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Softbank-backed Oyo’s China operations are on the brink of collapse with worrying implications for private equity investors

Oyo has perhaps been given a dose of reality and has been forced to curb their ambitions to be the world’s largest hotel chain by 2023. Despite rapid growth, their aspirations appear to be normalizing after a backlash from disgruntled hotel owners, widening year-after-year losses, and perhaps a tightening fundraising landscape.

 

Already in 2020, they have cut as many as 2,000 jobs in India, fired more than a third of it’s US staff, and laid off more in the UK after it’s decided to remove more than 1,000 hotels from it’s platform across more than 200 cities globally.

 

Company insiders report that Oyo was in trouble even before COVID-19 broke out - losing a whopping two-third of their Model 1.0 hotel partners as reduced bookings, fall-outs with existing hotel partners, and an unclear value proposition mark a huge reversal in their fotunes.

 

It’s not unique to Oyo or Softbank but rather a reality check for private investors that business models must be credible and show a path to sustained profitability if they want to avoid taking losses on their exits.

 

Recent IPOs and private market deals have shown that investor appetite towards premium priced “growth at any cost” business models where the path to future profitably is dubious is starting to wear thin. Investors are starting to shun loss-making IPO following a dismal 2019 for the likes of Peloton, Smiledirect.com, Uber, Lyft and of course WeWorks' failed listing. Poor performing share prices on those companies that were also loss making is proving a difficult hurdle to overcome for the likes of Casper Sleep who have recently had to slash their IPO valuation, taking a fairly substantial haircut from their last private funding round. Take for example Lyft. It IPO’ed at $24 billion in March 2019. Since then however the market cap has fallen to less than $14.5 billion.

 

Softbank’s speculative investments in WeWork and Oyo are both free cash flow negative and experiencing accelerating or widening losses due to sky-high valuations and exceptional topline growth that is only possible because of the irrational market environment we find ourselves in in 2020.

 

Venture capital and private equity AUM has boomed in the last 10 years. Data compiled by Woozle Research suggests that the number of assets under management in the private market is north of $5.75 trillion dollars in 2020 with about two fifths of that amount sitting in cash.

 

Negative real interest rates, weak active manager returns in public markets, cheap debt, and the search for yield has fueled phenomenal growth in private market fundraising by approximately 70% in the last two years, going from an estimated $3.4 trillion dollars in 2018 to an estimated $5.75 trillion in 2020 according to data compiled by Woozle Research.

 

Rather than being symptomatic of Softbank, private market valuations and deal multiples have steadily increased in each of the last 4 years as investors search for returns in a low or negative interest bearing world. Since the financial crisis, ultra-low interest rates have made fixed income assets particularly unattractive while a record long bull run in public markets has failed to match the returns of investments in the private market.

 

Against that backdrop, we’re increasingly seeing long-term pension funds and insurance companies struggling to close long-term asset and liability gaps leaving them with no alternative but to increase allocations to private equity.

 

Whereas the average deal multiple for private company transactions was priced at approximately 9.6 times EBITDA in 2015, that figure now stands at around 12.1 in 2019 as a glut of capital chases fewer opportunities.

 

The real story behind Oyo, WeWork and Softbank in my view is this. Recent IPOs in 2010 have performed dismally and this has knocked public equity market confidence in sky-high private market valuations that are coming to market, illustrated by the failed WeWork IPO. The private markets valued WeWork at around $46 billion but the company still wasn’t able to list publicly even at a valuation cut of more than half to less than $20 billion before it was finally pulled.

 

This has resulted in negative investment sentiment, sizeable and arguably growing valuation gaps, a divergence between business fundamentals and market prices, and reduced investor appetite that is making it harder and harder for private equity funds like Softbank to exit deals at favourable valuations. We are in the midst of a serious asset bubble in private markets and a change in interest rates or risk sentiment might dampen private equity returns for many years to come.

 

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