Boris Johnson's Suspension of Parliament Was Unlawful, U.K. Supreme Court Rules; WeWTF, Part Deux; WeWork's IPO delay threatens SoftBank; Kraft Heinz: Two food giants that haven't gone so well together

By Whitney Tilson

Tuesday, September 24, 2019
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1) I’ve said it before and I’ll say it again: Brexit ain’t gonna happen.

Today’s court ruling is an important step in that direction: Boris Johnson’s Suspension of Parliament Was Unlawful, U.K. Supreme Court Rules. Excerpt:

The British Supreme Court ruled on Tuesday that Prime Minister Boris Johnson illegally suspended Parliament, dealing him another heavy blow and thrusting the nation’s politics into even deeper turmoil, barely a month before Britain is scheduled to leave the European Union.

The unanimous decision, which upheld a ruling from Scotland’s highest civil court, said that the suspension of Parliament until October 14 is void. That means that the lawmakers are still in session and will continue the debate over Brexit that was short-circuited when Mr. Johnson asked the queen to suspend, or prorogue, Parliament for five weeks…

Legal and political analysts had speculated that the court, which has historically avoided politics, might decide that it had no authority to rule on the prime minister’s actions, or might arrive at a mixed judgment.

Instead, it made a landmark decision to intervene in a fierce clash between Mr. Johnson and Parliament, and delivered a resounding defeat for the prime minister and an unequivocal victory to his critics.

Mr. Johnson has suffered an extraordinary string of legal and political defeats since becoming prime minister in July.

2) This article, WeWTF, Part Deux, by Professor Scott Galloway on “The Whee Company,” is incredibly insightful and provocative. Excerpts:

We has gone from unicorn to distressed asset in 30 days. In just seven days, We lost more value than the three biggest losers in the S&P 500 have lost in the last year combined: Macy’s, Nektar Therapeutics, and Kraft Heinz…

As I said two weeks ago, the lines between vision, bullsh*t, and fraud are pretty narrow. I can’t wrap my head around what’s gone on here. Something is wrong. Something stinks. Something … Just. Doesn’t. Add. Up.

It’s beginning to smell like malfeasance at We. The lines between vision, bullsh*t, and fraud have been crossed here. To be clear, I’m not a journalist, nor a forensic accountant. This is pure speculation based on my experience as a CEO, investor, and director. Something is very, very wrong here. In no specific order:…

If you liked the Theranos documentary The Inventor: Out for Blood in Silicon Valley, you’ll love Community-Based EBITDA: The Story of We, coming soon to Hulu.

At some point, tech’s gestalt of overpromise and underdeliver can paint founders into a corner where they begin massaging numbers…

I can see how one gets in too deep and begins believing his or her own bullsh*t, almost as a defense/coping mechanism. I speak from experience: if you tell a thirty-something dude he’s Jesus Christ, he’s inclined to believe you…

How did this happen?

A frothy market coupled with our gross idolatry of innovators creates an ecosystem that enables incremental disingenuous acts such that, if We had gotten public and managed to spend their way out of this hole, they might be lauded as “visionary.” What if Ms. Holmes had been able to raise another $2 billion and the technology had begun to show promise? Wouldn’t she be on Oprah and CNBC, instead of HBO?

We’ve witnessed a halving of journalists since 2008, while the number of corporate communications execs has tripled. In sum, the ratio of bullshit/spin to watchdogs has increased sixfold…

The halcyon of the markets coupled with feckless regulatory bodies and the decimation of investigative journalism has made the markets ripe for fraud. We is falling off the tree.

Predictions:

  • In the next 30 days, a series of explosive investigative journalism pieces will document breathtaking malfeasance at We.
  • In the next 60 days, a state attorney general, SEC, or other regulatory body will launch a formal investigation into We.
  • Over the next 12 months, SoftBank’s Vision Fund will be shuttered.

3) This article on the front page of today’s WSJ certainly reinforces Galloway’s last prediction: What Drove SoftBank’s Vision Fund Up Is Dragging It Down.

