Internet Warrior On the Defensive
feer.com
Masayoshi Son's Softbank is the world's boldest attempt to create a New Age empire of Internet businesses. But these days Son looks less like a conquering hero, and his empire is a jumble of disparate interests that outsiders find hard to fathom
By Bruce Gilley/HONG KONG, Chester Dawson/TOKYO and Dan Biers/LOS ANGELES
Issue cover-dated November 16, 2000
IF THERE WAS EVER a time when the hopes of a whole generation of entrepreneurs were riding on the fortunes of one company, it is now. The entrepreneurs are the builders of the New Economy. The company is Japan's Internet giant, Softbank Corp. To the builders of the New Economy, Softbank is the dream of a super-connected and super-profitable Internet juggernaut.
Until recently, that dream was alive and well. Softbank and its founder, Masayoshi Son, were the toasts of Asia. When its shares peaked in February, the company was worth $190 billion. Investment bank Lehman Brothers said the figure would double by year's end, making it equivalent to 8% of Japan's GDP.
But today, Softbank has stumbled. The company is worth just $23 billion, and Son, who used to affect a gentle professionalism, is sounding more like a frustrated evangelist: "This is like a religion, OK? You believe in one big theme, no matter whether people understand it or don't understand it," he told the REVIEW in a recent interview.
In the pages that follow, the REVIEW peers deep into Softbank's predicament. It's a story that echoes around the world because few companies anywhere are so heavily and widely committed to the Internet business. Softbank manages about $6 billion through 11 venture-capital funds worldwide, half of it from outside investors. Directly and through its funds, it has stakes in roughly 450 Internet companies globally. In the words of Ronald Fisher, Softbank's main man outside Japan as vice-chairman of U.S.-based Softbank Inc., the company is "the largest and broadest-based participant in the Internet economy." It's also a model for Internet zaibatsu elsewhere, including Hong Kong's Pacific Century CyberWorks and U.S.-based CMGI.
NEED TO FOCUS
The news is not good. A lengthy investigation of Softbank by a team of REVIEW reporters, including interviews with Son and other top Softbank executives, reveals a company pursuing different agendas and at times even groping for direction. Its vast store of Internet-related investments shows few signs of coming together to form the basis of a coherent and durable operating company in the near future. By most estimates, it still makes most of its operating profits from distributing software. Organizational weaknesses and confusion over strategy are partly to blame. So too is Son's penchant for rapid-fire deal-making.
In the meantime, the downturn in Internet stocks worldwide is hampering Softbank's ability to raise money, weakening an already deteriorating balance sheet. Even the California cool of Softbank's U.S. venture-capital head Gary Rieschel doesn't conceal the need for firm action. "People need to have some comfort that someone's got their hand on the tiller," says Rieschel. "Masa has to respond to that."
Softbank isn't the only putative Internet giant struggling with the shortcomings of the broad-brush approach to investing in a tumultuous industry. Besides PCCW and CMGI, other firms like U.S.-based Internet Capital Group have taken a similar approach, and suffered for it. But to varying degrees, companies like CMGI and ICG have already changed course by announcing more-focused strategies and expanded disclosure. Softbank has yet to take up that challenge.
The immediate need, analysts say, is for Softbank to zero in on certain sectors of the Internet rather than try to be all things to all people. Closely related is the need for more disclosure and less hype to attract investors. That could mean putting in place a better financial and organizational structure to replace Son's freewheeling laissez-faire style. If it does these things, Softbank could still realize its dream of "building the global e-future." If not, the corporate upstart could become the largest and most painful disappointment of the Internet age.
"They're stretching themselves too thinly. They need to focus," says Lee Yen Anderson, an analyst with Indosuez W.I. Carr Securities in Tokyo. "Otherwise they'll have to write off a lot of investments and shareholders will never see a profit."
Masayoshi Son's own garage story goes back to his founding of Softbank as a software distributor in Japan in 1981. Nothing much was heard from the company until 1994, when it listed on Japan's over-the-counter market. In the next two years, Son made waves by buying U.S. computer-trade show and publishing concern Ziff-Davis, as well as memory-board maker Kingston Technology. But those investments went badly wrong. Softbank paid roughly $3.5 billion for them, only to sell them a few years later for about $1.7 billion.
