Arm’s Length
Arm’s Length
Behind Masayoshi Son’s big bet on Arm's IPO
“I’m the king of debt.” – Masayoshi Son
In July of 2019, news of a most curious transaction in the private market crossed the wires. Shares of OYO, the Indian startup connecting deal-seeking travelers to cheap hotel rooms, traded hands at an eye-watering $10 billion valuation. What caught our attention was who did the buying. We turn to the Wall Street Journal for details:
“The 25-year-old founder of Oyo Hotel & Homes, an India hotel brand, has led a $2 billion share buyback in the company, which has transformed the country’s budget-hotel industry and gone global.
Oyo Chief Executive Ritesh Agarwal is buying part of the shareholdings of early investors Sequoia Capital and Lightspeed Venture Partners. The buyback, which is still subject to shareholder and regulatory approvals, will be through a Cayman Islands company called RA Hospitality Holdings, and financed by institutional banks and finance partners, the company said.”
Styled after Adam Neumann’s WeWork, OYO entered into long-term contracts with hotel operators to book a fixed number of rooms and then worked to fill those rooms with users of its app. This is the functional equivalent of signing long-term office leases and hoping to find enough short-term subletters to pay the bills, a strategy that has long been understood by normal investors to be a particularly dubious one. Although it has since tweaked its model in the aftermath of the Covid-19 crisis, OYO still shares other characteristics with the Neumann version of WeWork. It has a charismatic young founder, it hemorrhages cash at an alarming rate, it is struggling to get its initial public offering (IPO) over the line, and it is primarily backed by SoftBank and its swashbuckling CEO Masayoshi Son. Son is anything but normal.
You might be wondering how a 25-year-old got his hands on $2 billion worth of credit to make a highly speculative bet on his own fledgling startup—an enviable “heads I win, tails you lose” situation for Agarwal. After all, if OYO becomes a smashing success, he achieves outsized gains, but if it fails, the banks will find themselves in quite the pickle. It didn’t take long before the mystery was solved:
“In a highly unusual move, Agarwal, now 26, borrowed $2 billion to buy shares in his own company as the valuation rose, and Son personally guaranteed the loans from financial institutions, including Mizuho Financial Group Inc. Banks may ask for more collateral if Oyo’s valuation drops, and the two men could face personal losses.”
The revelation of Son’s reckless guarantee merits a rather more cynical interpretation of the transaction. Early investors with excellent reputations wanted out of OYO, something that would normally be perceived by the market as a negative sign. Son—who directed both Softbank and the Vision Fund to make major investments in OYO and has pledged significant amounts of his Softbank stock for personal margin loans—likely wanted to avoid triggering any fallout from such news. Through the power of his own signature, the valuation of OYO magically doubled, Sequoia and Lightspeed made a killing, Softbank and the Vision Fund got to mark up their investments twofold, and the circular show went on.
The OYO saga serves to contextualize what many on Wall Street hope will be the most important IPO of the year. Arm Holdings—a UK-based designer of computer chips that Softbank took private in 2016 for $32 billion—might become a publicly traded company once again, thereby potentially providing liquidity to Softbank and desperately needed fees for investment bankers. Son is looking to leverage the wave of excitement around artificial intelligence (AI), especially as he watches Nvidia’s market cap soar past the trillion-dollar mark. Ahead of the main event, Son is up to his old tricks, aggressively using related party transactions to up the ante on Arm’s perceived value. See if you can spot the echoes of OYO:
“SoftBank Group Corp has acquired the 25% stake in Arm Ltd it does not directly own from its Vision Fund unit in a deal that values the chip designer at $64 billion, according to people familiar with the matter. Details of the transaction will be unveiled on Monday when Arm makes public the filing for its blockbuster stock market launch, the sources said, requesting anonymity as these discussions are confidential…
SoftBank is currently in talks to list Arm at a valuation of $60 billion to $70 billion in the IPO, which is expected to happen in September, Reuters has previously reported. SoftBank, which took Arm private for $32 billion in 2016, sold a 25% stake in the company to Vision Fund 1 (VF1) for $8 billion in 2017.”
With the financial world anxiously awaiting the start of Arm’s roadshow in the hopes that Son can reignite the flaccid IPO market, Son has decided that his chip-maker is worth $64 billion because Son agreed to buy a chunk of it from Son for that price. In so doing, Son agreed to pay Son twice what Son sold it to Son for six years earlier.
Just how big of a risk is one of the world’s most notorious gamblers taking by bringing Arm back to market now? The fallout from a flop could impact both private and public markets alike. Let’s do some due diligence of our own.