In the age of the unicorn valuation, WeWork is only the latest company to incur massive losses and still fetch a valuation in the tens of billions of dollars.
That’s the kind of stock market that should scare investors. Not only is it indicative that the market itself is overvalued, but investors in IPOs of these unicorns are getting burned. We already know that the Uber and Lyft IPOs have been crushed – and been an incredible disappointment to investors.
Yet WeWork, recently rebranded as The We Company, may be the most egregious example of fantastical valuation yet. The good news is that the investing public seems to be wise to this particular attempt to extract money from it and is balking at the company’s prospective valuation.
WeWork Valuation Careens $45 Billion Lower Ahead of IPO
The company’s original IPO valuation was $65 billion. It is now making the rounds at an estimated $20 billion. Earlier this year, the company raised capital at a valuation of $47 billion.
If the company were to IPO at a valuation of $20 billion, it would mean those late-round private investors would experience a 60% loss on their investment.
Here are five reasons why WeWork’s IPO is falling apart, and why those investors will likely incur that 60% loss…or greater.
Reason #1: Business Model
On the surface, WeWork’s business model seems like a good idea. The company leases space in highly desirable, upscale areas. It renovates the space into a shared workspace environment, filled with luxury amenities like kitchens with food and common areas, along with high-end contemporary design and cool furniture.
It then subleases this shared work environment into individual workstations. There are conference rooms, small offices, and long tables outfitted with chairs so people can work “family-style.”
In theory, as long as the company makes more money subleasing all this workspace than it costs to lease the entire space, and pay for operating expenses and debt service, the company should make money.
Yet there are several problems with this model.
It depends on unpredictable demand.
Whereas most office rentals, or even timeshares, have tenants that sign long-term leases, WeWork spaces are literally rented by the hour or the day. There must be constant demand to maintain occupancy at capacity.
The biggest problem is that operating expenses and debt add heavily to the company’s overhead. That puts a lot of pressure to get space occupied.
Reason #2: A Recession Kills WeWork
Long-term leases are the cornerstone of any real estate business.
Tenants that are locked in for long-term leases have obligations to pay those leases, in good times and bad. You’ll notice that even during recessions, many large national chain stores still appear in your local mall. That’s because the chains have enough capital and liquidity to continue paying on their leases and stay in business even during an economic slowdown.
With the micro-leases that WeWork traffics in, tenants could vanish within days or even hours.
WeWork targets a younger demographic that has limited disposable income. WeWork itself loves to push the idea of “community,” enticing younger individuals to become part of something larger, and to turn WeWork spaces into quasi-social clubs.
That’s fine as long as that demographic has money to spend. In a recession, they won’t. If they are there to work, and they lose their job during a recession, WeWork doesn’t collect rent anymore.
This is critical, because revenue could dry up. That takes us to…
Reason #3: The Company Is Loaded With Debt
The company carries several billion dollars in debt, and it will be paying close to a quarter-billion dollars in debt service annually. If revenue dries up because of a recession, cash flow could be devastated.
The fact that WeWork has a tranche of debt triggered by going public is the best part of this whole circus.
These are usually tied to inverse stepfunctions in credit risk…public liquidity imo is the greatest possible long term risk for a credit of this profile.
— Blake high HF Richman 💀 (@thebrichman) September 10, 2019
Without the cash flow to make debt service payments, debtholders will take control of the company. Shareholders will be wiped out.
The news gets even worse than this because the company already has a cash flow problem, and that takes us to…
Reason #4: WeWork Operates With Mammoth Losses
For the six-month period ending June 30, 2019, WeWork doubled revenue to $1.54 billion. That’s a fantastic increase, except for the fact that location operating expenses also doubled to $1.24 billion.
Total expenses were $2.9 billion.
That means WeWork already lost $1.37 billion in the first six months of the year from operations. Its annual run rate is a $2.75 billion loss from operations alone.
The company did pick up some interest revenue, which brought its pretax loss to $900 million for this first six months, or $1.8 billion for the year.
This has to be of concern to investors.
Not only is there no margin for error, WeWork has to maintain its present revenue growth rate going forward. It does have an advantage in that pre-opening expenses only occur once for each property, although there remains ongoing maintenance at these locations.
Reason #5: CEO Self-Dealing
CEO Adam Neumann has to be credited for being an amazing entrepreneur and coming up with an idea that appears to have snookered a lot of investors. He’s a bit like Elon Musk.
WeWork's CEO Is the Next Elon Musk – That Should Terrify You https://t.co/OTq0GMgvAo
— CCN.com (@CCNMarkets) August 15, 2019
One of his smarter moves was to actually buy the real estate that WeWork itself is leasing. He is the landlord for the public company that is his primary tenant.
There is nothing illegal about this. It’s a brilliant maneuver.
It’s just that the optics are terrible, and the IPO is insanely overpriced on top of it all.
For a company that is trying to set up an IPO, it leaves a bad taste in a lot of people’s mouths, and with good reason. While there are certain protections in place regarding the company paying fair market rents to Adam Neumann, every investor knows that there’s a conflict of interest here that likely percolates within the company.
The result is that the company may be paying above-market rates, and find reasons to do so that pass muster with the SEC and shareholders.
The company also loaned Adam Neumann a sizable amount of money, but to his credit, he has seen the wisdom of returning that loan.
We Will Know the IPO’s Fate Soon
WeWork continues to press on with its roadshow this week, and the investing community will know in a few days whether or not the IPO is going to occur.
With all the talk of a possible recession around the corner, it creates an interesting dilemma for Neumann.
On the one hand, he’d like to rush out the IPO prior to any recession so that he can cash out before the company experiences any possible recession damage.
On the other, the market appears to see right through his shenanigans.
That’s why the IPO valuation has taken such a tumble. Should he wait and keep the company private in the hopes that the likelihood of a recession retreats over the next year?
Disclaimer: The views expressed in the article are solely those of the author and do not represent those of, nor should they be attributed to, CCN.com.