Last month “The We Company”, originally known as WeWork, a co-working space, released its S-1 filing in order to go public. The company’s red herring prospectus has already raised a few eyebrows in terms of the valuation that the company is demanding. At last count,WeWork’s valuation stood at a staggering $47 billion. The crux of this exuberant valuation is based upon WeWork’s positioning strategy. Throughout the prospectus, WeWork extensively claims to be a tech company, so much so that the word “technology” appears roughly around 110 times in the prospectus. In reality, the pundits have long argued that it is not a tech company, but a modern day real estate company which purchases long-term leases from landlords and rents them out as short-term leases to tenants.
Throughout this article, we would try to understand whether WeWork’s business model justifies the valuations that it has able to achieve. Whether the company would be able to unleash its market potential or not? The future profitability, vision and corporate governance are intact or have loopholes within them? And is there any competition threatening WeWork’s market share that they are aiming for?
About “WeWork”
WeWork in their own words is a community company building a worldwide platform that supports growth, shared experiences and true successes by giving their members flexible access to beautiful spaces, a culture of inclusivity and the energy of an inspired community driven by extensive technology infrastructure. The business model is like any other co- working space model that provides access to space for any kind and any size of business (ranging from large multi-national corporations to start-ups to freelancers), aiming to remove the office space as a fixed investment from the balance sheet of such businesses and converting them as a variable cost for them. The company started in 2010 and has witnessed a 100% membership growth since 2014 along with 527,000 memberships in over 528 locations in 111 cities across 29 countries.
WeWork pioneered a “space-as-a-service” membership model across its global portfolio of locations, where the individuals and the organizations are able to receive the flexibility to scale the workspace up or down as needed, with the ability to consume the space by the minute, by the month or by the year. This flexibility and global mobility comes at a lower variable cost rather than a higher fixed cost and it reduces the complexity of leasing real estate to a simplified membership model, while delivering premium experiences like 24/7 access to their locations, beautifully designed workspaces, flexible workspace configuration as needed, on-site community teams and a member experience powered by technology, all of which has the power to elevate how their members would work, live and grow.
WeWork’s ambition and the problem with it
Back in 2006, Amazon launched Amazon Web Services and in 2010, Microsoft launched Microsoft Azure both of which are majorly on-demand cloud computing platforms provided to individuals, companies and governments, on paid subscription basis. These platforms have seen enormous growth purely because of the fundamental shift that these companies were preaching for: “from servers and clouds as capital investment to variable costs”; the benefits were less about saving dollars and cents and more about increasing flexibility and optionality.
Consider this phrase, “fixed cost”, in any business, there is nothing more fixed than a real estate investment, yet the offering of WeWork transforms real estate into a variable cost for all kinds of businesses, with the benefits nearly being a replication of the cloud based platform. The implications of creating a company which would trade a fixed cost for a variable cost by absorbing all of these costs are in itself a massive up-front investment.
Just as these cloud based companies needed to first build data centres and servers before they could sell storage, WeWork also needed to build offices before it could sell cabins and conference rooms to their prospective clientele. But the trick here is that the cloud based companies can spread the cost of data centres around the world over a huge pool of customers and WeWork can too achieve this but only up to an extent and not as massively as these actual technology companies could obtain. In other words, if WeWork aims to grow like a tech company, it would be strange if they are not losing enormous amounts of money. The growth strategy and market potential approves of the same; excerpts from the S-1: “In the 111 cities in which we had locations as of June 1, 2019, we estimate that there are approximately 149 million potential members. For U.S. cities, we define potential members by the estimated number of desk jobs based on data from the Statistics of U.S. Businesses survey by the U.S. Census Bureau. For non-U.S. cities, we consider anyone in select occupations defined by the International Labour Organization—including managers, professionals, technicians and associate professionals and clerical support workers—to be potential members, because we assume that these individuals need workspace in which they have access to a desk and other services. We view this as our addressable market because of the broad variety of professions and industries among our members, the breadth of our solutions available to individuals and organizations ofdifferent types and our track record of developing new solutions in response to our members’ needs.We expect to expand aggressively in our existing cities as well as launch in up to 169 additional cities. We evaluate expansion in new cities based on multiple criteria, primarily our assessment of the potential member demand as well as the strategic value of having that city as part of our location portfolio. Based on data from Demographia and the Organization for Economic Cooperation and Development, we have identified our market opportunity to be 280 target cities with an estimated potential member population of approximately 255 million people in aggregate.”
Did you find any glitch in the same? WeWork is keeping a towering ambition of claiming nearly every desk job around the world as its potential market and by the definition of its target market, WeWork claims that it has realized only 0.2% of their total opportunity globally and 0.6% of their opportunity in their ten largest cities.
