WeWork, Softbank and the Loss Aversion Dilemma
by Zach Marsh on Nov 22, 2019
Last week, in this note, we discussed the behavioral tendency of hindsight bias and offered a couple simple models to combat it. We believe that a pre-designed “model” is the pathway to improving decision making and avoiding the pitfalls of cognitive biases. Models, or pre-determined actionable steps are necessary because the danger of most cognitive biases is that you cannot think yourself out of them. After all, its tough to reason yourself out of something that your reasoning got you into. Posing an additional challenge—now, this is my opinion--the “smarter” we are, the more difficult the cognitive flaws become to escape. Like a strong gravitational force, our advanced rationalization skills allow us to construct a better developed and believable narrative. This intricately woven narrative allows us to become even more entrenched and certain about our flawed decision.
Investing is the great petri dish where cognitive flaws are cultivated, grown and harvested. Even smart investors are not immune from making bad decisions. The best traders and investors are the ones who build models and algorithms and never break them. Some of these algorithms are intricate computer models, some are simpler pre-written rules to be adhered. Additionally, employing a team approach, with open and frank discussions, egos abandoned, works well for some of the most successful hedge funds and investment firms—Bridgewater Associates, Renaissance Technologies, Berkshire Hathaway, to name a few. Each of these firms employs various levels of models to arrest cognition problems and achieve smarter decision making.
One investment firm that either discarded its models, or never had any to begin with is Softbank, a Japanese venture capital fund. Softbank, who’s business model is to investment money in private companies with outsized growth potential, invested nearly $11 billion in WeWork, a workspace/office rental company. WeWork CEO Adam Neumann marketed his company, an office/workspace rental company, as a technology company designed to “re-invent” the workplace. Positioned, not as a property management company, but as a future-driven technology company, valuations for WeWork exploded, pushed even higher by Softbank’s $11 billion injection in January. However, those valuations wouldn’t last. After a failed IPO launch last month, the WeWork’s valuation plummeted from $47 billion in January to nearly roughly $5 billion in October. Causing massive losses for Softbank.
How did this epic collapse happen under the watch of a “titan” of private equity investment? Well it turns out no one is immune to snake oil salesmen. Mr. Neumann’s charisma was enough to charm Mr. Son and convince him that WeWork was more than just a simple office property company, like Regus, but rather an innovative disruptor like Uber or Facebook. In a November 6 Wall Street Journal article, Mr. Son said, “My own investment judgement was really bad. I regret it in many ways.” The article went onto say that “Mr. Son said he had been too enamored of Mr. Neumann’s positive qualities and turned a blind eye to negatives, including governance problems.”
Mr. Son’s comment is fascinating on so many levels and helps us see how bad decision making evolves. Mr. Son was taken in by Mr. Neumann’s charm, causing him to look past items that would normally have been red flags for his investments. While it seems easy to fault Mr. Son for being gullible, who among us hasn’t also been deceived by a smooth talker. However, Mr. Son’s true fault was not having a better model in place to protect against these types of decision errors. One model would’ve been to have a committee in place as a sounding board for investment decisions, with others in the committee having had no personal contact with Mr. Neumann. Being blind to Neumann’s charm the others could’ve provided a more reasoned case against the investment.
I wish I could say that was the end of the story for Softbank’s WeWork failure, but alas the saga continues, proving there are 101 ways to lose money. WeWork’s failed IPO in October subjected it to a cash crunch. The company needed the money raised from the public offering to pay its debts and the loss of those public funds threw the company’s survivability into question. Rather than watch all of his $11 billion investment disappear, Mr. Son tossed another $9.5 billion into the company in order to prevent it from going bankrupt, bringing his total investment in WeWork to nearly $20 billion. At present, WeWork’s bond prices have fallen like a rock, casting further doubt on the survivability of the company even with Softbank’s most recent cash injection.
Mr. Son, by throwing additional money at WeWork, committed the cardinal sin of investing, averaging a loser—or becoming loss averse. Instead of taking his $11 billion loss he now owns the entire company, worth perhaps $0 for a purchase price of $20 billion. But Mr. Son’s behavior is not uncommon in investor psychology. You buy a stock for $100; it is now trading $75. You liked it at $100 now you love it at $75, but that is a bad way of viewing it. If you bought 100 shares at each price you now own $17,500 worth of a stock that is valued at $15,000. You’ll feel justified if it goes back up, but what if it goes to $50? Do you buy even more?
Conversely, if you waited for a stock you bought for $100 to trade for $115 before buying more then your average price is less that the current price, $107.5 vs $115. By waiting to average a winning investment you’ve created a model whereby you aren’t letting your original loss cloud your decision making. It is questionable if WeWork would’ve been able to find funding had Softbank not stepped in. By not pushing more money into the company it is likely that his original investment would’ve gone to $0, but that is where model thinking and algorithmic processing can be helpful.
Investment decision making is so emotional that without a model we are doomed to fail. Investing for a goal, such as retirement only makes those emotions more prevalent. One model many employ, whether they realize it or not, is using an advisor to manage their money. Simply turning the decision making over to another person, who is less emotionally attached to the money, permits decisions that are less clouded by behavioral biases. At Calibrate Wealth we are strong advocates of model investing and employing algorithms to manage our client’s money.
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 Wall Street Journal, “SoftBank Founder Calls His Judgment ‘Really Bad’ After $4.7 Billion WeWork Hit” November 6, 2019