SoftBank Rescues WeWork, Owning WeWork, Zuckerberg in Congress

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On to the update:

SoftBank Rescues WeWork

From Bloomberg:

WeWork has secured a $9.5 billion rescue package from SoftBank Group Corp., a deal that hands 80% of the company to the Japanese conglomerate while capping one of the more dramatic business debacles in recent memory. The transaction announced in Tokyo Wednesday marks the end of an era for the troubled co-working giant, which raised money at a $47 billion valuation in January, pulled out of a botched initial public offering attempt last month and is now valued at less than $8 billion in the bailout.

WeWork’s arc — from one of the world’s most valuable startups to surrendering much of the company in an emergency bailout — has captivated Wall Street and Silicon Valley. Founder Adam Neumann will now leave the company’s board as part of the package, to be replaced by SoftBank executive and newly appointed Executive Chairman Marcelo Claure. Neumann is set to walk away from the deal with as much as $1 billion from the sale of WeWork stock, a $500 million credit line from SoftBank and a roughly $185 million consulting fee, people familiar with the matter have said.

This is a very strange transaction on multiple levels.

First and foremost is the fact that SoftBank is even doing it: is an additional $9.5 billion on top of the $9 billion SoftBank (and Vision Fund) have put into the company a wise investment when the company is only valued at $8 billion?

Actually, is it $8 billion? $3 billion of SoftBank’s outlay is going towards a tender offer to SoftBank’s existing shareholders that values the company at $8 billion, but the $1.5 billion of fresh investment into WeWork values the company at only $5 billion (the other $5 billion is a loan).

Also, that $3 billion number is weird as well: $1 billion can be claimed by Neumann; that may be particularly unsavory (Matt Levine is an absolutely must-read on this), but it’s also understandable given that Neumann, thanks to his special class of stock, had complete control of the company. What, though, of the other $2 billion? Why would SoftBank bail out its fellow shareholders when, in the end, taking SoftBank’s offer was completely up to Neumann?

My best guess — and to be very clear, this is only a guess — has to do with these paragraphs in the funding announcement:

After closing, and following the tender offer, SoftBank’s fully diluted economic ownership of WeWork will be approximately 80 percent. Since SoftBank will not hold a majority of voting rights at any general stockholder meeting or board of directors (“Board”) meeting and does not control the Company, WeWork will not be a subsidiary of SoftBank. WeWork will be an associate of SoftBank.

How, you might ask, could SoftBank own 80% of the company yet not have a majority of voting rights? The answer is a couple of paragraphs down:

In connection with the agreement, WeWork’s Board will appoint Marcelo Claure, Chief Operating Officer of SoftBank Group Corp., to the position of Executive Chairman of the Board of Directors of WeWork, effective upon closing of the accelerated $1.5 billion payment commitment. Adam Neumann, the founder of the Company, will become a Board observer. The size of the Board will be expanded and it will receive voting control over Mr. Neumann’s shares.

Remember, Neumann’s shares still have the 20-1 super-voting rights; that means that even though SoftBank owns 80% of the company they don’t have a majority of the outstanding voting rights — the board does. And, conveniently enough, SoftBank doesn’t control a majority of the board seats.

The benefit to SoftBank is clear: declaring WeWork as an associate instead of a subsidiary means that WeWork’s balance sheet is kept off of SoftBank’s books; WeWork’s only presence on SoftBank’s balance sheet is as an equity investment.

It also appears to be legal. According to Securities and Exchange Commission regulations a “majority-owned subsidiary”, which would have to have its balance sheet incorporated into its parent’s books, is indeed defined by voting shares:

(n) Majority-owned subsidiary. The term majority-owned subsidiary means a subsidiary more than 50 percent of whose outstanding voting shares is owned by its parent and/or the parent’s other majority-owned subsidiaries.

At the same time, by definition SoftBank can’t pull this off on its own — it can’t have majority control, because that would make WeWork into a majority-owned subsidiary — which means that the other WeWork shareholders would have to go along with SoftBank’s plan. And so we arrive at what I suspect was the purpose of that extra $2 billion in the tender offer. SoftBank couldn’t vote itself into control without ruining its own books so it bought its way in.

That still leaves the question as to whether SoftBank is throwing good money after bad, and, all things considered, I think this makes sense. Regus, WeWork’s shared office space competitor, is worth $4.37 billion. If the choice was between seeing SoftBank’s previous $9 billion investment go to zero (because WeWork ran out of cash), or putting in some extra money with the assumption significant cost-cutting can at a minimum realize a ~$5 billion valuation, then this makes some degree of sense, particularly if SoftBank still thinks there is upside. But only, of course, if WeWork is kept as far away from SoftBank’s books as possible.

Owning WeWork

That noted, I can understand if you take anything I say about WeWork with a very large grain of salt.

While I:

  • Said from the beginning I would not invest in WeWork
  • Clarified that WeWork’s economics were very different from AWS in a Daily Update
  • Declared that WeWork was not a tech company

I think my mea culpa in Neither, and New: Lessons from Uber and Vision Fund was insufficient. I wrote:

It also means I should have been more explicitly skeptical about WeWork; my goal was to write a contrarian piece exploring the upside, while still being clear that I wouldn’t invest. I did state that, but I wasn’t nearly clear enough about just how absurd the valuation was, because I didn’t spend enough time discussing margins.

