Oyo’s China collapse threatens Vision Fund returns

The rate of Oyo’s demise in China is dizzying. No sooner had TechNode reported a 60% reduction in Oyo’s China workforce, local news outlet Jiemian broke news of a further 3,000-head layoff. That brings the cull to 72% of Oyo’s China workforce. 

Despite being a glorified real estate company, Oyo is a consumer internet company.

The only silver lining for SoftBank, Oyo’s biggest backer, is that it has just enough cash in the kitty to paper over an Oyo-sized hole on its balance sheet.

Favorite Son

While Oyo certainly isn’t SoftBank’s largest investment, it’s reported that Oyo ranks among SoftBank CEO Masayoshi Son’s favorite portfolio companies. SoftBank’s Vision Fund has invested in 91 companies, including household names like Uber, Grab, Nvidia, and Bytedance. 

The initial spark has turned into a steady flow of capital.

Among that all-star cast, Oyo has received special treatment. Masayoshi Son was said to be charmed by Oyo founder Ritesh Agarwal and his business model—improving fallow assets, giving budget hotels a makeover, and improving search and booking efficiency. A former Masayoshi Son favorite, Jack Ma, created a $146 billion windfall for Softbank.

The initial spark has turned into a steady flow of capital. To fuel Oyo’s expansion in India, SoftBank led Oyo’s Series B ($100 million), its Series C ($90 million), and its Series D ($250 million). SoftBank opened its coffers further and led two later funding rounds worth a combined $2.8 billion to help Oyo export its model to overseas markets. Masayoshi Son has encouraged and enabled Agarwal to try and crack China, the US, the UK, and Japan at the same time—a feat no other consumer-focused digital platform has attempted. 

It’s no secret that the Vision Fund’s recent track record has raised eyebrows.

With reversals in each of those markets, this plan looks to have backfired. With the latest layoffs from China added in, Oyo has slashed more than 8,000 jobs since June 2019. That’s around three times the number of employees WeWork let go after it imploded in the lead-up to its IPO. 

Black and red

It’s no secret that the Vision Fund’s recent track record has raised eyebrows. Its portfolio companies Uber and Slack quickly shed market capitalization following respective IPOs in May and June 2019. Those selloffs made it hard for SoftBank to cleanly sell its stakes and head for the exit. A few months later, WeWork’s aborted IPO precipitated multi-billion dollar losses and sharpened questions around SoftBank’s go-hard-or-go-home strategy. An avalanche of smaller failures followed. Wag, CloudMinds, Rappi, Getaround, Zume and a handful of other bad ideas with too much SoftBank capital have adjusted their valuations or shed staff in the last few months. 

SoftBank has so far made a $10 billion profit from its Vision Fund investments.

However, despite the Nelson Muntz-style pointing-and-laughing, the Vision Fund has still delivered positive returns. Well, kind of.

Last month, the Vision Fund disclosed an operating loss of 225 billion yen (about $2.05 billion) for October-December, compared with a 176 billion yen profit in the same period a year earlier. The most favorable read-through suggests that, even taking into account some of SoftBank’s financial engineering and accounting wizardry, it’s so far made a $10 billion profit from its Vision Fund investments.

So what impact could Oyo’s downfall have on the Vision Fund’s profit pool? 

In the context of the $100 billion Vision Fund, SoftBank placing a multi-billion dollar bet on India’s largest hotel chain probably passes the sniff test. But look a little closer, and the smell gets slightly more iffy.

Despite being a glorified real estate company, for SoftBank’s purposes, Oyo is a consumer internet company. To date, SoftBank estimates the fair value of Vision Fund investments in the consumer internet sector is $15.8 billion. Analysts reckon anywhere between 20% and 33% of that figure can be attributed to SoftBank’s investment in Oyo. Masayoshi Son has bet big on his favorite portfolio company.

Even-handed analysis suggests SoftBank’s track record in the Middle Kingdom remains largely intact. 

Currently, it’s highly questionable whether that bet is anywhere near paying off. Overseas expansion is estimated to have lifted Oyo’s valuation five-fold, so SoftBank wouldn’t be pleased with pullbacks and reversals in markets like China, the US, and Japan. Capitulation in Oyo’s second-largest market, China, means the company’s current $10 billion valuation looks like a pipe dream.

As Oyo attempts to pull itself from the brink of a WeWork-esque meltdown, SoftBank is keeping a careful eye on the damage bill. Tactical retreat from a couple of overseas markets and consolidation in India might be enough to salvage SoftBank’s investment. But, if Oyo gets outwitted and outplayed in India, SoftBank could be starting into financial black hole. 

Clued-in China investments

The nature of venture capital investing lends itself to spectacular successes and equally spectacular failures. The “Venture Capital Power Law” suggests 6% of deals make 60% of returns, and over 50% of deals won’t ever come near a return. 

Although Oyo’s fortunes in China have indeed flopped, even-handed analysis suggests SoftBank’s track record in the Middle Kingdom remains largely intact. 

Outside of its part-stroke-of-luck-part-stroke-of-genius investment in Alibaba, SoftBank’s Vision Fund deserves credit for decisive investments in Didi, Bytedance, SenseTime, Ping’An Good Doctor, and Alibaba’s local services investment vehicle. These investments will bear fruit, with profits likely harvested for SoftBank’s second Vision Fund. 

Yes, there’s also some poorly thought-out investments there too. Ever heard of OneConnect? Me neither. Would you want to touch China’s cash-burning second-hand vehicle market? Didn’t think so. 

But, those failures matter less than media hype has us believe. Here’s ex-Andressen Horowitz Partner Ben Evans on failure in venture capital:

None of this means that failure is good—failure is horrible and painful for everyone. You’re not supposed to fail. Nor does it mean that doing stupid things is good, nor that screwing up is good. It certainly doesn’t mean that no tech company that failed ever did something stupid or screwed up, nor that no VC has ever made an investment that they shouldn’t have. People screw up in tech all the time. But failure is part of risk, and failing, by itself, does not mean that anyone was stupid, or screwed up.

Venture capital firms get better returns by having more really big hits, not by having fewer failures. Oyo swung the bat in China, hard. It didn’t connect, but SoftBank’s next China-related investment very well just might hit a home run.