Asia start-ups: The SoftBank effect

The $627 million investment in Indian e-commerce marketplace Snapdeal last October was significant for two reasons: it was the second-largest venture capital round the country had ever seen (rival Flipkart raised $1 billion three months earlier); and it marked the start of SoftBank Corp's latest spending binge.

A second India deal was announced the same day. SoftBank led a $210 million Series D round of funding for taxi-booking platform Ola, with participation from Tiger Global Management. The investments were accompanied by a pledge from the cash-rich Japanese technology conglomerate that it would sink as much as $10 billion into India's fast-growing IT, communications and e-commerce sectors.

The Snapdeal and Ola transactions were made through SoftBank Internet and Media Inc. (SIMI), a new entity set up to identify and execute technology investments for the Japanese company. It is headed by Google veteran Nikesh Arora who was tempted away from the US search giant last July. Despite the headline-grabbing $10 billion pledge, SIMI's remit extends beyond India. So far it has committed approximately $1.87 billion and has also been active in China, Indonesia and Malaysia.

To understand the reasoning behind SoftBank's recent investments one need only look back to an event that took place four weeks prior to the Snapdeal transaction: Alibaba Group raised $25 billion in the world's largest-ever IPO. The stock soared on its first day of trading, valuing the e-commerce business at $231 billion. SoftBank initially invested $20 million in Alibaba in 2000 and its 32% stake is now valued at around $82 billion.

On the back this success, it appears that SoftBank - now with more resources at its disposal - is looking to tap into the next big tech trend, perhaps even recreating its success with Alibaba. But how does the recent spate of investments tie into the company's long-term ambitions, and perhaps more importantly, can it realize them?

"What SoftBank is looking for are online businesses that generate real money and have real money coming through them - where it is not just an advertising-based model, but a transaction-based model," says Neil Juggins, a partner with research firm Ji-Asia, who tracks the SoftBank. "Alibaba has proved that its business model can generate money, so SoftBank has gone into Snapdeal and Tokopedia because they are two companies very much within that model."

The golden goose

Clues to SoftBank's broader strategy can be found in the exhortations of its founder, Masayoshi Son. In the six-month earnings presentation given to investors in December, Son's message was simple: "SoftBank = Goose." By drawing upon Aesop's fable about the goose that laid the golden the egg he sought to explain that investments in companies like Alibaba, US internet giant Yahoo and games developer Gung Ho represent massive windfalls - and SoftBank has plenty more to offer.

Comparing SoftBank's market capitalization to the value of its holdings gives an indication of the sheer size of these eggs. The three most significant assets in which the company has a controlling stake - Yahoo! Japan, Gung Ho, and Sprint - are worth $41 billion. Add in the Alibaba interest and the total sails past the listed entity's $75 billion capitalization.

"One would have to say he has been the best investor in the internet age - he has a vision that goes back 20 years, looking at where the internet was going to hit," says Gary Rieschel, founding managing partner with Qiming Ventures, who formally worked for SoftBank Venture Capital. "Sometimes he has been spectacularly wrong but when he has been right, no-one has been righter."

It is perhaps no exaggeration to say that Son's vision for the last 20 years has been for SoftBank to become the largest technology company in the world, at least, if not the largest company in the world, period. Even in the company's earliest years, Son pinned his colors to the mast. Within the first 15 years, after SoftBank established itself as a software distributor, its tentacles were reaching out into several sectors including communication, events and financial services. With the creation of Yahoo! Japan in 1996 internet services joined the portfolio.

It wasn't until 2004, 23 years after the company was founded, that SoftBank entered the industry to which it is most readily associated by purchasing Japan Telecom. Since then the company has evolved from a little-known upstart, competing against the incumbents such as the formerly state-owned NTT Docomo, into a market leader.

The crowning glory came in mid-2013 when SoftBank acquired its US counterpart Sprint Nextel for $21.6 billion. But becoming a global telecommunications leader is not an end in itself, but a platform from which to support further growth.

"Son is quite serious when he says he is setting up SoftBank to be a 300-year-old company and he is laying the foundations for that," says Oliver Matthew, a senior research analyst at CLSA. "He does not see SoftBank merely as a telecoms company."

In addition to making acquisitions, Son fueled the company's early ambitions by setting up several venture capital entities. In many cases these were set up either as joint ventures with other firms or raised capital from third-party investors. SoftBank Asia Infrastructure Fund - the forerunner to SAIF Partners - was formed in 2001 in collaboration with Cisco. US-based SoftBank Capital, SoftBank Ventures Korea, SoftBank China Venture Capital, and later iterations of SAIF Partners all cultivated their own LP bases.

The strategy has given SoftBank the ability to tap external sources of capital and expertise and allowed the company to broaden its investment activities. At the same time, it has presented opportunities to seek out synergies between businesses within the group and portfolio companies.

There are, however, two principal limitations to this approach. First, deal size is ultimately capped by the size of the funds from which investments are made. Second, traditional private equity and venture capital vehicles are obliged to exit businesses after a relatively short holding period in order to return capital to LPs.
While the funds have arguably given SoftBank access to a greater number of start-ups with fewer resources, they have restrained its impulse to bet big and bet long.

"In the mid-to-late 1990s SoftBank experienced rolling periods of boom and bust in terms of cash positions, so sometimes the company had money to execute on its strategy and sometimes the VC funds would go out and raise institutional money to support the strategy," says Qiming's Reischel. "There was a strategic benefit even through SoftBank couldn't put up all the cash."

