Is WeWork too big to fail?
The We company, parent of the better known WeWork, just pulled out their IPO but ensured that it will happen before the end of this year. WeWork was created less than 10 years ago and is now the single largest office tenant in the US, valued at $47B after raising close to $14,2B in 9 investment rounds! Get used to the billion dollar notation as this will be common throughout the analysis. This valuation is 20 times higher than the coworking stalwart IWG plc public valuation, a direct competitor. We can hear the CEO, Adam Neumann, talking about “one of the fastest physical expansions seen in the last 10 years”. Today, it is present in 485 locations and has more than 466k members, with customers such as Airbnb, GE, and Viacom, which proves one critical point for any company — product market fit.
WeWork is here to revolutionize the way people work, creating communities through new coworking spaces with beer on tap in an office-as-a-service business model. The ultimate vision is to build a platform that joins together work, living, education and banking, spaces where they are tapping in right now. The reality of today creates a doubt in investors and analysts about what Wired states as an overvalued real estate company or a misunderstood tech company. The argument from WeWork is that its data-driven approach is what enables the sale of a range of products and services beyond desk space, which could become the ultimate advantage against the uncertain future of real estate.
The hard truth is that WeWork lost more money than Uber last year, very close to $2B. And while in Uber’s case if no one uses the app tomorrow Uber doesn’t have to pay all their drivers, WeWork has hundreds of owned and long term leased offices, meaning huge financial obligations — calculated as at the end of June in $47B. This is called asset-liability duration mismatch, where WeWork obtains real estate using long-term contracts (which have a long duration of liability) and rents properties through short-term contracts (which have short duration of revenue-generating assets). This feature is typical of many real estate–based businesses, such as hotels.
WeWork is indeed growing super fast, following the tech startup playbook, a strategy that private markets have been quite receptive. But now that these companies are going public, the public investors are showing a different attitude towards this growth at all cost as they want to see a path to profitability, something that WeWork desn’t really have. One example of this demand of the public markets is Uber, its market cap is close to $58.5B today, while it went public at $82.4B after successive forecasts from important investors in the startup ecosystem of values ranging from $100B to $120B.
Why not focus on just growth now and go public later?
Company structure, shares structure and the relationship with the CEO
I will not touch hard on these topics but I will leave a very brief point for each one as it appears to me that these are all red flags to bear in mind in the deal. The company structure is extremely complex for its size, usually not a good sign. Its shares structure is just not friendly to new investors, both Class B and C have 20 votes per share against 1 vote per share in class A, stock that the underwriters (us) have the option to purchase. This is very similar to what Facebook presented back in the day. There is also a very significant amount of strange movements between Adam Neumann and the company. Between buying properties that were later leased to the compay, loans that Neumann received with extremely low interest rates and credits borrowed against some of his own stock, not sure what is the worst indicator.
This is one of those classical examples of top line growth fueled by bottom line losses. The growth is amazing for the scale — always a bit above 100% in the last two years! I would say that this is an acceptable strategy for a startup in a scale up stage with a very big potential market and the threat of incumbent companies with deep pockets. But in my view this hyper growth strategy at scale is a double down bet: it is incredibly heavy resource consuming to keep it but people usually forget that fighting the inertia to change to a more sustainable approach will probably consume as much resources. To understand the magnitude of what we are talking about here, per each $ that WeWork bring in revenue they loose almost a $.
Its full-year net losses jumped from about $900m to $1.9bn in 2018. For the first six months of 2019, net losses grew again, from $723m to $904m, even though revenues doubled from $764m to $1.54bn.
An important aspect of tech companies are gross margins because their fixed direct costs of offering their services are usually fairly low. This ensures that there is substantial fuel to other critical parts of these businesses, such as sales and marketing and research and development. For us to have a benchmark, let’s take google parent Alphabet, its gross profit margin was 56% of its sales last year. In the documentation of WeWork there isn’t a such a line in the income statements. Nevertheless let’s use a proxy such as “location operating expenses”. Those expenses include the costs it incurs to operate and maintain the spaces it rents to its members and related costs, such as insurance on those spaces. Last year, the portion of its revenue it had left over after such costs were only 16%. We can see that is it increasing to close to 20%, still very far from what is expected from a tech company at this stage.
WeWork has raised close to $14.2B, mostly from SoftBank. The prospectus for the IPO states that WeWork is now raising $1B, a number to test the market as the real expectation is to raise a multiple of that. In the documentation is also stated that there is a commitment letter for a new senior secured credit facility providing up to $6B signed with more than 10 banks, including Goldman Sachs and JPMorgan.
Big part of the WeWork hype comes from its through the roof valuations. The last round with SoftBank, the Japanese giant, in January this year raised it to $47B, which is close to 20 times revenue, an absurd multiplier for a low margin, high risk liability, non tech business. Today, the market is pushing it down to a number as low as $10B. This was its valuation four rounds ago, June 2015! So the real question is: do WeWork and SoftBank really believe on a significantly higher valuation or are they aware of the much higher probability of a down round? I’m betting on the second one. If we assume that, was the last round an attempt to push the valuation so high that a down round today would be interesting anyway? And why would they even want this down round?
WeWork is clearly in a hyper growth stage, with a rate a little above 100%, which at their size is very impressive! Nevertheless this growth comes with ever increasing huge bottom line losses. Adding to that, its gross margin is quite low and it is not clear what could be the turning point for them there. This is another good indicator to help state the idea that we are not in a presence of a tech company but really a real state one. In truth, there is clearly a product market fit and I can honestly see, far in the horizon, a possible amazon effect if they could pull off such a platform. The problem is the path chosen to achieve that.
I don’t think that WeWork has a path to sustainability and, while the private market is still wiling to accept or to thrive on that, public markets are showing a different attitude towards this phenomenon, which, in my view, will force significantly down the valuation of the company.
We all know that we are already late in our economic cycle, a recession is just outside the door. I can already feel the tension in the markets, so anything can really trigger the inevitable. I hope that the bubble that in 2008 was in the real state and investment banking sectors doesn’t transfer itself to the startup world.
Answering the question that I raised above: why not focus on just growth now and go public later?
There are two main reasons. One, when you are burning $2B a year there are very few private investors with the capacity to write the kind of checks that SoftBank does, meaning that the public market could be a last resource. Secondly, it gives me the impression that WeWork is racing to escape this potential recession in a global slowdown scenario, as their model is far from recession proof. Actually they can vanished pretty quickly in a severe recession scenario.