WeWork’s S-1 is a Hot Mess
Forgive the clickbait title, but it’s kinda undeniable. Last week WeWork submitted an S-1 filing to the SEC, a step every company must take when it intends to go public (aka sell shares on the stock market). In an S-1, a company provides information for investors to use when deciding whether or not to buy their stock offering (read more about IPO’s in our IPO primer). There’s been no shortage of discussions of WeWork’s S-1 in the blogosphere this week, from the high-level theoretical to the hot take. I won’t add another post summarizing the document, but will share why I, personally, will not be buying into WeWork’s IPO. Nothing against the company (I’m writing this in their Soho location in NYC as we speak) but for me, a non-professional investor with limited time to devote to understanding companies, WeWork is far too complicated and uncertain, and their S-1 did little to add clarity. In a future post, we’ll discuss whether IPOs in general are a good idea for retail investors… stay tuned.
S-1’s are interesting (to me, at least) because companies that were previously private, and subject to speculation about their internals, now disclose all kinds of juicy information to the public. Reading through the S-1 in it’s entirety, I found myself at various points baffled, and without a clear picture of We’s prospects for the future. I’m reminded of Warren Buffet’s maxim to “never invest in a company you cannot understand”. Here’s a few reasons why I think WeWork is too complicated to invest in at IPO.
Their corporate structure is convoluted
The above diagram is taken directly from WeWork’s S-1 filing. It’s a simplified version of their organizational structure. Now, they may have a very good reason for having such a structure, but I find it difficult to understand. Just figuring out how cash flows through this labyrinth to the company I would be investing in, The We Company at the top, is a daunting task.
WeWork recognizes two risks arising from this corporate structure in their S-1. The first one is that The We Company relies on its subsidiaries to provide it with “distributions”, or give it money, to do things like pay bills, taxes and dividends. Fair enough, I suppose. But, the subsidiaries The We Company relies on to provide it money are themselves taking on lots of debt from big banks, which comes with restrictions to mitigate the risk its lenders face. If for some reason those restrictions prohibit it from moving cash over to The We Company (perhaps because it has to pay the banks first) The We Company might be in some trouble. I don’t think this risk is too serious, but it adds complexity.
The second risk WeWork notes is a regulatory one associated with a law called the Investment Company Act of 1940. Delving into this one is beyond the scope of this post, and frankly a bit boring, but if you’re interested you can read more about it here by searching for “Risks Relating to Our Organizational Structure”.
Their locations require as much cash to run as they bring in
If you’ve read anything at all about WeWork in the past week or so, you already know they lose a lot of money. That’s not unusual for high-profile VC-backed IPOs in 2019 (in fact, making money would be an anomaly). When a business with high upfront costs (like renovating buildings), high customer acquisition costs (marketing and high-touch sales), and longish-term recurring revenues payable over the life of the customer, is investing heavily in growth, losses are expected. However, one thing jumps out at me. WeWork’s revenue and their “location operating expenses”, or how much it actually costs to run their locations, are pretty close to equal.
In the first 6 months of 2019, WeWork made $1.5B in revenue from its locations, and spent $1.2B running them; in other words it has a 20% margin there. That’s pretty good, after all that leaves $300M¹. It’s not tech company margins, but when compared to 3 years ago when they had a <1% margin on operating locations, it’s a nice improvement. But hold on — this is purely the costs of operating the locations. It doesn’t include the substantial pre-opening costs, sales and marketing costs, and costs of running their business. Once you take all that in your end up with WeWork spending about $1.45 to make $1 this year. My concern isn’t so much the losses, but rather that the losses stem from the relatively fixed costs of actually running their locations. What this means is to reach profitability WeWork will need to either increase its revenue per location, or decrease the cost of running its locations. They can almost certainly do the latter. Location operating costs have been declining as a percentage of revenue every year since 2016. Though cutting costs too much may adversely affect their product offering and thus their brand/revenues. It’s unclear if they can do the former.
Almost 90% of their revenues come from membership fees, with ancillary services (printers, conference rooms) making up the rest. Perhaps they could increase membership fees (they do offer a lot of upfront discounts) or add more services to get more revenue per member. However, there’s no indication of that occurring yet and I believe the majority of WeWork members are quite price sensitive. In fact, revenue per member has declined for the past three years. WeWork attributes this decline to two factors; their expansion into international markets with “different pricing structures” (I think this means lower prices) and upfront discounts to attract new members. They don’t disclose what proportion of the revenue decline is attributable to each factor.
Their unit economics are really hard to figure out
By unit economics, I mean how much revenue they make per member and how much it costs to serve those members. Both of these are highly variable, which makes it difficult to get a clear financial picture of the business. Unlike, say, an iPhone which Apple can manufacture millions of at a well known cost and sell at the exact same price all across America, it’s unclear the costs associated with a WeWork “workstation” and the revenue that can be attained from that workstation. This makes cashflows difficult to predict, particularly in the early and high-growth stage the company is currently in.
While we can calculate the average revenue and cost per subscription, this average smooths out a lot of the noise associated with different countries, different membership types (enterprise vs freelancer), and different maturity of locations. WeWork claims they will benefit from economies of scale in a given market where they cluster many locations, as well as lower costs as their buildings reach maturity and require less investment. There is evidence of this, but from the S-1 I can’t determine exactly how significant they are, or how the cash flows change over the life of a location. As such, the financial prospects and exactly how cash flows through the company during its operations is very unclear. In short, it’s a tough business to understand.
None of this should be taken as a knock against WeWork. I think the company has revolutionized commercial rentals, and plan to stay a customer as our company grows, perhaps forever. That said, I’m taking a wait and see approach on the investment decision.
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[1] This is roughly what WeWork refers to as their “contribution margin” — a non-GAAP measure that refers to their revenue from locations, minus their cost of running those locations, and also minus “non-cash stock-based compensation” in those locations (aka stock options granted to the employees running their locations).
