It’s time to say goodbye to beer on tap.
Instead, WeWork “members” — which is what the company calls its tenants — across North America are now saying hello to kombucha, seltzer, and green tea.
This sudden sweeping change comes as part of Marcelo Claure’s financial reforms for the bleeding startup after Softbank installed him as WeWork’s chairman, filling the gap that former CEO and co-founder Adam Neumann left when he was ousted by the board.
That ouster cost Softbank $1.7 billion as part of the rescue deal, which saw Neumann selling all his shares for a sweet $1 billion in cash.
Ironically, he was paid $185 million as a “consultancy fee”, despite managing to cause the company to lose $365 per second. Dubbed a “golden parachute”, it caused a major outrage, to the extent that a minority shareholder even filed a lawsuit against the executives and Neumann himself.
$1.7 billion was only a small part of the cost. In sum, Softbank shelled out $10.6 billion thus far into the co-working giant. The rescue deal was worth $9 .5 billion, a rescue deal so severe that Softbank CEO Masayoshi Son vowed to never do it again.
It is insanely difficult to measure the depth of sh*t that WeWork is in today and removing the beer on tap is an exemplary instance of how immeasurable it is. A definitive thing, however, is that the company is now armed and poised to get out of the rut.
The big question is: can Claure replicate his insane feat at Sprint at WeWork?
“WeWork does not have sufficient funding to meet its growth plan.”
That was a note written by global credit rating agency Fitch Ratings in the wake of WeWork’s abandoned IPO. October last year, Fitch knocked WeWork’s credit rating two notches down to a “CCC+”, alongside fellow agency Standard & Poor’s rating downgrade of “B-”.
To lenders, WeWork is now deep in junk bond territory: although such bonds are typically high-yield — which means investors can get higher interest rates on the principal they loaned out — it also means investors aren’t that confident about WeWork being able to repay their principal.
It also means analysts believe WeWork is nearing a defaulting risk level.
At the very least, Claure is clear about his objective: in a staff meeting, he posited six “pillars” for WeWork to focus on, each detailing the core of WeWork is all about. Bolstered with a new leadership team today, since Brookfield Property Partners’ retail group chief executive Sandeep Mathrani is now part of the WeWork executive team as a CEO, both seasoned veterans will have much hole-plugging to do in this sinking ship.
The current State of WeWork
After the botched IPO, WeWork placated existing investors with a 50-slide presentation deck on how they are going to be profitable. The plan is simple: focus on what’s working, remove everything that’s not.
Although it has been discarded since Softbank’s massive takeover, the goal remained the same. Ever since Softbank’s lifeline support, Claure and his executives are knee-deep in red ink trying to make it green.
Delayed Lifeline Package
Softbank’s life support is worth $9.5 billion, with $5 billion coming in as debt, $1.5 billion as cash commitment and the rest in a stock tender offer. Yet, Softbank rang in the new year without enough debt financing for WeWork — $3.3 billion is still needed and Japanese banks are reluctant to loan the conglomerate.
This roadblock was what led to Softbank getting a $1.75 billion line of credit arranged by Goldman Sachs. Essentially, there’s still billions left, and WeWork desperate needs more funding at this stage.
Offloading Unnecessary Costs
“I’m actively working to buy back my company.”
That was what Managed by Q co-founder, Dan Teran, said at the SALT conference in Abu Dhabi December last year. Earlier in 2019, Teran sold his company to WeWork — now it’s being sold off again at a 75% loss.
Other acquisitions are also being offloaded as well, with Conductor sold back to the founder and Teem being acquired by iOffice. WeWork’s stake in women’s workspace startup The Wing is now acquired by GV.
All of the aforementioned companies are still losing money, despite hundreds of millions in revenue. Like many of WeWork’s counterparts in the Softbank Vision Fund portfolio, layoffs are rampant across the globe, with WeWork sacking 2,400 employees thus far with more to go.
1,000 maintenance staff that were stationed at WeWork workspaces were transferred to real estate firm JLL, then being contracted out to other companies. Other executives in the Neumann dynasty got the sack as well, with some of the executives being extended a “silver parachute” (a much lower tier relative to Neumann’s $1.7 billion exit package).
These are predictable moves and for WeWork co-founder Miguel McKelvey, it’s in line with his plan to “slow down”. Other absurd costs like Neumann’s private jet and WeWork’s elementary school WeGrow have also been dumped.
Freezing the Heat in Leasing
Besides the financial winter that WeWork is experiencing, the temperature of leasing rates and landlord attitudes are also seeing a dramatic downturn — major landlords were already skeptical of WeWork’s profitability before and during the IPO.
Leasing activities began slowing down right after the failed IPO: lease agreements were halted as early as September 2019.
Over at land down under, WeWork backed off from several large lease deals worth tens of thousands of square meters. Claure is also attempting to back out of up to 100 leasing deals that WeWork previously negotiated for, with as much as 15% of leases worldwide waiting to be unwound.
WeWork also came close to a complete halt in leasing activity in the last quarter, signing only 4 new leases.
