THE OLD-OLD THING
by Eric J. Fry 07:00 AM 04|02|2001
Softbank Corp. is a new-economy company that became a tech-bubble darling. But when it came to its investment in Urban Media, Softbank resorted to some very old tactics. Of course, pulling the plug wasn't nice, but do we detect a whiff of desperation in the air?
Urban Media had national sales offices, logo-emblazoned polo shirts for its enthusiastic employees and big plans. New-economy big plans. The broadband company even had a luxury skybox in San Francisco's PacBell Park, purchased from Willie Mays. And then, just like that, it was over. In late January, the company's venture-capital backers, led by Softbank, yanked their remaining millions out of Urban Media, abruptly unemploying some 500 people in the process. Advance warning? None. Severance provided? None. Welcome to the new economy! "We were just beginning to live up to our promise," said one Urban Media insider, but "Softbank caused us to hit the wall. Five hundred employees were gone, and not one of them expected it." As the Internet bust unfolds, Softbank's withdrawal from the Palo Alto, Calif.-based Urban Media is noteworthy for being both startlingly callous and utterly desperate. Only the desperation is understandable.
Softbank founder Masayoshi Son, the quintessential new-economy capitalist, elicited admiration and envy by parlaying a well-timed bet on the venture-stage Yahoo! into an Internet juggernaut with -- momentarily -- a $199 billion market cap. It was a marvel to watch the Japanese house of cards under construction. Flush with his Yahoo! paper profits, Son offloaded Softbank's profitable, if prosaic, old-line businesses to chase after other Yahoos. The company's rapid success inspired legions of imitators. Let's hope that none imitates the archetype's use of human capital. Indeed, to Softbank's storied history must now be added a new chapter: "Employees -- a Disposable Commodity." For all its high-tech sheen, the company's treatment of Urban Media employees seems utterly Dickensian.
First, some background. We have not admired Softbank for some time. On Oct. 29, 1999, a Grant's publication was disbelieving of the Internet titan's business plan and warned against its extreme valuation. We remarked on the then-ascendant Softbank: "In a world in which Martha Stewart Living (MSO) is worth $1.5 billion and the World Wrestling Federation (WWFE) is worth $1.6 billion, perhaps there is no reason why Softbank should not be worth each and every one of the dollars comprising its $41.3 billion market capitalization. In the kind of world envisioned by the authors of 'Dow 36,000,' Softbank would no doubt be the very stock to own. It is the quintessential stock for this particular phase of this particular global tech-stock bull market. [But] its continuing success is, in a word, contingent . . . because Softbank has, of its own choosing, abandoned the relative security and certitude of positive cash flow to seek Internet riches (the kind that don't throw off cash -- at least not yet). . . . Thus, Softbank is no longer an operating company. The self-anointed "Net-batsu" has, by design, become one part holding company, one part venture capital fund. It is an Internet Berkshire Hathaway, without those really neat annual meetings in Omaha. . . ."
In 1998 and 1999, the investment world lauded such reckless speculation as savvy and forward-looking. And as markets make opinions, so the opinion made was that Son possessed a genius rivaling that of Warren Buffett. Come the bust, Son's Softbank appears to be neither savvy nor forward-looking. The final chapter is not yet written, of course, and Softbank is still a visible force in the Internet world. Witness Cisco's recent agreement to kick in a cool $1 billion to a new $5 billion VC fund that Softbank will commandeer. (Funny that Cisco can still afford to gamble $1 billion on Asian Internet ventures, and also consider launching a share-repurchase program, even as it lays off 17% of its workforce.) The fund aims to make "concentrated investments in promising ventures handling broadband or next-generation wireless technologies. . .," reported the Nikkei Weekly. But so what? Wasn't Urban Media also a promising "next-generation" venture once upon a time?
Urban Media once described itself as the "premier provider of broadband business services to small and medium-sized businesses." The company's plan consisted of contracting with landlords to wire office buildings with fiber-optic cable. In vintage Internet-speak, Urban Media founder Sean Dougherty proclaimed early last year, "Our model is comm [communications] plus dot.com -- winning customers with free broadband and upselling phone and data services." Internet historians might remember Dougherty as the founder of @Home, which was sold to Excite on May 28, 1999, for $6.7 billion. Thus, Urban Media could boast impeccable Internet bloodlines and an impressive roster of VC backers. As an Urban Media press release proclaimed four months ago, "Founded in 1999 by visionaries from @Home Network, UrbanMedia is backed by the technology sector's most prestigious investors, including Accel Partners, Comdisco Ventures, Softbank Venture Capital, Tyco Ventures and Western Technology Investment."
In short, there was nothing not to like, Internet-wise, about Urban Media, and Softbank, as they say on California beaches, was "all over it." Upon leading a $25 million investment in Urban Media early last year, Gary Rieschel, executive managing director of Softbank Venture Capital and Urban Media board member, gushed, "We love Urban Media's strategy and intend to leverage our strong Internet portfolio to help support their development." Four months later, a Forbes story found Rieschel beaming about Urban Media: "With broadband on every desk, the opportunity to sell is monstrous. . . . What's going to differentiate the players is what they put through those pipes. . . . [Softbank's stakes in] a hundred-odd companies like Yahoo and Biztro [will help]." The Forbes story also noted that Urban Media was "trolling for $1 billion more [funding] over the next year." Weren't we all.
