SoftBank should flex its muscle: Flipkart buys Snapdeal or the deal snaps

The Masayoshi Son led SoftBank is in a boardroom battle to save its investment in Snapdeal, which is well known to us all. Softbank has invested $900 million which is 12 times more than the combined investment of Nexus and Kalaari ($77 million), of which Kalaari has already cashed out $100 million so the investment from SoftBank is infinitely bigger.

Despite the excruciating circumstances at Snapdeal, Kalaari and Nexus are locking horns with SoftBank to keep the company from being sold to Flipkart. Neither of the two funds would want to invest hundreds of millions to save Snapdeal and neither can they justify an investment (if they could make it) at a $6.5 billion valuation. 
The media paints a picture that SoftBank is trying to convince Kalaari and Nexus to allow the sale. However, situation is quite dire for the two smaller funds (in comparison to Softbank) since the exit valuation is between 10-15% of Snapdeal’s last round valuation.  

If the sale were to go through, the markdown in valuation would be devastating for both funds. Their investments would essentially be writeoffs (explained below) and the promised returns they have shared with their LPs would be cut drastically. This will affect any current or future fund raises the two funds would make so it cannot be held against them to protect their markups, even though their strategy hurts Snapdeal.  

What would you do if you were in Softbank’s shoes? 

First I’d try to rally the board and make sure everyone was convinced on the course for the company. But only to the extent that the two funds weren’t trying to bat for their existence by playing on Softbank’s generosity and patience. However, if push comes to shove I’d present these options to the two VCs: 

Option 1:  Flipkart buys Snapdeal for $1 billion with Softbank backing the deal

Consequence: SoftBank will invoke its anti-dilution clause and will own 90% of the company.

Result: Kalaari and Nexus get nothing. 

Option 2:  SoftBank lets Snapdeal die

Consequence

1. Snapdeal’s core business has FY16 losses of Rs. 2960 crores on revenues of Rs. 1457 crores so it is essentially bankrupt without a fresh round of financing.

2. Snapdeal shuts down and starts liquidating, at which point Softbank invokes their liquidation preference to recover $900 million.

3. Softbank gets first charge on all the cash that remains in the company’s coffers after paying its debts and selling its assets.

4. Incase Softbank’s liquidation preference is more than 1x (very likely) then Nexus and Kalaari will be even worse off.

5. Can or will Nexus and Kalaari take that gamble?

a. It is unlikely that Snapdeal’s liquidation yields over $1.5 billion in cash to pay off its debts, employees, SoftBank (and its liquidation preference) and still have enough left to return money to them

b. The bigger question is whether there would be enough cash left (incase there is cash left) to payback principal – unlikely

c. Whether it provide them a few multiples – even less likely!

d. The founders, of course, liquidate last

6. Freecharge, Unicommerce and Vulcan can easily fetch $300-500 million but it will all go to Softbank’s wallet due to its liquidation preference.

7. SoftBank can use that cash, add another billion and infuse it into Flipkart at a $5-6 billion valuation to take 20-30% of the largest Indian ecommerce firm.

Result: Nexus and Kalaari get nothing.

Upside for SoftBank: They can negotiate better investments terms with Flipkart in return for letting Snapdeal die (instead of being acquired) since IMHO Flipkart would be happier keeping its books clean than taking over the mess at Snapdeal.

Option 3: SoftBank will take a haircut on their investment and own 33-50% of the markdown entity thereby losing ~$450-600 million.

Consequence: Kalaari and Nexus would get $80m and $100m in shares of Flipkart as they own 8% & 10% equity (respectively) in the billion-dollar sale.

Result: Nexus & Kalaari protect their principal investments from being written off*

I am sure that the infinitely more intelligent minds at Nexus and Kalaari have already figured out these scenarios but Softbank displaying the muscle they have in this fiasco should help prodding them in doing the right thing i.e. sell Snapdeal to Flipkart before the deal snaps.

*(Whether the funds would see cash from owning Flipkart stock is a different question but let’s keep that for another post.)