Selling Stakes from Expansion Bets
The co-working space giant lucked out in Asia, with the entry to China being the worst expansion bet. WeWork needed an occupancy rate of 65% at least to breakeven in places like Shanghai and Beijing — with occupancy rates at 35.7%, spaces in China have emerged to be WeWork’s biggest blood-sucker. The company is wasting no time to offload those loss-making business units, with Kr Space in talks to acquire all of the units in China.
Singapore state investor Temasek Holdings is also eyeing WeWork China’s stake alongside Trustbridge Partners which is aiming to increase their percentage holdings. Besides China, spaces in Hong Kong are also being sold off.
Competition from All Angles
Who’s at the top in the flexible office leasing market? That used to be WeWork, who ceded the top spot to IWG-owned Spaces.
Other landlords have also caught on to the flex-office bug without having WeWork as an operator. New York’s biggest office landlord SL Green Realty Corp has their co-working spin with Emerge212. Boston Properties launched Flex by BXP. Real estate goliath Tishman Speyer created Studio, and its first site at Rockefeller Center in New York achieved 100% occupancy in 5 months.
Besides legacy companies, Softbank’s haphazard investment has created a fustercluck where portfolio companies go head to head against one another for market share. There will be mounting pressure on WeWork India as Softbank portfolio company Oyo betted on co-working in early 2019. Oyo is now operating co-working spaces in its home country after the acquisition of co-working space provider Innov8.
Besides counterparts, startups who awaited WeWork’s downfall are also rejoicing.
“…now the music is over, it’s time to dance,” said Amol Sarva, the CEO of office-space firm Knotel, in an interview with the Financial Times.
Since WeWork does not have a business idea moat, any company can easily replicate their model. For companies like Knotel, Impact Hub, Industrious, and a whole list of competitors, WeWork’s downfall will be beneficial to them.
Any competitor that has a great track record for near-full occupancy rate will attract any landlord that was disappointed by WeWork. Better compensation, less refurbishing allowance, and other compensation packages that triumph over WeWork’s would rally these disgruntled landlords.
Any business can be affected by the economy and for WeWork, the future global economy outlook does not bode well.
Unproven Business Model in a Recession
Middle of July last year, the U.S. economy broke its record for having the longest economic expansion since the 1991–2001 economic boom, according to data from the National Bureau of Economic Research. The U.S. economy has even avoided a recession after a decade of expansion, marking a historic moment in the U.S. economy when the boom began in 2010.
Generally, as the economy expands, businesses expand and start driving employment rates up. As these companies hire more people, it also means increasing the number of “members” they have at WeWork workspaces. Since WeWork was founded in 2010, it has since enjoyed riding on the decade-long economic boom.
As with economic cycles, WeWork will have to experience an inevitable recession, which will also mean higher unemployment rates, businesses downsizing costs and shrinking company size. Although WeWork has proven that its business model works during a boom, it will have significant trouble operating in a recession, especially when they are drowning under burgeoning losses — early warning signs have already started showing as global labor force growth slowed down since 2018, with global unemployment rates remaining essentially unchanged over the past two years, according to ILO modeled estimates.
Since job creation is the primary driver of real estate demand, it will be difficult for WeWork to bolster their profitability when we land in an inevitable economic recession. In the 2019 Global Coworking Survey, it’s estimated that one in four co-working spaces will be hurt by a financial crisis, and WeWork is already in a deep enough peril.
Persistent Demand for Office Space vs. Slower Growth in Flexible Space Demand
WeWork’s plummet may be softened by persistent growth in office leasing activity. For instance, tech companies dominated office leasing, occupying 22% of all office spaces. The tech industry is still expected to grow, according to a report by CompTIA, which may mean more potential tenants for WeWork.
Despite WeWork’s crash and burn, co-working spaces are still thriving.
For the rest of the other co-working spaces around the world, they are still retaining both their popularity and profitability — more than 40% of all co-working spaces are currently generating a profit. Another one-third has already broke-even.
The co-working space market is one that many firms predict to continue growing: London-based real estate services firm Savills believe that the trend of flexible working spaces is “irreversible and spreading across sectors”. Nevertheless, the co-working craze is cooling off, as CBRE predicts that the growth rate of 2019 at 23% will go down to 13% in 2020.
Lower Temperatures for Venture Investment
Henry McVey, the head of the global macro and asset allocation at KKR & Co., believes that investors should stay underweight many high-profile, unprofitable companies, even if they are funded by venture-capital firms.
“The WeWork situation was not a ‘one-off’ occurrence’,” he added in an outlook report for 2020.
Premature scaling for the capital-intensive real estate sector can be an insane ordeal. For real-estate startups, it was unthinkable when the cash burn in tech companies sputtered over to the concrete world of office buildings. These real-estate companies are not exactly Airbnb, which was a perfect meld between tech and lodging properties.
Unlike tech companies, there is a much smaller moat for competition in the real-estate sector. Even if you’re Marriott International Inc., you can still find yourself competing with cash-heavy startups like Oyo.
For WeWork, that would be the plethora of real-estate startups.
