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The following segment was excerpted from this fund letter.
Softbank Group Holdings (OTCPK:SFTBY).
This past week, we initiated a new short position in Softbank Group Holdings (OTCPK:SFTBY). Softbank’s last hope for liquidity is an IPO of Arm Holdings, a semiconductor design & licensing company. Unfortunately for Softbank, which is riding the tech collapse down with a true loan-to-value ratio of nearly 60%, the inventory correction that’s building in the semiconductor industry could be one for the history books.
Panic ordering of chips in 2021 and the first half of this year has created a significant surplus of chip inventory in nearly every channel. The most constrained channel, that of the automotive supply chain, has fully caught up, and reports of double-ordering of chips is starting to ebb. Inventory channels, as measured by number of days, are roughly 50% above their peak before the last chip correction of 2018, and are more than double levels from two decades ago. At the same time, underlying demand is terribly weak- with personal computer shipments accelerating to the downside recently.
Thus, while we are believers in the digital revolution, as is almost every other human, the inventory correction and loss of pricing power that commodity chip makers are likely about to experience could be particularly brutal.
All of these businesses are in the latter stages of experiencing the “bull-whip” effect. Due to various impacts from Covid-19, whether it be that initial customer demand slowed, or manufacturing slowed due to labor or parts shortages, many industries found themselves to be “under-stocked.” Eventually when demand snapped back, the reverse occurs with companies quickly ordering more goods, often too much, and due to a global economy that is much more reliant on just-in-time supply chains, there were cascading supply chain effects and shortages leading to prices increase.
Extreme moves on the upside have resulted in excessive behaviors that will result in a major snap-back effect, which are most evident today in the retail and apparel industries where suddenly companies are flooded with excess inventory and will need elevated promotions to move product.
We generally are now in the phase of elevated inventory-to-sales ratios, unclogging supply chains and cooling consumer demand, which should lead to lower prices for “core” goods even as food and energy prices remain elevated. While macro-economic indicators like consumer price inflation are hard to predict, if not impossible, taking one industry at a time is a far different process. Each of our shorts are in some “inventory correction” stage and should lead to lower prices and margins. We have no opinion on the direction of CPI, nor the Fed’s reaction to the next inflation print, the two million dollar questions of the day.
But if we look at semiconductor inventories or the container ships order-book, anticipating supply/demand imbalances is quite a bit easier on a micro level. Industry insiders think “this time is different” and in fact, the CEO of Taiwan Semiconductor (TSM) actually used those exact words when talking about its capacity expansion in the current environment. Thus, while the equities have begun their descent, the inventory de-stocking has yet to even start, and we think has downside risks to being particularly brutal, with most industry insiders still optimistic the correction will be mild.
These shorts are helping us maintain our neutral posture to the tech sector even though we have exited our ARKK puts. Using Sir John Templeton’s rule of thumb for the emotional evolution of investing cycles, we don’t believe we are anywhere near the level of “despair” required to start aggressively moving here. Companies like HPQ and Softbank are still propping up their share prices through fairly aggressive buybacks. Although we are spending much more of our time looking at longs in this space, we feel like time is on our side here.
On the other hand, time is running out for Masa, CEO of Softbank, whose considerable personal leverage is causing the company to report dishonest levels of leverage at Softbank. Not only are leverage levels quadruple what Softbank claims they are, but the private portfolio of the Vision Funds is not actually marked to private market transactions. The company recently touted how the private portfolio for the Vision Fund I is still in the black, using its discounted cash-flow and relative valuation methods.
Yet, just marking this portfolio at current secondary trading levels reveals the company has overstated values of this segment of the portfolio by 25%. And that’s on the high-profile and large holdings like ByteDance (BDNCE). Vision Fund II is filled with lower quality and less liquid positions. The notion that these positions are only down 20% this year is hard to make up. Yet, that’s the story Softbank is spinning. Thus, not only is the leverage not ok at Softbank, ringing up today at a 59% LTV, but the assets are not marked to the current reality.
Clearly the first leg of the tech draw-down played out in unprofitable disruptive technology companies. This has largely run its course. But we believe the next leg will take place in private markets. With no further liquidity left to prop up its companies in follow-on equity rounds, Softbank’s holdings look particularly vulnerable. A great example of this is Vision Fund II holding Klarna (KLAR), which recently had to clear its financing without the traditionally ebullient participation of Softbank. The recent follow-on financing took place 85% lower than its prior round.
In conclusion, we believe the lag private markets are experiencing to public markets, combined with a particularly poorly-placed collection of leveraged private tech assets could result in an even worse draw-down for Softbank than the 2000 correction.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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