Son was saved, however, by his U.S. venture-capital chiefs, who, in 1995, discovered a little-known portal called Yahoo!. Softbank has lived off its spectacularly successful $433 million investments in Yahoo! and its Japanese arm ever since. Its stakes in the companies were worth $13 billion by early November, accounting for more than two-thirds of the value of Softbank's listed holdings.
Softbank has had other successful IPOs, to be sure. These include computer anti-virus specialist Trend Micro in Japan, and telecoms-equipment maker UTStarcom in the United States. It has also successfully brought other branded U.S. companies to Japan such as on-line brokerage E*Trade (see page 67).
But more often than not, Softbank's public offerings have been a flop. Shares in PeoplePC, a much-touted computer-services provider, have fallen to nearly a third of their offer price since its listing in August (see page 68). Its Internet infrastructure listing, Asia Global Crossing, has remained at its already low October offering price. Sure, a lot of Internet IPOs have failed spectacularly in recent times, but Softbank was supposed to be different; it was the apostle of the Internet. By the REVIEW's estimate (Softbank itself wouldn't provide a figure) only a handful of the company's roughly two dozen listed holdings in the U.S. are making money.
"A lot of people think Softbank was lucky, had a great success in Yahoo!, and it is now in the process of losing a lot of money over time," says Fred Hickey, publisher of The High-Tech Strategist, an influential New Hampshire-based investment newsletter.
In the year to March, Softbank's net profits fell by nearly 80% to Yen8.4 billion ($77 million) because of reduced proceeds from sales of venture investments. That figure is expected by Indosuez W.I. Carr Securities to recover to around $120 million this year, mainly on the back of investment-fund management fees and an end to losses at the now-disposed-of Ziff-Davis.
But the bear market, which Softbank U.S. venture chief Rieschel believes could last through 2001, is going to hit Softbank doubly hard. It makes it difficult if not impossible for the company to make listings without significant write-downs. It also means it cannot sell shares in listed holdings without setting off a downward share-price spiral (see page 65).
There are also worries about double taxation. Softbank pays twice on gains from disposals of U.S. shares, once in the U.S. and again in Japan. The rates vary, but on average the company has paid taxes of about 40% on its gains from U.S. venture investments. Taken together, the weak market and the double tax mean that Softbank's $19 billion worth of listed holdings (as of early November) could easily be valued at closer to $4 billion, according to Benjamin Wedmore of HSBC Securities in Tokyo. On that calculation, Softbank's total market value of $23 billion looks generous.
Potential operating losses from its takeover of Nippon Credit Bank also cloud its balance sheet (see page 66). As Commerzbank Securities wrote in an October 10 report that lowered Softbank's rating: "Investing in the parent company carries the risks associated with its unprofitable businesses and the uncertainty surrounding NCB."
Where is Softbank's earnings growth supposed to come from? In theory, Softbank should be making more and more money from the operations of its long-term core holdings. Son and his lieutenants claim they are building an Internet giant to outlast the Roman Empire, not just a big venture-capital outfit. Yet Softbank's operating profits have been falling steadily since 1997. In the year to March, they accounted for just a quarter of pretax profits, down from 100% in 1996, with a large part coming from the company's old-time software-distribution business.
Softbank's long-term goals change so regularly that investors are understandably confused. Son says broadband and business-to-business, or B2B, Internet plays will be the building blocks of the company's long-term future. Other ideas pushed by his U.S. executives include on-line financial services, wireless technology and Internet infrastructure.
Softbank nonetheless owns stakes in some of the key players of these five Internet subsectors (see chart on page 56). In October, it spent $40 million for a 40% stake in the new Japanese arm of U.S.-based e-commerce enabler Ariba. Son calls it one of the most important partnerships Softbank has ever had. Its on-line brokerage, E*Trade Japan, is both profitable and the biggest in Japan. And Asia Global Crossing, despite its poor listing, remains in contention to be one of the region's biggest Internet backbones.
But Softbank has had little success finding long-term operating companies outside Japan. It is in any case questionable whether the five chosen areas are too broad for a company with just six top managers to handle. Additionally, wireless and infrastructure are likely to remain big money-eaters for several years.