The effect of slower and more prudent venture investment can be profound. As real-estate startups begin to pick up the change, they’ll step on the brakes and start heading for long-term revenue, which will allow them to scale during a recession. Startups like Common, Knotel, and Industrious have already shown signs of deceleration, something that WeWork is too late to get to.
Unless you’re truly a tech company, venture investment will remain cold for the real-estate sector. Venture investing is expected to become more judicious, especially after Uber’s and Lyft’s languishing stock price. For Softbank, the financial winter is also an exemplary example of how growth at any cost is no longer acceptable.
The Analysis: WeWork’s Outlook
Fundamentally, WeWork is changing public perception of what they position themselves to be. Under Neumann’s leadership, WeWork made tech startup acquisitions and positioned itself as a tech company. With the new leadership team, WeWork can eventually transition into a full-fledged real estate firm, joining profitable firms like IWG in the long run.
WeWork bought more food than it could chew: most of its startup acquisitions were poorly merged with the company. Although the way people work is changing, it does not mean that WeWork needs to venture into sectors such as living spaces, education, and gaming.
This isn’t just about selling a few acquisitions. It’s about complete bloodletting. If anything’s not related to the flexible office space product, it should be dropped as soon as possible. WeWork will have to do it with speed and ruthlessness — hence being a cauterization.
One of the biggest costs would be financing the capital restructuring from leasing and debt.
WeWork’s biggest problem comes from not owning any real estate: without holding any buildings that WeWork is in, the core costs will never get lower since landlords have full control and purview.
It’s a big game of lease arbitrage that WeWork is losing in: lease a building for 3–5 years, sublease individual desk and offices short-term, invest a great deal of money branding and refurbishing the properties… In the end, WeWork feels the brunt of the low occupancy rate — landlords will simply consider the entire floor leased to WeWork as “fully occupied”.
WeWork has at least $47 billion worth of lease liabilities that will eventually see the co-working goliath take drastic measures. According to real-estate brokerage George Smith Partners, WeWork could be asking landlords for rent forgiveness, reductions, or some kind of lease rewriting.
Otherwise, WeWork would find their financial metrics being dragged on indefinitely since these liabilities are highly illiquid. Without early termination provisions (something as part of WeWork’s lure for landlords), it’s going to take more cash to burn the thread connecting them and landlords.
Hence, the only way out is to root every profit-making building whilst downsizing even further.
One, Claure will have to step up on his negotiation game. More leases will have to be canceled as fast as possible. Once WeWork established a threshold for how much profit they need to make per office, they will have to shut down every office that’s not doing well.
Two, all expansion plans for any city that doesn’t meet the liquidity threshold will also have to be shut down. For WeWork, the focus should be on Tier 1 cities (e.g. San Francisco, New York City, Tokyo). WeWork should be downsizing to such a point that entire markets may be abandoned, focusing on companies that can rent longer-term.
Three, more money must be spent on luring enterprise leases, rather than on flexible office space leasers. The key is to ensure that the company has a pile of long-term leases that generate a fixed income, instead of a come-and-go entrepreneur or freelancer.
Freeze any Goals for An IPO
SoftBank CEO Masayoshi Son gave an ultimatum to his portfolio companies last year: get profitable, or else. This came along with a deadline for an IPO. For instance, Oyo needs to IPO by 2022–2023. Paytm has 5 more years.
It seems sensible for companies that are still planning for it since they can start getting profitable before the IPO, but it might be too ambitious for WeWork.
It’s the specificity of the issue that makes the IPO a lot less improbable in years to come.
One, WeWork has already suffered a steep reputation loss, alongside poor unit economics and high fixed costs that made the company an unattractive investment. That’s easily established.
Two, the botched attempt had a rippling effect on Wall Street’s appetite for unprofitable startup unicorns. Although Techcrunch claimed that they didn’t care, it came before disappointments like Uber, Lyft, Peloton, just to name a few. With more unprofitable unicorn IPOs to come (e.g. Postmates, Casper), the chances are even slimmer for WeWork.
Third, public markets now have a full understanding of how economics in real-estate business works. Firms like IWG traded at small multiples and aren’t insane enough to masquerade as a tech company. Low marginal revenue and high fixed costs may deter investors, but a business that bleeds money with those characteristics is a definite red flag.
Four, real estate firms aren’t truly the crux here: it’s co-working space startups. WeWork’s failure to go public sent a chilling effect across the market and for other big players in the market, it’s extremely disadvantageous. Both Citibank Group and Credit Suisse AG have walked away from underwriting UCommune’s IPO. For WeWork, it means that financial institutions won’t be as kind as to underwrite and shoulder the risk of losing $80 million.
For WeWork to IPO, the most likely way for them to court the hearts of public investors is to go into the market with profitability large enough to take a few hits from economic shrinkage.
WeWork is not an inherently bad business: they simply suffered from mismanagement. Should they keep their heads down, amputate every bleeding unit, and focus on what gives them green, their initial meteoric expansion can prove to be useful. Many people widely believe that WeWork does not have assets, but that’s only if you focus on the tangible — WeWork is a global brand.