Softbank maintained sufficient enthusiasm for Urban Media to lead a $57 million financing round (about $5 million per Internet buzzword) just last December. But shortly afterward, Softbank et al. reversed course and pulled their money. "Look, the bottom line is that Softbank was a major sponsor of Urban Media. They were having their own portfolio problems, which caused them to pull the plug on us," our source said. "They gave Urban Media 24-hour notice. That gave us just days to find a buyer, contact customers and make other arrangements, and you just can't do that in this market." One shocked regional sales manager with whom we spoke added: "We were the guys with money. It's unbelievable. One moment we're talking about merging with other parties, the next we're closed. Just like that." What provision did the company or its VC backers make for employee severance and/or job placement? we asked. "None," he answered. "Softbank and Tyco simply gathered up their toys and went home." Former Urban Media vice president Mark Davis concurred: "Softbank did nothing. They did nothing to take care of our employees."
Incredulous, we phoned Softbank Venture Capital to get its side of the story. Rieschel obliged. "We didn't continue with the financing [of Urban Media] because we did not believe we could raise enough capital to get to breakeven in the current environment," he explained. But Rieschel denies Softbank's responsibility for the human consequences of its withdrawal. "The timing of the decision and how it was executed was not a Softbank matter," he asserted, "but one for the entire board of which we are a minority holder."
In light of Rieschel's response, is it Softbank's fault that 500-plus people lost their jobs without warning and without severance? Maybe not. But to recast the question, would it have been possible to extend one or two weeks severance pay to Urban Media employees, even as Softbank withdrew funding? Probably so. Even as a minority shareholder, the influential Softbank certainly had an audible voice on the board. Perhaps we should applaud Softbank's resolve to preserve capital no matter the human cost. But so extreme is this "prudence" that it smacks of desperation. Certainly, desperation -- if that's what it is -- would be understandable.
Softbank's operating earnings are disappearing, forcing the company to rely increasingly on realized gains from its VC portfolio. Back in 1997, when Softbank's operations included the likes of disk-drive maker Kingston Technologies and the publisher Ziff-Davis, EBITDA totaled 52.2 billion yen ($413.7 million) on respectable EBITDA margins of 14.5%. But once those operations were sold, the Internet powerhouse's operating earnings totaled a mere 8.2 billion yen ($65 million) for the first six months of fiscal 2000, as its EBITDA margin collapsed to 4.5%. Not surprisingly, therefore, the company is vaporizing cash -- from 40 billion yen ($317 million) of positive cash flow from operations in 1997 to a negative 79.2 billion yen ($627.7 million) in the first six months of 2000 alone. However, investment gains of 78.9 billion yen ($625.3 million) saved the day, reducing the negative cash flow for the six months to less than one billion yen ($7.9 million).
Without such recurring "nonrecurring" gains, Softbank's balance sheet is no picture of health. EBITDA minus cap-ex no longer covers interest expense. Furthermore, the well of investment gains is running dry. For example, the value of its Yahoo! holding alone atrophied from $18.9 billion in March 2000 to $10.7 billion six months later. And today, assuming that no shares were sold in the interim, that value would be only $1.6 billion. Even more troubling, the quoted component of Softbank's investment portfolio is melting even faster than the polar ice caps. Specifically, since 1998, the long-term investment line on the balance sheet has grown nearly sixfold, but investments having a "quotable market value" have decreased dramatically. The result is that, as of March 2000, only 3.4 billion ($26.9 million) of Softbank's 221.4 billion-yen ($1.8 billion) investment line had a quotable market value. Given that the balance of the investment line -- all 218 billion yen ($1.7 billion) of it -- is unquoted, what value might these investments now possess? It's impossible to say for sure, and the company's not telling just yet. But it is possible to speculate. The Nasdaq has fallen 63% since last March, and the IPO window has all but slammed shut for venture-stage tech companies. Perhaps, therefore, these investments in aggregate would fetch something far less than 218 billion yen if sold today. Furthermore, investments without quotes are most often investments without liquidity -- a not-unimportant consideration for a company that, as of Sept. 30, 2000, had 436 billion yen ($3.5 billion) in debt and only a paltry six billion yen ($47.6 million) of net current assets.
All in all, it's not a great time to be a Net-batsu. And yet, despite the company's fading financials, a minimum level of human consideration would still seem to be in order. Certainly, Softbank is entitled -- if not obligated to its own shareholders -- to seek the highest possible return on its capital, including the human kind. By the same token, though, the Urban Media employees were entitled to something more than a kick in the end zone on their way out after laboring to help Softbank, Tyco Ventures and the other VCs generate a return on their investment. A former employee, speaking on condition of anonymity, asked rhetorically, "Since when does severance, even in entrepreneurial circles, consist of 'f--- you for your efforts. Try not to spend any more company money on your way out the door?'" Good question. We have another one: Is this Net-batsu worth even $13.4 billion?
©MM Grant's Investor, Inc.
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