The next LTCM, the next Lehman Brothers

I think I know what’s going to cause the next financial panic.

Or at least, who’s going to be hit hardest when it comes.

If it doesn’t cause it, it’ll be the first and largest victim.

I’ll tell you why in a moment. Just allow me to set the scene.

A while back I wrote in another publication, Capital and Conflict, about Long-Term Capital Management, the hedge fund that blew up in 1998. It nearly took the whole of Wall St with it.

It was so confident that it used crazy amounts of leverage to boost its returns.

Thanks to its star traders, academics, and Nobel Prize winners, it felt its models were infallible, that they could model away risk through risk management and diversification.

But the balloon that keeps having air pumped into it will eventually pop.

The higher the pedestal, the further the fall.

The higher the leverage, the finer the margins.

It didn’t take much for the tide to turn against LTCM, but when it did, the excess leverage that had been its source of power in the good times, became the cause of its rapid, terrifying downfall.

So grave was the risk to the global financial markets that the Federal Reserve was forced to step in. The Fed got all the banking chiefs of Wall Street into a room for a weekend, and convinced them to stump up nearly $4 billion in cash to bail out the fund.

What’s the moral of the story?

Markets are not predictable. What goes up must come down. Leverage is a friend in the good times, and a foe in the bad.

I wondered, in my article, whether there was another LTCM out there.

Quick quiz

Let’s play a game, based on this viral cricketing meme:

(That’s supposed to read “he CAME to mind” by the way.)

That’s Pat Cummins, the Australian world number one bowler who has just put England’s finest batsmen to the sword. A truly special bowler.

Right, so you get the concept, let’s have a go at our own version.

After the longest bull market on record, surely some foolhardy group, too young or too foolish to have learned the lessons of LTCM, is taking on huge debt in order to maximise their returns from investing in the best performers of the last decade?

I didn’t say a name, but you thought of them, didn’t you?

I think the next crash is going to involve the SoftBank Vision Fund in some major way.

The Vision Fund

Taking on massive debt? Tick.

Investing in past winners? Tick.

Growing so large that it threatens the whole financial system? Tick.

Doubling down? Tick.

It’s the largest investor in most of the highly optimistic, futuristic, trendy startups coming out of Silicon Valley.

It’s the largest investor in Uber.

Flipkart, Nvidia, Slack are on the list too…

It’s borrowed heaps of money to fund all of these rather hopeful, dotcom bubble-style companies.

And it’s funny I should mention that (no it’s not funny I did it on purpose) because Masayoshi Son, the man pictured and the CEO of SoftBank, lost $70 billion when the dotcom bubble burst.

SoftBank’s stock went down by 93%.

His, SoftBank’s, and the Vision Fund’s primary belief is in investing in companies that might change the world in just a couple of decades.

That’s an honourable goal, something we all dream of doing. It’s like hitting a six in cricket, or a home run in baseball. Doing it once would be a good achievement.

But no good cricketers try and hit every ball for six, and I’m no baseball man but my impression is that there are very few home runs in a game, and the smart strategy involves bunting and stealing and other ways of getting round the bases.

Now imagine that not only is a foolhardy opening batsman going to try and hit every ball for six, but he’s also borrowed a couple billion dollars and bet on himself being successful.

That, in essence, is what Masayoshi Son and the Vision Fund have done.

And they’re now raising money for a second Vision Fund. Extraordinary.

How many times have you seen the “this is how much you would’ve made if you’d bought Apple in 2000” headline. Or Amazon, Microsoft, whoever.

The reality is that very, very few people did, and to be perfectly frank, many of them will have just been lucky.

Nassim Taleb warns us not to be fooled by randomness – and I know all early investors will protest that they had the vision and foresight to see great things ahead. But really, there are millions of investors investing in thousands of companies and pure chance dictates that some of those must invest in those stock in their early years.

Masayoshi Son and co are trying to beat chance and randomness. They are trying to hit 50 home runs in an innings. And they don’t even have Ben Stokes on the board of directors…

I see a lot of parallels with Long-Term Capital Management. Arrogance, leverage, and a total misunderstanding of risk.

Both ignore the herd mentality of investors. Herding is a behavioural trait in all of humans – Daniel Kahneman and Amos Tversky have shown us that.

It’s especially prevalent in investing.

LTCM suffered because once one of its trades went kaput, all investors in similar trades feared that the trend would spread, and bolted all at once.

What the Vision Fund, amazingly, seems not to see is that although during the boom years, investors, are happy to invest in these growth tech stocks which promise to change the world in a decade. This has made their valuations soar, especially relative to earnings of which there are often very few.

But should one domino fall, should one tree catch fire in the woods, investors will flee and the whole forest will burn.

Folk wisdom has taught children not to put all their eggs in one basket since time immemorial.

