Kathuria, a Delhi-based venture capitalist.

Since then, SoftBank's Vision Fund, with nearly $100 billion of capital supplied by major sovereign wealth funds, tech companies and private investors, has become perhaps the most powerful funder in global technology. It has fueled a wave of disruptive companies, from ride-hailers Uber Technologies and Grab to office communication business Slack Technologies.

Now, the wheels are coming off. WeWork, the office rental company into which SoftBank had invested billions, announced in September that it would list in New York, seeking an extraordinary valuation of $47 billion. The company's prospectus revealed a business model and a highly unusual governance structure that rattled investors. Its valuation dwindled, and eventually the listing was pulled.

SoftBank moved quickly to replace WeWork's CEO and inject fresh capital, but the damage was already done. Analysts and investors had begun to publicly challenge the models on which SoftBank and the Vision Fund have built their reputation -- spending big to buy breakneck growth, and backing charismatic founders who promise transformative change. And valuations driven, in part, by the promise of an unending supply of capital from Tokyo, now look increasingly fragile as SoftBank struggles to raise a second Vision Fund to keep the money flowing.

"Watching SoftBank is like watching a slow-motion car wreck. And then we all remember we are also in the car"

Jason Tan, chief investment officer at Jeneration Capital Management and a former executive at Tiger Global

For the companies that accepted SoftBank's investments, that raises existential questions. But the impact reverberates even further, affecting the entire venture industry and young startups everywhere. Indeed, SoftBank has become among the biggest risk factors for tech ecosystems worldwide.

"Watching SoftBank is like watching a slow-motion car wreck," says Jason Tan, chief investment officer at Jeneration Capital Management and a former executive at Tiger Global in Hong Kong, in the wake of WeWork's implosion. "And then we all remember we are also in the car."

Nowhere is that more true than in India.

Son rises

For Indian entrepreneurs, SoftBank was the ultimate gift. Even five years ago, there was little local capital for startups. Unlike in the U.S., where the first generation of technology founders became angel investors in subsequent waves, India's industrialists did not fund startups. U.S. technology businesses still saw India as a way to arbitrage labor costs, rather than as a venture opportunity.

With characteristic hyperbole, Son announced at a Delhi conference in December, 2016, that he was prepared to put $10 billion into the country's tech sector over the next decade. "India has the best opportunity ahead of us," he said.

By the following May, SoftBank had its first big deal -- a $1.4 billion investment into Paytm, an e-commerce platform based in the state of Uttar Pradesh. More followed: notably, a $2.5 billion stake in online retailer Flipkart, which would prove one of SoftBank's most successful deals when the stake was sold on to Walmart in 2018.

From the early days of India's startup scene, a handful of local venture capitalists such as Sanjeev Bikhchandani, a widely respected, Delhi-based entrepreneur-turned-investor, had tried to instill discipline in young founders. They warned inexperienced entrepreneurs that the mark of success lay not in a successful fundraising round, but in generating real cash flow. But it was hard to heed such warnings when SoftBank offered so much money at such heady valuations, and seemed unconcerned by cash burn as long as it generated growth.

An advertisement for online payments company Paytm hangs among vegetables at a roadside market in Mumbai.   © Reuters

Venture capitalists developed a complicated relationship with SoftBank. Even as the Vision Fund threw capital at its portfolio companies in an attempt to out-compete other VC-backed startups, the VCs themselves were beneficiaries of the inflated valuations. They could mark up the value of their own investments, while still appearing more conservative than Son. They also targeted SoftBank as their exit of choice when they were ready to take profits, since the Vision Fund offered higher valuations than any available in the public markets.

But the unusual metrics that SoftBank prioritized at its portfolio companies, such as "gross merchandise value" -- a figure which is not recognized by most generally accepted accounting principles -- rather than unit economics or cash flow, meant that more disciplined investors looked askance at the balance sheets of many of the startups it backed. Many were under no illusion about what was driving the valuations.

"When SoftBank stops putting money in, nobody else will write a check," says the Mumbai-based head of India for one of the big international private equity firms.

Snapdeal represents one cautionary tale for what can result when a young tech company takes too much from a single source of capital, particularly one with a divergent model from the rest of the industry.

"[Son] just cares about growth, whatever it takes, so no other investor will step in following SoftBank," says one entrepreneur in reviewing the Snapdeal story. "You are screwed. The lesson is that you need to show a path to profitability."

In line with the growth mantra advocated by SoftBank all through 2015, Snapdeal duly focused on its gross merchandise value. But by the end of the year, the company realized that it needed sensible economics, with a sharp focus on reducing its fixed costs, to put the company on a stronger foundation.

"Venture capitalists have many companies in their portfolios, but entrepreneurs have only one in their portfolio," says one industry insider. "They need to balance between being bold and being conservative. They need to course-correct if the situation so demands."

Snapdeal made considerable progress in that correction over the following year. But when Son's deputy, SoftBank president Nikesh Arora, unexpectedly quit in June 2016, it left Snapdeal without an anchor. Because decision-making was both intuitive and centralized at SoftBank, there were none of the processes that were the norm in more institutionalized investment firms to smooth the transition. There was nobody to talk to, nobody familiar with the details of the investment -- and nobody to ensure continuity of approach, insiders said.

