The Last True Believer
In this season of dot-com lynchings on Wall Street, a little bit of gallows humor goes a long way. It was the inspiration for a five-minute video spoof of the popular ER TV medical drama that Softbank Corp.'s top venture-capital partners presented to 150 investors at an autumn gathering in San Francisco. The patient: One sick puppy of a dot-com outfit suffering from fast cash burn, high employee turnover, and panic stock selling by insiders.
The video opens in a mock operating room. Enter a trio of Softbank VCs costumed as surgeons. Gary E. Rieschel, head of Softbank Venture Capital, sizes up the patient and orders a "business-model transplant." Cutting and stitching, they convert the dot-com into a business-to-business company. Whoa, the patient starts to flat-line. So they try making it a player in the newly hot sector of peer-to-peer computing. Finally, the dot-com pulls through. Deadpans one of the "surgeons," Softbank Venture Partner D. Rex Golding: "It's not a miracle--it's just great positioning."
While that quip earned Golding hearty laughter from investors, last year was anything but a yuck-it-up 12 months for Softbank. The Tokyo company rose to the top of the venture capital heap in the 1990s by placing large bets on Net startups like Yahoo! Inc. and E*Trade Group Inc. and going along for the ride as their stocks pierced the stratosphere. These days, only a lucky few young companies are going public and last year the collapse of tech stocks on the world's financial markets vaporized $180 billion worth of Softbank's market cap, leaving it with a $21 billion valuation. Its share price has plummeted 94%, from a peak of $590 to $34.
So is Softbank throttling back? Anything but. The company is thinking even bigger than before. Indeed, Chairman Masayoshi Son seems to be the last true believer in the Internet Revolution. He already has invested $8.8 billion in corporate and venture capital money in more than 600 companies--about half of the dough coming from institutional investors. Now, he's got another $4 billion he raised before the market swoon that he plans on investing over the next two to three years. The goal is 800 Net companies in his portfolio.
To get there, Son is now focusing on what he thinks are the hottest technologies showing the best growth prospects. That means networking, software-infrastructure players, and wireless-communications companies--as opposed to all but the most proven consumer sites. And if he can get them on the cheap, all the better. His latest deal announced on Dec. 15: A $100 million investment for a 16.5% stake in Korea Thrunet Co., which provides high-speed Internet access to 720,000 subscribers. At the end of 1999, it had a market cap of $3.8 billion. Now it's worth all of $269 million, thanks to the collapse of Internet stocks. As for its existing portfolio, Softbank will prop up companies it believes are on the path to profitability, like U.S. e-tailing site buy.com. But others it sells off--such as me-too pharmacy site More.com.
Far from being the end of the line for Net investments, says Son, "it is still the beginning of a big thing coming." His master plan: To create a cyber-conglomerate that will transform the Net into a truly global phenomenon. "I admire their stick-to-ittiveness," says C. Richard Kramlich of venture capital firm New Enterprise Associates.
The global part starts now. In Europe, Softbank has raised $1.4 billion to go after the hottest wireless and broadband technology players. All around the world, from far-flung burgs like So Paulo and Seoul, Softbank is fielding 1,000-plus pitches a month from high-tech companies that are dialing for dollars. Son even has teamed with the World Bank to seed startups with $200 million in the developing world. Says Ronald D. Fisher, who manages non-Japan investments as chief executive of Softbank Global Investors: "This is a great time to have money and courage."
Other companies that once stood alongside Softbank as gutsy Net investors are in full retreat. Web investor Internet Capital Group Inc., of Wayne, Pa., doesn't plan to raise more money now. And Chicago incubator Divine Inter Ventures Inc. last year laid off half its staff. Its CEO, Andrew "Flip" Filipowski, wishes he could walk in Son's shoes. "I think it's a brilliant move on his part," says Filipowski. "While the easy money has gone home, he can pick up the pieces left by the folks abandoning the market."
So what does Softbank have that the others don't? In two words: Staying power. In addition to more than $2 billion in venture funds, the company has $1.6 billion in corporate cash and marketable securities and is sitting on more than $10.1 billion in unrealized gains from its early venture investments in the likes of portal site Yahoo! Inc. and software standout VeriSign. On top of that, its operating businesses are expected to deliver $318 million in profits in the fiscal year ended in March, according to analysts' projections. Unless the financial markets get much worse and stay lousy for years, this company is in shape to wait out the storm. When the markets recover, Softbank should be able to raise money by selling stock or bonds--and make money by cashing in on capital gains from its investments.
