Is WeWork’s IPO Premature?
We’ve heard a lot about WeWork’s (or post their re-brand, the We Company) plans to go public as soon as next month. You may have heard that they’re the largest commercial tenant today in cities like New York and London. You may have heard that their revenues are growing 100% year-on-year.
However, while WeWork’s office decor certainly looks glamorous, I have concerns with their business model, traction and risks should the economy turn bearish. Here’s why I believe WeWork’s IPO could premature.
The WeWork Business Model — and its Pitfalls
WeWork at its core makes money by leasing large prime-real estate buildings, sprucing it up its décor with its signature glass walls and coffee rooms, and in turn leasing the space out. The way this model works is the timing mismatch between these leases. WeWork signs relatively cheap long-term leases and in turn leases it out with more expensive, short-term ones. The idea is that individuals and companies don’t want to be “tied down” with long-term leases, so using WeWork’s “space-as-a-service” subscription model affords them greater flexibility to move in and out seamlessly.
WeWork gets the buildings with leases that last around 15 years, on average. On the flip side though, the lifetime of its average customers is a small fraction of that — 15 months. This reduces a lot of the certainty surrounding WeWork’s revenues. Its 100% YoY top-line growth over the past few years makes sense as the economy was strong.
However, with instances of slowing global economic growth at every turn, risks abound. Existing corporate tenants may downsize and entrepreneurs may be reluctant to found new ventures in a slow economy. This decreased demand could substantially hurt WeWork’s revenue.
This hypothesis is supported by WeWork’s latest occupancy rates. As we saw the first signs of the economy slowing in the latter half of 2018, we saw their occupancy dip from 84% to 80% at the end of Q4 2018.
Soaring Valuation, Mounting Losses
WeWork has been in the headlines recently with their plans to go public at an astounding $47 billion valuation. Looking through their S-1 IPO filing, though, their financials paint a somewhat worrisome picture.
While loss-making companies heading to IPO is hardly uncommon, WeWork’s expenses have been almost double their revenues, leading to a net loss almost equal in magnitude to their revenue! The company has stated that if they cut down on their aggressive growth, they’ll break even. However, their total location OpEx was $1.5 bn last year, relative to their revenues of $1.8 bn. That leaves limited room for SG&A and marketing spend, making it challenging to reach profitability soon.
More troubling still, As per the WSJ, Neumann liquidated around $700 MM of his stake in the company ahead of the IPO, an uncommon move which doesn’t particularly inspire confidence.
So…What Should WeWork Do?
This story doesn’t have to be all doom and gloom, however. The avenue I see to inspire more confidence in WeWork is to lock down more long-term enterprise contracts to make them less exposed to cyclical changes in their occupancy rate. They’ve already started doing this, with contracts tied down with Goldman Sachs, Yelp, Lyft and Peloton for instance. In fact, WeWork’s average lease length doubles from 7.5 months in 2017 to the 15 months it is today.
Furthermore, WeWork is expanding into new business lines with WeGrow, a private school, and WeLive, a housing development. These have the potential to derisk the company further, making it less susceptible to business cycle fluctuations.
Between these lengthening lease terms and diversified revenue streams, WeWork has the potential to be far less risky, making it far more enticing to investors. I think WeWork should continue growing these ancillary channels, improve their unit economics to become more profitability-geared, and increase the term of their corporate leases, with the aim of going to IPO around late 2020.
Sources:
https://www.wired.co.uk/article/we-work-startup-valuation-adam-neumann-interview
https://www.businessinsider.com/heres-the-latest-wework-news-2019-6
https://www.vox.com/2019/5/24/18630126/wework-valuation-ipo-business-model-we-company
https://www.fool.com/investing/2019/08/20/why-you-should-probably-avoid-wework.aspx
“Why WeWork’s Business Model Is Risky | WSJ”. Youtube.