I had no idea that 40% of the Vision Fund’s assets – $40 billion! – were preferred stock paying a hefty 7% dividend. Excerpt:

Investors’ sudden skepticism toward pricey, profitless tech companies is threatening SoftBank Group’s Vision Fund, which may take a hit on some of its high-profile investments…

The downturn highlights the risks SoftBank has piled up: The fund effectively borrowed money to make risky investments; it raised and spent its cash in record time, deep into the longest bull market in history; and it took huge stakes in unprofitable companies, making it hard to unload them if their businesses or the market turn down…

By financing much of its assets with what is essentially debt, the Vision Fund has increased its risk. Roughly 40% of the Vision Fund’s capital – $40 billion – is in the form of preferred stock, which promises a return of 7% a year, just like debt. It is unusual for a fund to include preferred shares. SoftBank has retained proceeds from asset sales to ensure it can pay the coupon…

That structure meant that holders of the fund’s roughly $60 billion in common equity – SoftBank and its employees have roughly half of that – get big returns on the way up, but the potential for big losses on the way down…

Already, some of SoftBank’s plans for extracting cash to pay the Vision Fund’s investors are starting to look overly optimistic. SoftBank Chief Executive Masayoshi Son – the mastermind behind the fund – said he is counting on five or six IPOs from its portfolio during the fiscal year ending March 2020, and another 10 the following year. But many of the Vision Fund’s companies are still burning through cash and losing money, something that the public markets may not view favorably, as We’s attempt to list has shown.

Here’s a related Bloomberg article: SoftBank Founder’s Empire Is Vulnerable to WeWork Woes. Excerpt:

Masayoshi Son, who built a $15.2 billion fortune investing in tech startups like Alibaba Group Holding Ltd., is betting on himself more than ever, even as his empire shows signs of vulnerability.

The SoftBank Group Corp. founder has pledged 38% of his stake in the Japanese firm as collateral for personal loans from 19 banks, including Credit Suisse Group AG and Julius Baer Group Ltd., according to a June regulatory filing. That’s up from 36% at the start of the year and triple the level in June 2013.

“It lets him monetize a large share of his wealth without foregoing influence over the firm,” said Michael Puleo, assistant professor of finance at Fairfield University’s Dolan School of Business in Connecticut. “But there’s an elevation of crash risk. If the share price falls low enough, he could get a margin call and that could be pretty costly”…

“There is a danger in companies where the founder calls all the shots regardless of whether there are loans,” said Robert Pozen, a senior lecturer with the MIT Sloan School of Management in Boston. “And when founders borrow a lot against their shares, they might be more tempted to make riskier decisions,” he said, adding that borrowing against 5% of one’s stake is usually considered prudent.

4) Speaking of troubled companies, here’s a story from the front page of the business section of today’s NYT: When Mac & Cheese and Ketchup Don’t Mix: the Kraft Heinz Merger Falters. Excerpt:

In nearly all its deals, 3G’s strategy is fairly simple: Slash expenses, improve profitability and, typically, increase revenues by acquiring other companies. Repeat. The firm’s zero-based budgeting requires managers to justify every expense on an annual basis, not just build on the previous year’s budget. (3G did not respond to a request for comment, and Berkshire Hathaway declined to comment.)

When Kraft and Heinz merged, Bernardo Hees, a Brazilian economist who had led Burger King, became chief executive of the combined company. He told analysts that the merger would yield $1.5 billion in annual cost cuts.

Managers and employees inside Kraft said they had spent long hours and weekends after the deal closed gathering data on everything from expected travel expenses to estimates of how many paper copies their departments would make that year. Those figures were stuffed into voluminous spreadsheets and given to 3G.

That became the foundation for 3G’s cost cutting. Travel for some departments was cut in half. There were no more color printouts of presentations. Office snacks – like the free Kraft cheese and Planters nuts that employees could grab between meetings – were eliminated.

The biggest cuts came in staffing. In August 2015, about a month after the deal closed, Kraft Heinz laid off 2,500 employees, roughly 5 percent of its global work force. That included around 700 people, or about a third of the staff, at Kraft’s headquarters in Northfield, Ill. In November, Kraft Heinz announced plans to shut down seven plants in the United States and Canada, cutting 2,600 more jobs.

From London to Chicago, important responsibilities once divided among multiple employees, like market analysis and negotiations with supermarkets, fell to a single individual or a small group. With each round of layoffs, those who remained became increasingly dispirited, according to former employees. In London, talk of growing discontent at the Kraft Heinz office made it difficult to hire, said a former high-ranking official at that branch, who spoke on the condition of anonymity to discuss internal matters.

Kraft personnel, including some with decades of experience, were replaced by 3G leaders, some of whom had virtually no experience in the consumer packaged goods industry, said Robert Moskow, an analyst at Credit-Suisse who tracks Kraft Heinz.

“In other 3G companies, that strategy injected new energy and a new way of thinking and a way to get rid of sacred cows,” he said. “But it’s a very risky strategy.”

Best regards,

Whitney

Whitney Tilson

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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor's degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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