Then, early in 2017, SoftBank decided it made sense to merge Snapdeal with the Indian e-commerce retailer, Flipkart, in which it later became a large investor. "It was not positioned as an option," says one person familiar with the matter. "Throughout the year, there were two soap operas in the Indian corporate world. One was the fight over [the helm of] Tata Group -- and one was the fate of the deal between Snapdeal and Flipkart."

"[Snapdeal] had to sell the brass to save the family silver. ... [They] don't want to be on the hamster wheel of fundraising"

A company insider

The merger never happened. By the time it was called off, Snapdeal had a mere four months of cash left. The two founders led a turnaround strategy that they called "Snapdeal 2.0," which included selling noncore assets, cutting cash burn and sharpening the focus on unbranded products. One insider recalls: "[Snapdeal] had to sell the brass to save the family silver."

Today, after its near-death experience, Snapdeal has bounced back. Its traffic doubled in the last 12 months, while revenue grew by 70%. In the same period, its losses came down by a similar magnitude. The founders learned a lesson about raising money in the process. They "don't want to be on the hamster wheel of fundraising," the insider says.

There are other companies in SoftBank's India portfolio that have been able to demonstrate discipline and focus.

Bangalore-based Ola Cabs has been subject to the same contagion and valuation pressures as other ride-sharing companies in Asia -- including Didi Chuxing in China and Grab and Gojek in Southeast Asia -- in the wake of Uber's less-than-stellar listing. SoftBank has invested at least $250 million in Ola, which has also taken investments from Hyundai Motor, Sequoia Capital and Temasek.

While other ride-hailing companies have fallen to the temptation of strategic drift, buying into adjacent industries as they chase growth, Ola founder Bhavish Aggarwal has kept to his lane, resisting the cash-fueled customer acquisition sprees that have contributed to huge losses suffered by his rivals. Aggarwal has said that he believes too much capital makes entrepreneurs inefficient, and that many of his peers have fallen into the trap of viewing fundraising as an end in itself.

Aggarwal says his core India business is already profitable. "In the long term, the only metric that will matter for a business is profitability," he told the Nikkei Asian Review. "Everything else will just be vanity metrics."

Perhaps most importantly, the Ola founder has always been careful not to depend on only one source of funding, which has given him leverage to offset Son's influence. Aggarwal reportedly turned down a check of more than $1 billion from Son earlier this year.

"Ola has always understood that an entrepreneur cannot rely on SoftBank," says the head of Indian operations for one major growth and private equity firm in Mumbai. "It is too easy to lose control of your company."

Some of SoftBank's co-investors say they have experienced a more rational side of Son. The investor Bikhchandani is a backer of Policybazaar, an Indian insurance comparison portal, in which SoftBank also has a stake. "It hasn't flooded Policybazaar with capital it doesn't need," he says.

Even those with mixed experiences of SoftBank have kind words about Son. "He pushes you to think big," says an insider at Snapdeal.

The other shoe

Big questions still hang over companies that count SoftBank as a dominant investor -- particularly those that haven't yet demonstrated how they will become sustainable operations. One drawing inevitable comparisons with WeWork is the Indian hotel chain, Oyo.

Like WeWork, Oyo is as much a real estate play as a tech story. Founded by 26-year-old Ritesh Agarwal, the business was originally a capital-light franchise model, standardizing the quality of budget hotels in the country and putting its brand on them.

The concept made sense: There was demand for consistency in a market segment targeting cost-conscious business travelers and local tourists, whose only previous alternative might have been to stay with relatives. Son gave him a total of $2.5 billion.

But recently, Oyo's Agarwal has behaved, in some ways, as the antithesis of Ola founder Aggarwal. He abandoned his previously conservative vision, expanding aggressively in already-intensely competitive markets such as mainland China. Oyo was part of a group that spent $135 million to buy Hooters Casino Hotel in Las Vegas. The company also acquired assets in Europe and Japan and set up unrelated ventures, such as a wedding planning app and a "cloud kitchen" food business.

Oyo founder Ritesh Agarwal: The company has grown from a budget hotel aggregator to operating a quasi-franchise model. In July, it claimed to be the third-largest hotel chain worldwide by room count, overtaking InterContinental Hotels Group. (Photo by Shihoko Nakaoka)

Such initiatives suggested the company was increasing the speed at which it burned capital. In the last fiscal year, the Indian operations reported revenues of $61 million, and losses of almost the same magnitude -- losses which some venture capitalists believe have only widened.

In November, Reuters reported that Oyo's own internal projections show that its Indian and Chinese businesses will not be profitable until 2022. Its U.S. arm will remain loss-making until 2023.

Moreover, in recent months, Oyo's go-for-broke expansion has not gone well at home. In October, the Competition Commission of India announced it was looking into possible anti-competitive behavior. There have been workers' strikes, from Kochi and Bangalore in the south to the nation's capital in Delhi, and litigation from hotel owners claiming that they have not been paid fees owed by Oyo. A company spokesperson told Nikkei that regulators have dismissed most of the allegations against it.