There is another graph, which talks about the break-even time frame of each its locations:
It is interesting to note that more than 300 locations currently are in the negative side of the above mentioned graph which would clearly explain the reason behind the staggering losses that the company has been showing up year after year. Should the investment cycle stop, it would seem reasonable that the gap would close rapidly but given the fact that WeWork has not even entered 50% of their targeted cities, it seems like the cash burning process would not stop any time soon and hence the financial numbers are not going to improve any soon. Profitability seems like a distant dream right now for WeWork. It is also interesting to note that no private investor alone could sign such hefty cheques and pour in truckloads of money into a company which has already seen such a massive amount of cash burn; hence to sustain the growth purely by expansion, the company does need some source to fuel the growth plan mapped by them.
Financial Numbers that put light on WeWork not being a tech company
Below is the excerpt of the financial numbers posted by WeWork in its S-1 which highlight the concern that we are speaking of:
WeWork is growing at 96% year-on-year in terms of the revenue but nearly 80% of the revenue is utilized as “location operating expenses” in the year 2018 and 2019 and this number was at an even higher percentage in 2016 and 2017. WeWork spends nearly as much as it earns in creating and maintaining new properties and has very negligible gross profit when compared to other tech companies (Facebook has a gross margin of roughly 80%-85%).
These location operating expenses could be also be seemed as capital investments that are to be made on a recurring basis and therefore, WeWork has to infuse in much more capital than a normal tech company to earn the same amount of revenue. Also, the replacement cost of these assets is much higher for WeWork than for any other tech company. After all, the customers who are attracted to trendy office spaces would want broken chair or worn- out carpet to be regularly replaced.
Again, an Airbnb does not need to pay rent to its suppliers if no one rents their spaces or an Uber does not need to pay a cab driver if there is no one ready to book a cab but WeWork will have to continuously pay the rent for the leases across all its location irrespective of clients booking their space or not. This calls for a major asset liability mismatch within the company’s balance sheet itself. It can work as a double edged sword where WeWork could demand premium memberships over the fixed lease payment but it could call for a major bankruptcy crisis in bad times, because their fixed liabilities, that current stand at over $34 billion, would be due, come rain or shine.
In summation, a performance metric like EBITDA or gross profit would be valuable in valuing asset-light companies like Facebook or Airbnb but it is a meaningless concept for WeWork. The metric provided by WeWork, the community-adjusted EBITDA, which does not take into consideration even the most basic expenditures for providing services, such as lease rentals, make their financial metric even more redundant.
WeWork’s Competition
One of the really few points on which I could be really bullish on WeWork’s IPO is the company’s lack of competition.
The closest competitor of WeWork is IWG, with more than 3000 locations and 400,000 workstations as of June, 2019. WeWork, in comparison, had 528 locations and more than 600,000 workstations as of June 2019. The massive edge that WeWork gets over IWG is on the basis of the concentration strategy that is being used. It has fewer locations but with more workstations in the same. When the growth is compared, WeWork is growing exponentially faster, courtesy, the truckloads of money that is being poured into its system. But a contradicting point and relatedly, IWG is making money (154 million Euros last year) and hence IWG is restricted by the money that it makes but on the flip side WeWork has access to the world where investment cheques can run to infinity.
Hence, it is difficult to think that IWG would be able to compete on the long run or even for that matter any other company as any investor would want to invest in an established entity rather than burning their hands in a new start-up with the same business model.
WeWork’s Corporate Governance
One of the major screener before investing in any company is the corporate governance of that company. However good the business model may be, the company can go for a toss if it has a weak corporate governance structure and my fear is that WeWork falls on the same lines.Let’s take a glimpse at some of their disclosures:
- WeWork paid its own CEO, Adam Neumann, $5.9 million for the “We” trademark when the company reorganized itself from WeWork to “The We Company”.
- Neumann has three different types of shares that guarantee him majority of the voting power. These shares would tend to retain their rights even if they are sold.
- Rebekah Neumann (CEO’s wife) and a company co-founder would be amongst the two or three people who would succeed Adam if he dies or immobilises.
- WeWork recently created a complex partnership structure that pays out profits to Neumann in a setup that minimizes their individual tax liability.
It has also been reported that Neumann has personally owned at least parts of the office building that WeWork leases and that Neumann has already reported to cash out $700 million of his holding though sales and loans.
When everything is brought onto the same plate, it hints that there is no accountability with respect to the executive, who is looting a company running massive losses and may be very well fragile whenever the next recession hits.
So what lies ahead?
While the company is still finding ways and means to sustain the growth and position itself as a tech company by accessing the world of unlimited capital, the fact of the matter is that the company has too many overheads to look into, especially when the next recession hits. WeWork argues that the recession would be an opportunity as a downturn would make their company the platform for flexibility and in fact could attract new customers and that a recession, provided the company would have access to sufficient capital, would actually accelerate its expansion activities with new leases being signed at rock bottom prices. But the truth is that in a growing economy the concept of signing leases at low cost and rolling out memberships at a higher value would be tempting but when the recession turns in, the lease rentals would stay as it is, but would the customers stay?
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