At the mercy. Things could still go terribly wrong for Softbank, though. While none of its high-profile investments has gone belly-up yet, one-quarter of the U.S. startups Softbank has backed are consumer Net companies--a segment that has been especially hard hit. Retailer Buy.com Inc., for instance, in which Softbank holds a 20% stake, last year lost 97% of its value, wiping out most of Softbank's investment gains. Its $125 million 1999 investment in grocery-delivery service Webvan Group Inc. is now worth $10 million. On top of that, Softbank's 21% stake in Yahoo puts it at the mercy of one company's fortunes--and Yahoo stock has dropped 88% from its peak last year. Nightmare scenario: Yahoo goes into a tailspin, and Buy.com, Webvan Group, and other major bets go out of business, destroying hundreds of millions of dollars of Softbank equity.
For a number of high-profile Softbank companies, it's not clear how long they can hold out. At the rate it's spending money, Interliant Inc., a company that runs corporations' e-businesses in its data centers, could be out of cash by midyear. The same is true for Webvan. It warned last month that it will need to raise at least $80 million to make it to 2002. Buy.com has a little more time in its hourglass: About a year at the current burn rate.
The meltdown scenario is a turnoff to some potential investors in Softbank's venture funds. Grove Street Advisors General Partner Dave Mazza says he wouldn't park a dime of the $2 billion in pension fund money he manages into Softbank funds. The reason: Softbank paid generous amounts for shares in prepublic companies. Of the 25 publicly-traded U.S. companies in which Softbank holds a stake, 20 are now trading below their IPO. "They would outbid everybody for deals that are now underwater," he says.
Another challenge for Softbank: The organization is spread mighty thin. Besides owning pieces of all of those Net startups, the company owns all or part of dozens of media, distribution, and Internet companies in Japan. Overall, it has stakes in 318 companies in Japan, 189 in North America, 14 in Europe, and 30 in China. It has bet on a wide range of sectors, from portals and Web content on one end to technology infrastructure on the other. In Japan, it owns 42.5% of Nasdaq Japan, the brand-new and still unproven Tokyo stock market. From the outside, Softbank looks like an unwieldy sprawl of operating companies, venture capital funds, joint ventures, and startup incubators.
Son himself is the key to making this huge gamble pay off. The 43-year-old ethnic Korean remains the imperturbable optimist. He dresses up in samurai garb to motivate Japanese entrepreneurs and hasn't lost a bit of his fabled appetite for dealmaking on the fly. The latest: $40 million for a 40% stake in a Japanese joint venture with the hot American e-marketplace software company Ariba Inc. That deal escalated from a 30-minute sales pitch last Aug. 31 to a preliminary agreement in the span of 24 hours. Nor has Son thrown away his messianic vision of an Internet that transforms society by blowing communications and commerce wide open. He talks of a 100-year plan for building 19-year-old Softbank into a giant on the world stage. Son dismisses today's worrywarts: "The market always overreacts in the short term, but I'm not a short-term player."
At its core, Son's plan is simple. The company takes minority stakes in companies that it thinks will be the winners in their business segments on the Web. In some cases, he tries to replicate an already well-established American brand overseas--such as Yahoo Japan, and E*Trade Japan. To give his portfolio companies an edge, Son has created what he calls a Netbatsu, a modern reprise of the old Japanese zaibatsu trading networks that swapped ideas, capital, and contacts to expand their industrial empires throughout Asia. Son's fund managers and the executives of his portfolio companies can share information and easily do deals together that benefit all parties.
Softbank's five-year love affair with Yahoo shows the power of the Netbatsu. Yahoo has expanded into Japan, South Korea, and much of Europe--with Softbank as the joint venture partner. Partial payoff: Softbank's paper gain from Yahoo Japan alone is more than $3.5 billion. Softbank goes flat out to make these projects work. Masahiro Inoue, chief executive of Yahoo Japan, points out that during the first year of operation in 1997, Son lent his own engineers and salespeople to launch the service. "We received almost everything from Softbank," he says. Yahoo Japan turned a profit within a year. And the alliance works both ways. Yahoo Japan bolstered Softbank's e-Shopping! cybermall with an investment and a premier spot on its Web site.
In these dark days, the Netbatsu means that when a Softbank company hits a patch of trouble, it's not left standing alone. For instance, most investors seem to have given up on buy.com. Its stock is trading at about $1, down from a peak of $33 last year. Its site traffic was up an anemic 11.5% during the critical second week of December, according to market researcher Media Metrix. Yet Softbank is still bent on helping the retailer build its business, says CEO Greg Hawkins. Softbank recently brokered a partnership with ProSavvy, another portfolio company, whose tech-consulting services have been added to buy.com's business-to-business e-commerce site.
Indeed, Softbank is pulling out the stops to help some of its upstarts go public in a down market. Take PeoplePC Inc., the San Francisco company that gives away PCs to individuals who agree to subscribe to its Internet-access service for three years. Last August, in spite of poor market conditions, the company decided to go public to raise cash for expansion. Softbank pitched in by purchasing an additional $10 million in stock at the IPO price of $9. That helped the stock rise a little to $10 per share, but it has been on a downward slide since September and is now trading at about $1 per share. Softbank has faith that PeoplePC will thrive in the long run. "We wanted the investors coming in alongside us to have a sense of comfort that we'd put our money where our mouth was," says Fisher.