As the crisis at WeWork led investors to examine the -- apparently artificial -- valuations of companies receiving huge injections from SoftBank, Oyo began to behave in a way that seemed to confirm their suspicions.

A few weeks ago, Agarwal borrowed $2 billion against his shares from Japanese financial institutions to buy out early investors, including Lightspeed Venture Partners and Sequoia Capital's Southeast Asian and Indian arm, at a $10 billion valuation -- double the previous mark. This kind of related-party transaction was great news for those early investors, but it failed to provide independent verification for what Oyo is actually worth. The deal is yet to close, and is pending final approval.

In recent months, Oyo has seen strikes across the country, and litigation from hotel owners claiming that they have not been paid fees owed to them. (Photo by Akira Kodaka)

In recent months, the China arms of Sequoia and Warburg Pincus declined to invest in Oyo's Chinese operation, Oyo Jiudian, believing that its numbers made no sense, according to people with direct knowledge of both decisions.

An Oyo spokesperson says that "unlike e-commerce businesses, we don't spend a lot on customer acquisition," and that the company's cash is largely spent on capital expenditure, talent acquisition and technology. The company is profitable at a building level, the spokesperson says: "We strongly believe in capital-efficient and sustainable growth."

Paytm, SoftBank's first big India investment, is also under scrutiny. The payments company received a major boost three years ago, when the government's "demonetization" policy wiped out almost 90% of cash in circulation in India. Since then, though, it has faced rising competition while burning through cash -- as much as $650 million, according to the head of one e-commerce company who has had dealings with Paytm. The company's losses multiplied by 2.5 times for the fiscal year ended in March.

"Paytm is stuck between a glorious past that was built on the back of digital payments, and a future that doesn't look anything like Jack Ma's Alibaba, one of Paytm's largest investors and [company founder Vijay Shekhar] Sharma's inspiration," wrote business journalist Ashish Mishra in an essay entitled "Paytm is Stuck," which is making the WhatsApp rounds among venture capitalists in India.

"In the last six months, our revenues have increased 25% and our costs have been reduced 10%; our revenue-to-cost mix is healthy," says Sharma, founder of Paytm. "We don't sell a dollar for 90 cents in subsidies. Our payments bank is profitable and has [built] 52 million users in two years. ... People say we have lost momentum after demonetization, but the numbers on the ground are better than people believe."

Paytm announced a $1 billion Series G funding round in November. SoftBank invested $200 million. The deal values Paytm at $16 billion, and stipulates that the company must either go public within five years, or give SoftBank the right to sell its stake.

Sanity returns

A spokesperson for SoftBank says it has "always worked to help the companies we back strike the right balance between growth and profitability. Some of them are already profitable, and we believe that many will be soon."

The spokesperson says that SoftBank's valuation process is "robust," reviewed by independent auditors, and "validated by more than 120 sophisticated investors who've invested alongside and after us."

They added that fundraising for Vision Fund 2 is "progressing as expected." "We believe our performance is strong," the spokesperson says. "In just two and a half years, Vision Fund 1 has already had seven initial public offerings, $4.7 billion of realized gains, $11.4 billion in cumulative investment gains and returned $9.9 billion to our limited partners."

However, analysts say that chances are receding of the second Vision Fund reaching anything like the scale of the first. The first Vision Fund's investment period is coming to an end. The big IPOs that it hoped would gloss its reputation and provide new capital have not got away. Some of the largest names in Vision Fund 1 -- notably Saudi Arabia's Public Investment Fund, which invested $45 billion the first time around -- are yet to commit to the sequel.

The implicit promise of endless capital from SoftBank's coffers has supported the valuation of several of its portfolio companies. Now that promise is likely to prove illusionary, those valuations will surely fall, leaving the field more open for companies which are able to clearly articulate their financial sustainability.

"If a startup only has a 'grow-at-any-cost,' cash-burning model and a high valuation, there is no longer limitless capital," says Vishal Mahadevia, head of Warburg Pincus in India. "But for companies that do have attractive unit economics and a path to profitability, this is a much better environment."

Announcing disastrous earnings in Tokyo in November -- including losses of nearly $9 billion from its tech funds -- Son himself sounded a warning. "I want to make it clear that firms that accept SoftBank investment must be self-sustaining," he said.

"A downround is the only choice for SoftBank companies," says the head of Indian operations in Mumbai for one major international bank, referring to a fundraising at a lower valuation than the last round.

In India, the impact of SoftBank's curtailed ambitions could be softened by the easy money from the developed world that is pouring into emerging markets and swelling the coffers of venture capital and private equity funds.

In any case, SoftBank's troubles are already being greeted as an opportunity by other investors. "My team has been chasing the founder of one consumer internet firm that was in talks with SoftBank for months, but he refused to return my calls," says the head of the Indian office of one New York-based private equity firm. "But now, they are chasing us. Sanity has returned to the market."

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