WeWork — Most Overvalued Start-up or Catch of A Lifetime?
How GreenDesk became WeWork — The Initial Days
Miguel McKelvey thought he was just going to his friend Gil’s house to spend a Saturday night. But as he and Gil got on to the elevator, this tall Israeli guy walked in with his shirt off and began conversing with everyone on the elevator. Miguel, initially taken aback by his audacity, later learned that he was in fact Gil’s roommate. Apart from their 6 ft 8 inches frame, they had no commonality. Yet, as the adage that goes poles attract, Miguel McKelvy and Adam Neumann went on to become the Founders of WeWork.
In hindsight, the fact that they stumbled upon this concept of a communal work-space is not startling. Miguel grew up in a home with five other women who were his best friends, living a hippie life and breaking all norms. Adam on the other hand came from Israel, where he served in the army for five years and traveled a lot. He had his roots of community upbringing as well.
While Adam brought to the table the raw passion and an unwillingness to settle for a ‘no’ from landlords, Miguel brought his business acumen and knowledge of architecture from working as an architect for a New York firm. They first founded GreenDesk in 2008, focused on sustainable co-working spaces featuring recyclable furniture and electricity. Soon, they realized it was not scalable and sold it to their landlords while pocketing a million dollars each.
But the idea of a communal work-space never left their mind. So, enter WeWork (a Green Desk 2.0?). Founded in February, 2010 in New York’s SoHo district, WeWork got its first mysterious investor the same year — Joel Schreiber. A Hasidic orthodox Jew, Joel met Adam and Miguel for a potential real-estate deal. When that didn’t fall through, Joel instead called them up and offered $15 million to be a part of the company. You’d rarely find a picture of Joel online, who maintains an incredibly low-key lifestyle. Although he is said to have propelled the initial days of WeWork, he has a dozen law-suits against him for defrauding investors and not paying on time.
Fast forward to 2018, WeWork has gobbled up over $6.5 billion in funding, is valued at a whopping $47 billion, built over 15,000,000 sq ft of office space in 300+ locations spread over 24 countries, and has ventured into tangential projects such building a kindergarten school and an artificial wave pool (not kidding). All in 7 years.
So I’ll be playing the Devil’s Advocate for both sides to understand the supporters and critics (which are many) to give you a bulls-eye view of both sides. Whether you want to belong to the former or latter group, I’ll leave that up to you.
‘Most Overvalued Start-up’ — What’s the Backstory?
Given the time frame and the value proposition of the company, scores of real-estate traditionalists and company executives have pointed fingers at WeWork calling it overvalued.
“If you had positioned this as a real-estate company, it wouldn’t be worth this,” said Barry Sternlicht, who runs Starwood Capital Group LLC, with more than $50 billion of real-estate assets under management.
Let’s look at a few reasons why this is so.
1. Volatility of the real estate market:
When asked this question, Adam retorts. “WeWork isn’t really a real estate company. It’s a state of consciousness, a generation of interconnected emotionally intelligent entrepreneurs,” he argues. However, when you remove the free spa and the hardwood floors, WeWork is indeed a real-estate company, and is subject to all the risks that one would speculate for that category. The business model is simple: rent arbitrage. It charges its users more than what it pays its landlords.
The current model requires WeWork to pay millions of dollars to its landlords over a decade, irrespective of economic calamities, like the 2008 crisis or the dot com bubble. In fact, another company that works on the same business model, Regus, filed for bankruptcy in 2003 when the bubble burst. If the interest rates go up or if start-ups begin to walk out the doors, WeWork is in big trouble.
2. Bigger competitors catching up
Although WeWork is enjoying a big share of the pie, it didn’t bake it. The concept of a communal work space has been there for decades, Regus (now IWG) being one of the big players with over 3,000 locations. When the CEO Dixon was interviewed, he says he is not worried about WeWork. “There’s no magic ingredient that they have that everyone else doesn’t have,” he says. In 2018, there were 19,000 co-working locations around the world*.
Keeping aside the egregious size difference, WeWork is, as you can see, not a cheap deal either. Some start-ups are seen moving out when the trade-off for finance tips over. A single desk starts at $400/mo and a private office for four is a whopping $1640/mo in NYC. Is it worth the price? or only as good as sitting at Starbucks for free while sipping a $3 cup o’ joe?
*There are some notable upcoming competitors as well, including Krontel and RocketSpace, both raising $155 and $336 million respectively.
3. Surprising lack of assets:
Although WeWork managed to spread out to 300+ locations, it still does not own any of the property. It signs 10–15 year lease contracts with landlords where it pays a fixed agreed-upon rate while it leases them for a higher price (it has $18 billion of lease obligations). But can they rake in more and more revenue this way even when markets crash? Critics don’t think so.
Yet, unaffected, they keep growing ferociously. Their latest brainchild is Dock 72, a 16-story building in Brooklyn’s old Navy Yard that costed $400 million to build. This wavy, origami-like edifice is meant to become a pinnacle of co-working space — filled with office space, restaurants, bars, and luxury spas.