CROSS-TALK
Besides that, interviews reveal a lot of internal confusion among Softbank executives about what other sectors the company should be investing in. Rieschel, for example, disparages niche consumer Web sites. "I'm sorry, do you really need 17 companies that you can buy watches from on-line?" he says. But just two days earlier, Softbank's U.S.-based head of international venture capital, Eric Hippeau, talked enthusiastically about Softbank's investment in an on-line diamond company that sells watches over the Net. Softbank's China venture arm, meanwhile, has a stake in a niche site for weddings, 51Marry.
Rieschel also says business-to-business exchanges are out because they can't generate revenues. Yet Junichi Goto, the head of Softbank's Hong Kong arm, says he's building a business-to-business exchange for chemicals on the remains of the dyestuffs company that Softbank acquired to gain a listing in Hong Kong. The exchange, he says, "is going to provide the platform for Softbank's expansion in Asia."
There are also some conflicting investments within the portfolio. China-based B2B exchange Alibaba, for example, held by Softbank's China venture arm, is in direct competition with MeetChina.com, held by its Hong Kong-listed subsidiary. "We're in the process of trying to clarify this conflict," says Chauncey Shey, president of Softbank China Venture Capital. Softbank Inc.'s Fisher acknowledges that the group's long-term direction isn't crystal clear. But he promises that "over the next year you'll see us making some selections" on long-term holdings.
OPAQUE ACCOUNTING STANDARDS
Even with a focused investment strategy, Softbank faces some major organizational challenges. While its promotional literature divides the company into six clear operating units--e-commerce, finance, broadband, media, infrastructure and global investment funds--in practice, there appears to be little in the way of structure.
Unlike CMGI and PCCW, Softbank has no plans to release separate accounts for its operating units or offer shares in them. Son says this is to keep Softbank's taxes down and to allow him greater flexibility without worries about minority shareholders. But HSBC's Wedmore says the real reason is that Softbank simply lacks any clear organization. "They just draw a blue pencil around a different set of boxes," when they restructure, he says.
The lack of internal organization may also explain Softbank's legendary lack of transparency. It took the Review several weeks of fruitless phone calls and a final door-stepping exercise to obtain a copy of the company's annual report. Analysts throw their hands in the air when trying to value the company because of the lack of information. Six months after a three-for-one stock split at the end of April, the company's Web site still hasn't been updated to reflect the development.
The company's accounting practices, meanwhile, are confusing. It doesn't consolidate results from several loss-making companies that it directly or indirectly controls, including Global Sports, a U.S. on-line sales enabler for sporting goods, and the Japan arm of on-line insurance broker InsWeb. Nor does it tell investors which companies produced its operating profits--the results are presented by division only. And Softbank itself doesn't even hazard a guess about what its profits will be in the year ahead.
Son acknowledges the need to open up in terms of meeting media and investment analysts more often. But he argues that Softbank needs to keep a lot of information about its investments out of the public eye. "Our competitors would increase their competing actions if we open up that kind of information too much," he says. As for management, Rieschel says Softbank needs about 30 top-level executives to strategize its future instead of the current six who also manage its diverse portfolio. "It's too thin," he says.
Yet Son appears reluctant to bring in more senior personnel. The reluctance to decentralize may owe partly to the low-key rivalry between Son and the head of Softbank Finance, Yoshitaka Kitao, who has riled Son with critical statements about the viability of Nasdaq Japan and Nippon Credit, both units of Softbank. In October, staffing at the central headquarters was boosted to 50 from just eight as the office took over accounting, financial oversight and legal duties from its subsidiaries, including Softbank Finance.
The way out for Softbank is clear: more disclosure, less hype, a robust corporate organization, and a more focused investing strategy. Those are sobering challenges. Yet rather than confront them head on, Son continues to talk giddily like a fallen rebel, lying across the bloody barricades of a faltering revolution: "Ten, twenty, or thirty years from now people will realize that we were the ones who always talked about the importance of this revolution," he says.
Son may be right about the revolution. The question is whether Softbank will be there to greet the new dawn.
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