It’s a lesson Masayoshi Son would do well to learn.

The trigger

LTCM’s troubles began when Russia defaulted on its debts in 1998. That triggered a de-risking sell-off in emerging markets, all off which caused LTCM to lose money – lots of it.

If Russia was LTCM’s white whale, what will SoftBank’s be?


SoftBank, believe it or not, is the largest investor in WeWork.

Lease long, rent short – genius plan! Well, not quite…

WeWork recently published its prospectus. It plans to hold an initial public offering, an IPO.

This is because it needs to raise money.

The reaction from investors has been pretty negative. The management structure is complex. The CEO has all the characteristics of a greedy charlatan, or a fool.

By leasing long and renting short, the company can make a margin, by charging more to companies per year than it pays on an annualised basis for its long-term lease.

That’s not too different from banks, which make their money in the margin between lending and borrowing.

So what’s the problem?

There’s your first clue. While investors can understand that by taking on a huge number of long leases in order to rent them out for shorter periods requires high upfront costs, the extent of the losses is truly staggering.

In the good ol’ days, such a company would have had to grow out slowly, using its profits to buy new buildings. But not in what may one day be called “Draghi’s Decade”.

If at first you don’t succeed, try and try and try and try and try again – that seems to have been the mantra of central bankers and policymakers since the financial crisis.

Interest rates at record lows have made debt so cheap that young, investable chaps (charlatans) like Adam Neumann and Elon Musk could cheerily raise funds to fuel their own pet projects.

Rockets to Mars? Great, go ahead, and take an extra billion just in case why don’t you, Elon.

In the environment, WeWork has expanded incredibly fast. Its debts are enormous. Debt? Who cares! Certainly not Adam Neumann.

And then there’s other problems.

The company lent him money, with which to buy commercial properties, which he then leases back to his own company to use as offices. Seems legit. 

The idea of the company is to lease out properties for 15 years or so, and then rent out the space to companies on shorter time horizons – a year usually.

Well just picture this. Imagine that in recent memory there was an example of a time when things don’t go to plan, and businesses shrink from paying for swanky offices with beanbags, music in the corridors and the odd free Heineken. God forbid.

My point is that WeWork is locked in to large, 15-year payments. But its tenants are only obliged to stay for one.

Any turbulence or downturn, and all of WeWork’s tenants have much more flexibility to back out than it does itself.

Counterparty risk, that’s called. And it’s a biggie in this case.

I hear a protest forming.

Oh Lordy, who is this stuffy fool, and why is he so stuck in the past, can’t he see that things have changed, I hear you saying.

Fine, I’m not definitely right about this. And as a business there is a lot to be said for it conceptually. I think that’s how Microsoft dominated the cloud computing space – by racking up huge losses for a bit to secure the servers required to be the field leader – and then monetising it later. Fine.

But this article is not about WeWork entirely, it’s about SoftBank’s Vision Fund.

The fund invested in WeWork again in its last funding round. That particular round valued the company at around $47 billion.

Since the prospectus though, rumour has been floating around that because of the negative reaction, it might only target a $20 billion valuation at IPO.

Well so what, a casual observer might think, if they are only thinking about WeWork.

But we are looking at the bigger picture.

What would such a huge downgrade in valuation do to the Vision Fund?

Well it would cut the value of its TEN BILLION DOLLAR stake in WeWork by more than half.

A five or six billion write-down.

The shockwave of such a big fall in valuation for a tech stock growth darling wouldn’t just damage the Vision Fund’s balance sheet.

It would affect investor confidence too. It would dent the Vision Fund’s reputation. If it got WeWork wrong, what else has it been wrong about, people might ask. What if everyone’s been wrong about this sector?

What if Netflix isn’t all it’s cracked up to be, they might think. What if Disney and Comcast pulling their shows from the platform and starting their own is actually bad for Netflix, and Netflix just becomes a content provider like anyone else – rather than the global streaming monolith we all thought it would become? Crikey, better sell…

And boy, noble cause all that saving the environment stuff. But Tesla’s valued the same as Ford and GM and doesn’t have 10% as many sales. And wow, would you look at those losses. Margins are shrinking too. Where’s that fleet of robo-Tesla-taxis that Elon promised us? The Solar Roofs, pick-up trucks, autonomous driving? He couldn’t have… he wouldn’t have… misled us?? Blimey, better sell…

And so it begins.

SoftBank’s Vision Fund is the biggest, most indebted, least diversified punter out there. And all its eggs are in a particularly fragile basket, perched on an awfully high pedestal.

Tread carefully…

Kit Winder
Investment Analyst, Southbank Investment Research

PS The last two headlines I’ve seen on this theme have been roughly – “SoftBank urges WeWork to shelve IPO”, and ‘WeWork wants to curb voting power to push through IPO”. Buckle up, folks!

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