This is definitely true, but what I did not do is fully take responsibility for The WeWork IPO. What do I mean by taking responsibility? Not simply saying I made an error but fully owning it and examining why I made the mistakes that I made. So that is what I am going to do now.

For the record, I absolutely thought the $47 billion valuation for WeWork was crazy, particularly once the S-1 came out. At the same time, it was so obviously insane that basically everyone was dunking on the company immediately. To write that “this is insane” would have been very boring! So I decided to write the contrarian viewpoint, and I think in retrospect I started to fall in love with the story I was spinning. To be clear, I still wouldn’t have invested — and I said so! — but I mostly justified that with concerns about WeWork’s corporate governance.

Now to be sure, those concerns were real, and have certainly been validated. I was not wrong! At the same time, I started caring more about my rhetoric — diving into balance sheets ruins the flow! — and besides, it was like midnight when I finished. My subscribers were waiting!

Frankly, I didn’t take it seriously enough. If the boring take was the right take, I should have written that (I think I got this right with Uber, where the big takeaway was that the S-1 was useless). If covering my bases meant having a less interesting article, I should have had a less interesting article. If including critical details meant publishing a day late, I should have published a day late. And, I’d add, all of these issues were only magnified by the fact that, you know, WeWork is not a tech company, and thus outside of my area of expertise.

In short, while I technically got WeWork right, in a big picture sense I got it wrong, and painfully, that error had a lot more to do with hubris than anything. On the bright side, I am very humbled by the experience, and perhaps my familiarity with hubris leaves more qualified to talk about this episode than I thought!

Zuckerberg in Congress

From the Wall Street Journal:

Facebook Inc. CEO Mark Zuckerberg vowed to move ahead with plans to create a cryptocurrency-based payments network despite strong opposition from some lawmakers, sounding a note of defiance in a hearing where he and the social-media giant were pressed over issues of trust and credibility.

The harsh tone of questioning by members of the House Financial Services Committee on Wednesday illustrates Facebook’s delicate position. Mr. Zuckerberg and other company executives remain eager to enter new areas of growth and launch new products like Libra. But three years after the 2016 election exposed the platform’s vulnerability to abuse, many lawmakers are increasingly uneasy about the company’s ambitions.

At the risk of hubris (😉), I thought the high-level takeaway from this hearing was the confirmation of a couple of points I made about Libra over the summer.

First, in this Daily Update, I wrote:

There are, though, also huge costs for Facebook, at least if the company is the one leading the effort: note the huge amount of interest Libra has aroused in countries around the world, from both regulators and politicians. Sure, Facebook has had the attention of regulators and politicians for a while, but the truth is that this has been attention with no point of leverage: as I noted in Tech and Antitrust, Facebook, for all of its problems, is not really doing anything illegal from a competitive standpoint. Yes, there are major questions about privacy, and certainly many would like to undo the Instagram and WhatsApp acquisitions, but at the end of the day Facebook is successful because lots of people find utility in it.

This is not to say that Facebook isn’t problematic, particularly when it comes to the distribution of information. Information, though, is speech, and particularly in the United States that is an area that government simply can’t interfere with. However, that is not the case when it comes to money: governments all over the world, including the United States, have both an interest and the capability of heavily regulating the flow of money, and not only should Facebook expect attention because of this fact, it should expect particularly heavy scrutiny as governments finally have something about the company to latch onto.

To put it another way, not only should Facebook expect compliance costs when it comes to the Libra ecosystem, it should expect compliance costs broadly borne as a company, and I could very much see those costs overwhelming the expected value of the benefit Libra might provide.

This cost was clearly seen in yesterday’s hearings, particularly from the Democrats (but not solely). Zuckerberg was asked about all kinds of non-Libra issues, including discrimination, child sexual abuse material, disinformation, foreign interference in elections, policing politician ads, alleged censorship of conservatives, etc. I highly doubt Zuckerberg wanted to be put on the spot by Congress about all of these issues, but there he was, because Libra gives Congress a lever.

Second was a point I made after David Marcus testified in Congress:

What Libra is pushing to the surface is that tension I mentioned above: Internet companies think of the world as borderless, because the Internet is borderless; lawmakers think of the world in terms of nation-states, because they are the governing officials of nation states.

The U.S. government has until recently been ok with turning a blind eye to this tension, largely because most of the dominant Internet companies were U.S. companies…There is also the fact that the Internet has been primarily concerned with information, which in the United States is nearly completely protected from government interference because of the First Amendment. That is certainly not the case with money, on the other hand, and U.S. lawmakers — on both sides — seemed intent on reminding Facebook of this fact.

This was a talking point primarily from Republicans, and I think a very valid one: what precisely is the benefit to the United States of a currency that is based in Switzerland and ultimately out of the reach of American control? Sure, the U.S. can regulate Facebook, but Facebook is insisting it does not control Libra. Why, then, would the U.S. not try to stop Libra from launching?

I continue to believe that Facebook outsmarted themselves here: the company is primarily concerned with competing with Chinese tech companies in places like Southeast Asia, and it is wary of Facebook’s reputation weighing down a digital currency, so it attempted to create something it could claim was independent of Facebook yet accrue to Facebook’s benefit. Instead it has a proposed currency that is much less efficient and harder to use than a theoretical Facebook currency, an unwieldy governance structure, and, for its troubles, massive amounts of government scrutiny. I think it’s time to let Libra go.

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