4. Risky ventures in unfamiliar territory
In an ambition to widen the net, WeWork has ventured into two major areas: residential space and education, completing the cycle of life. WeLive is said to be a co-living space consisting of dorm-like apartments with a gym and spa. While its goal was to reach 68 WeLive locations by 2018, it reached a scanty two.
WeGrow, on the other hand, is said to be the first ‘entrepreneurial’ school for kids. When it opened in September 2018, 46 students were enrolled for classes, ranging from pre-K to 4th grade. For a typical 1st grader, it charges a yearly price of — hold your breath — $42,000. I guess molding early entrepreneurs come with a price.
These ventures, and more, don’t bring in a ton of, if any, revenue for WeWork. Does it seem ingenious or imprudent? Time will tell.
How Does WeWork Justify Its $47 Billion Valuation
It’s time to flip the switch and take a closer look. Although some success could be attributed to the massive investment and pure happenstance, a whole lot of it is buttressed by data-driven initiatives and novel approaches to communal work-spaces.
1. Stream of acquisitions — some more shocking than others:
For a company that’s yet to file its IPO, WeWork has surely been active in the acquisition scene. They seem to have an average of acquiring one company every two months (including Naked Hub, Spacemob, Flaitron School, Meetup and more). What is surprising is the companies themselves do not seem to have a direct relation to communal spaces. They range from apps for construction workers to artificial wave pool generators to education technology.
With the cushion of extensive funding, and a strong thumbs-up from the Softbank CEO Masayoshi Son, WeWork seems to be building arms in various directions, hoping to connect them all into a holistic WeGroup company in the future. This also off-sets the risk of depending on real-estate as a one-legged chair.
2. Technology begets data begets optimization:
As a company that added roughly 500,000 to 1,000,000 sq ft of space per month, it’s hard to be profitable without a rigorous and focused approach to using data. And WeWork knows it. The flowchart below demonstrates a very diluted version of the set of tasks they perform.
What’s not shown in the above flowchart is the sheer detail to which they plan out their offices.
Sensors and other measurement tools like facial recognition software let WeWork track how its office space is used, down to data as granular as how members adjust their desks and what parts of the office see the highest foot traffic. Eventually, these tools might even be able to track how focused members are in meetings.
A company that is putting over 1,300 employees just in architecture, interior design, engineering and related activities — an employee roster that makes it one of the biggest architecture firms in the world — is a company that takes its job seriously.
3. Deep investor conviction (and pockets):
When asked about the supposedly inflated valuation in an interview, Adam is reticent but firm. He starts listing all the investors who back it up, including Benchmark Capital, Fidelity Investments, JP Morgan, Goldman Sachs, Harvard Management Company, Wellington Management, and of course, SoftBank.
These firms are known to have a string of successes, which points to their good instincts.
As for the Softbank CEO, he can’t stop raving about the company. Although he vastly downsized the $16 billion to a $2 billion investment due to investor pressures, he calls WeWork the next Alibaba. Walter Isaacson, the renowned biographer of Steve Jobs, Albert Einstein and Benjamin Franklin proclaims that Mr. Neumann has some of the qualities as the aforementioned aficionados. Clearly, WeWork has a strong backbone.
4. Steady expansion and growth:
WeWork needs 60 percent of a typical office space to be occupied to break-even. Guess how much they’ve been filling? 81 percent. That’s right, they raked in $1.5 billion in revenue in 2018 and $482 million just in Q3. This is not to say it’s been smooth sailing, financially. They had a net loss of $1.2 billion. However, at the rate at which they are opening new locations, acquiring companies and expanding internationally, that’s expected.
One of these expansions that proved to be successful is the Powered by We initiative. WeWork’s greatest value proposition is also its Achilles’ heel. The flexibility given for start-ups to move in and move out anytime hurts long-term stability. Powered by We counteracts exactly this — by offering office space solutions to enterprises. This accounts for almost 30 percent of its user base right now. They’re also mitigating risks by shifting from leases to co-management deals, purchasing properties — a recent acquisition is the Lord & Taylor building in Manhattan — and making members sign long-term contracts.
Although they’re riddled with market instabilities, at least they’re addressing them all.
Conclusion — A Revolution or A Recession?
One thing is certain — WeWork managed to break into a space that was populated by veterans and converted a blasé business model into a chic one. In the process, it also became an incubator for some of the most coveted start-ups and a networking ground for upcoming entrepreneurs. Our world is accelerating towards a sharing economy, and succeeding— as seen from Uber, Airbnb, Alibaba and the likes. WeWork is another great stride in this direction.
Whether WeWork creates a revolution or falls prey to recession depends upon three elements: a) strong advocation (and conviction) from current and future investors, b) decreasing dependency on leases from landlords and short-term users and c) diversifying its portfolio to enter more lucrative markets, in the U.S and abroad. When the next economic downturn comes, we’ll find out who was right: real estate traditionalists, or the ones trying to upend them.
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