Balance sheet behemoth

SIMI is the product of a different age. The unit essentially invests off the company's balance sheet and Reischel describes it as what Son wanted to do all along if sufficient resources had been at his disposal. The likes of SoftBank Capital and SoftBank Ventures Korea tend to focus on early rounds for start-ups in their respective regions, committing small amounts for periods dictated by the life of their funds. This is not the case with SIMI.

"SIMI's investments tend to focus on larger growth-stage companies, and they have a strategic component and with a longer time horizon," explains a spokesman with SoftBank Corp. "SIMI's investments are global -they are not limited to any particular region, but Asia is an area of focus due to the tremendous opportunities for growth that can now be found there."

The spokesman adds that earlier fund investments still complement SIMI's activities. For example, SoftBank Ventures Korea made a small investment in Indonesian online marketplace Tokopedia in mid-2013 before SIMI led its $100 million round last October. Nevertheless, SIMI's strategy is more specific in the kinds of companies it is targeting.

With the exception of Housing.com, an Indian property portal that received $90 million in December, all of SIMI's investments have fallen into one of two buckets. Tokopedia is an e-commerce market leader in Indonesia, just like Snapdeal in India; both have realistic ambitions to become as dominant in the B2C space as Alibaba has in China. Then there are the three taxi-booking platforms - Ola in India, GrabTaxi in Southeast Asia and Kuadi Dache in China - that are leveraging mobile technology to disrupt existing industries.

"I believe Masayoshi and Nikesh have come to a fundamental belief that things like shared economy, transportation, and on-demand services will be the main mega trend now," says Jixun Foo, managing partner with GGV Capital. "So they are betting on what they believe is the category winner in each region."

Ji-Asia's Juggins goes further, suggesting the investments in Ola, GrabTaxi and Kuadi are not just about taxi-booking but also distribution and logistics. By building a stable of Alibaba-type businesses and combining it with a potentially very strong distribution network - similar to the way US car-ordering start-up Uber has branched out into logistics with Uber Cargo - SoftBank has the makings of an e-commerce infrastructure to compete with the likes of Amazon.

SoftBank differs from Amazon, of course, in that it is neither owner nor operator of these assets; the company is building an e-commerce ecosystem of minority stakes. It typically seeks to buy a 30-40% stake in the businesses in which it invests, enough to have a say in what the company is doing but not necessarily assuming the role of ultimate decision maker. With the exception of Sprint in the US, all of the company's control deals have been in Japan.

"SoftBank are likely to look at whether they have the resources to run a business themselves; if they have faith that the management can do a better job, they will let them run it," Juggins says. "I think they are realistic about what they can and can't do when it comes to investing in these businesses."

As SoftBank pursues this strategy it is worth noting that the company has joined a growing roster of large ticket players coming into late-stage VC deals. In this sense, the approach has been facilitated by a general trend among young tech companies to spend longer under private ownership rather than rush towards a public listing. Plenty of capital is willing to back these businesses - which have already established themselves as market leaders - and valuations have risen steadily.

Industry participants would rather blame public market investors dipping into pre-IPO rounds for additional alpha than SoftBank for contributing to this trend.

"With the arrival of hedge funds valuations have gone up a little bit but all of that can only be put in the context of the exit," says Vani Kola, co-founder of Kalaari Capital, an early Snapdeal backer. "In hindsight if you look at what SoftBank has done with its investments in terms of value creation, the valuations represent good value."

The SoftBank network

Much of this value creation comes with the synergies that SoftBank is able to find with existing portfolio companies. According to CSLA's Matthew, this comes in two different forms: hard synergies, for example offering start-ups access to customers and technology; and soft synergies, such as providing expertise, advice and mentoring.

Kola stresses that the Snapdeal team has benefited from both SoftBank's experiences with Alibaba and its international network. This gives credence to the argument that the Japanese tech giant's presence reduces the amount of time it takes for a start-up to gain traction, develop its products, build market share, and raise subsequent rounds. Many argue that this snowball effect means market winners can be identified earlier.

"Masayoshi Son thinks long-term about how different aspects of the things he is involved in can be put together," says Qiming's Rieschel. "There is no question that if he invests in a company in India, plus its equivalent in China, they will wind up with some kind of synergy. He is very strategic and he always thinks about how can leverage the assets he has to bring them together in some way."

The caveat is that if SoftBank becomes as big as its ambitions suggest, will it still be able to bring all of its operational expertise to bear? Not everybody thinks scale will be an issue - least of all Son himself. He tends to target fast-growing companies and well-run businesses where management can be left to its own devices. If a business goes wrong, Son will either look to sell out or bring in new management. Taking the latter course of action depends on his level of influence in the boardroom and the strategic importance of the company.

The big question is what happens if Son - who is 57 - is no longer in charge. Ji-Asia's Juggins notes that building a company of such size requires enormous passion and drive. He thinks it is unlikely that a company with minority stakes in more than 1,000 businesses could survive in that form under different leadership.

So where does that leave SoftBank in the medium term? For the time being, telecommunications will still form the backbone of the group. While SoftBank might not identify itself as a sector specialist, this is the one business in which it has a direct relationship with a customer base. For all the other investments, someone else is doing the billing.

"I don't think it is out of the question that they would go for a another telecoms business, but if they try to do that now before they have definitively turned the corner with Sprint, we think they would get punished for it," says Juggins. "They would be biting off more than they can chew."

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• Topics
• North Asia
• Greater China
• South Asia
• Southeast Asia
• Venture
• Technology
• Expansion
• China
• Japan
• India
• Venture
• SoftBank Capital
• Southeast Asia
• TMT
• Growth capital
• Qiming Venture Partners
• GGV Capital
• Kalaari Capital