EVERY COMMERCIAL cycle, short of puff, reveals problems that seem obvious in hindsight. Twenty years ago, when the stock markets crashed, accounting frauds were exposed at Enron, an energy trading company, and WorldCom, a telecommunications company. Less spectacular were the revelations that many companies had cut back or acted recklessly. The actions of the titanic bosses ruling over General Electric and Vivendi, a French media group, ended up hampering them for decades. After 2008, it was revealed that the Wall Street emperors wore no clothes, with Lehman Brothers, Merrill Lynch and others crumbling under the weight of the huge losses and giant egos of their bosses.
It is not easy to guess where the uplifting tale of tomorrow might be. But investors looking to avoid explosions should pay close attention to the stocks, companies and bosses that encapsulate the current boom. One area of ââfinancial risk is the booming high yield debt market, where underwriting standards have fallen. In the corporate world, the main contender for a governance conflagration is the tech industry.
One of the reasons is the lingering exuberance for anything that smacks of tech. The recession caused by covid-19 has been a hammer blow to many parts of the global economy. But a side effect of the pandemic has been to supercharge Silicon Valley and its various offshoots, amplifying an already unprecedented bull run. All kinds of sins, from questionable bookkeeping to imperious leadership behavior, tend to be overlooked in good times. As Warren Buffett noted, it’s only when the tide goes out that you can see who has been swimming naked.
Another reason to watch technology is the plentiful funding of risky companies. Investors desperate for yield have shoveled money into companies with high valuations, but whose prospects are far from proven. Didi Chuxing, a Chinese rideshare company, could well receive a valuation of more than $ 100 billion in an upcoming stock sale, despite cumulative losses of $ 13 billion. More rum has added to the punch with the proliferation of ad hoc acquisition companies, or SPACs, which are listed pots of money intended to merge with private companies.
The last reason to be wary of tech companies is their bosses. Dotcoms and their corporate cousins ââare often still run by their founders. Many of them have majority stakes, thanks to inflated voting rights. These entrepreneurs tend to have a messianic confidence in their own abilities and a fortune to match. The intoxicating potion of control, wealth, and self-confidence can cause bosses to dismiss all criticism and see rules as things for others.
One company that highlights all of these concerns is SoftBank. The world’s largest technology investor, with a market value of over $ 120 billion, it has helped fuel the current turmoil. Some of his bets, including Didi and Coupang, a South Korean e-commerce champion, have been big hits. But in addition to sustaining some successes and its inevitable share of setbacks, the Japanese company has also become mired in companies like Greensill, a UK lender that collapsed earlier this year; WeWork, a struggling office business; and Wirecard, a fraudulent German fintech company.
This raises questions about how SoftBank itself is performed. Although it is a sprawling business, the business is best viewed as the Masa Lounge, where all the big decisions are made by its founder and boss, Son Masayoshi. This includes how to allocate tons of capital – the company currently spends over $ 200 million a week supporting businesses.
Risk control within the company is uneven. Its internal hedge fund, once dubbed the “Nasdaq Whale”, rocked the markets last year, sending the shares of various companies crazy. The company has changed so many times that analysts admit to having trouble understanding what is going on there. Transactions between the company, its funds, its managers and its subsidiaries can create risks of conflicts of interest.
SoftBank is not alone. Corporate governance is certainly questionable in other tech companies as well. Disclosure is patchy at best. In big tech companies, it’s much less demanding than in big banks: Facebook’s annual report is 129 pages, compared to 398 at JPMorgan Chase. This week, executives at Lordstown Motors, an electric vehicle start-up, resigned after the company made inaccurate disclosures. These dual-class shareholding structures often leave enthusiastic founders in control.
In technology, activist investors have relatively little influence. Their arrival would go some way to improving corporate governance standards by subjecting management to more rigorous scrutiny (as Elliott did at SoftBank). In their absence, shareholders and conventional creditors must be vigilant. At low tide, as it will someday, investors who paid the most attention during the dizzying boom days will be rewarded. â
This article appeared in the Leaders section of the print edition under the title “The Benefits of Foresight”