While Softbank's overall strategy hasn't changed in this roiling environment, its tactics are dramatically different. Over the last two years, entrepreneurs had enormous leverage when negotiating startup financing. "Because of the hype, the prices were getting crazy," Son says. Now, Son can get the companies he believes have a viable future at a reasonable price. Startups that were peddled with valuations of $400 million and up a year ago are now valued at one-quarter that much.
Twice over. It's similar with public companies. In August, Softbank invested $20 million in Global Sports Inc., a provider of e-commerce services for sports retailers such as The Athlete's Foot. The stock price: just $8 per share. That's way down from its peak last March of $24. That sets it up for a rich capital gain should Global Sports take off. The company's stock is now trading at $6, though, so it's too early to tell if Softbank had great timing or threw its money away.
To improve the chances of survival for the companies it backs, Softbank encourages some of them to buy out their competition. These are called "roll-ups." Already, with Softbank's approval, Global Sports last year bought FogDog Sports for $20 million in stock, and Webvan bought rival HomeGrocer.com for $550 million in stock.
Softbank urges all of its companies to conserve cash. The goal: avoid having to go public prematurely or return to the venture-capital markets for new infusions of financing. If the current business model doesn't look promising in the short term, try another one. And do it quickly. It still has hundreds of companies that need venture cash to stay in business. "The free capital ride that companies got over the past few years is over. And it's not a temporary change. It's long-term," says Fisher.
While Rieschel declares that "we can guarantee life-cycle funding for our companies," Softbank isn't averse to pulling the plug if necessary. He estimates that about 10% of the Net investments it made in the past five years have gone bust. Typically, Son urges companies to sell out that don't look strong enough to survive on their own. Example: Cruel World Inc., a California management-recruiting site that was sold in December to the Chicago headhunting firm Spencer Stuart.
Even though many startup incubators are contracting these days, Softbank is still committed to helping companies along in their earliest stages. It has its own startup incubator in Mountain View, Calif., a smaller one in Boulder, Colo., and is setting up others in Europe and Asia. Softbank invests $300,000 to $800,000 in startups that are just beyond the business-plan stage and nurtures them. Hotbank houses five startups, and Rieschel is looking for five or six new ones. The entrepreneurs share phones, PCs, and a high-speed data line for fast Net access. Softbank's in-house staff lends advice. In less than three years, 20 companies have graduated from Softbank's U.S. incubators, and the $50 million it invested in these companies yielded real and paper profits totaling $180 million.
Perhaps the most lucrative opportunities for Softbank are in its backyard. Son's audacious goal is to restructure the Japanese economy so the country is more friendly to entrepreneurs, and becomes more efficient and competitive. With partners, he invested $1 billion in Aozora Bank, formerly the deeply-troubled Nippon Credit Bank, so young companies can get loans more easily, and he hopes to package its financial services with those of his online companies. That way, a consumer could easily trade stocks with E*Trade, price a car loan with E-Loan, and track their investments with Morningstar Inc.--all Softbank partners. And Son helped launch Nasdaq Japan so startups could more easily go public.
Son has been hailed by some as a change agent for the moribund Japanese economy, but critics wonder whether he's another cartel builder in a country full of them. HSBC Securities Inc. analyst J. Brian Waterhouse worries that Aozora Bank will turn out to be Son's "high-tech piggy bank," steering preferential lending to its partners. Similar questions have been raised about Softbank's controlling interest in Nasdaq Japan. The suggestion that he's not playing fair gets Son's back up. He insists both the bank and Nasdaq Japan won't unfairly favor his other companies. "I shouldn't be criticized for doing the right thing for society," he fumes.
Son and Softbank don't face the same kind of static in other regions of the world. Softbank is just getting on track in Europe, where it has raised funds with News Corp. and Vivendi. The plan is to invest $2 million to $20 million in companies that already are up and running. Softbank Europe has done a half dozen deals since June.
In the developing world, the plan is to proceed with caution. Softbank has not yet made an initial investment from its Softbank Emerging Markets fund, though it aims to start soon. Even in more Net-savvy countries like India, it's not chasing consumer deals. A recent investment was in Intigma Inc., a company with offices in Dallas and India that uses Indian programmers for e-commerce projects in the West. Any investment in the Third World is by definition fraught with peril. Son shrugs off the risk. He revels in blazing a trail that other investors are unwilling to take. "We were the first all-Net company. We were the first global company. We're the first to go into developing countries."
Of course, pioneers often end up with arrows in their backs. And unless the markets turn around decisively, Son and his colleagues are going to be living in a hostile world for a long time to come.