The initial public offering filing of WeWork is the most audacious prospectus that we’ve ever seen. Yes, the company, which this year changed its official name to the We Company, is disrupting a big industry and revenue is doubling each year. But the exposure to economic risk, out-of-whack valuation, and absolute founder control are simply extraordinary.
Here are our five big questions about the WeWork IPO:
WeWork claims that its business would have “resilience in a downturn.” We disagree for two reasons:
- Dropping a WeWork office is a quick way to cut expenses. WeWork mostly serves freelancers and small businesses who could retreat to home offices to pare down expenses in a recession. Getting rid of a WeWork office is also an easy way for big companies to reduce expenses, compared to the large, fixed-cost expenses of a major headquarters.
- WeWork has small revenue commitments in comparison to its expense commitments. WeWork has only $4 billion—about a year’s worth—of revenue commitments from its members. In comparison, it has $47 billion of lease commitments—about 28 times its current lease expenses. Commercial real estate traditionally includes long-term commitments, but WeWork only has long-term commitments for expenses, not revenue. That doesn’t create resiliency.
Most of WeWork’s financing seems to be based on fixed interest rates. But its growth will require additional financing, much of it debt. If interest rates go up, its cost to borrow will go up. More broadly, the entire real estate industry revolves on debt. So, if rates go up, WeWork’s landlords’ costs will go up, which would likely increase WeWork’s leasing costs for new buildings. It’s very difficult to accurately predict the impact of increasing interest rates—but it’s pretty easy to say that increasing rates would be a negative for WeWork. We don’t expect rates to increase in the near term, but it’s important for investors to recognize WeWork’s reliance on debt and the impact that rate changes can have on the company—positive and negative. The company may want investors to think of it as a tech company, but its financial model is that of a real estate company.
It’s important to recognize that WeWork’s entire operating history has been during the longest bull market in history with an extraordinary availability of cheap capital. There might never have been a better time in history—and may never be a better time in the future—to start a business like WeWork. No investor should look at the company’s past and think it can ever be replicated in the future. The global economic forces will only get worse for WeWork, never better.
WeWork could lose 90% of its value. No kidding.
Despite saying it offers “Space as a Service,” WeWork is not a software-as-a-service, or SAAS, company. It’s a real estate company. The company’s business is in leasing buildings, developing the spaces, and renting those spaces to its customers. The value it can create is based on the difference between what it can lease the facility for and what its customers will rent it for. This value is created through experience design and financial engineering. Yes, WeWork is technology enabled. But it does not create value using bits and bytes the way technology companies do. WeWork’s true innovation in sharing spaces is more akin to the creation of the shopping mall in the 1950s than that of ecommerce in the 1990s.
The risk to WeWork is that, once the company is in the public markets, the investors who will be deciding on its value will be real estate investors, not tech investors. Its closest comparable will be IWG, the owner of Regus. IWG has almost identical revenue as WeWork—about $1.5 billion in the last six months—and is valued at about $4.5 billion. WeWork, on the other hand, was valued at $47 billion in its last private funding round. Yes, WeWork is growing faster than IWG. But it is also burning through a lot of money—WeWork lost $1.4 billion in the past six months, while IWG made $147 million in operating profit. We can’t see any way that a responsible real estate research analyst will be able to initiate coverage saying that WeWork is worth 10 times IWG.
Here’s the issue: high-growth companies normally trade at higher multiples because investors will pay more for growing companies. But once a company’s growth slows, its multiple declines to the industry’s norm. In WeWork’s case, the company would need to increase its revenue by 10 fold before its valuation matched the industry norm. However, in order for investors to make money, WeWork would need to increase its revenue much more than 10 fold so that its valuation continued to grow. Predicting that a young company with a limited operating history facing an inevitable recession will grow by 15 to 20 times is crazy.
Real estate businesses can be complex. Properties are held in special purpose entities that can have complicated relationships with the parent company, and which don’t necessarily protect the parent company as is commonly thought. WeWork has secured $1 billion of letters of credit outstanding that guarantee the leases of its subsidiaries. And, as one example, WeWork has a very complicated involvement in the building at 424 Fifth Avenue in Manhattan. Through a partnership, WeWork is a part owner of the property and guarantor for up to $900 million in debt taken out for the property. WeWork also provided a performance guarantee for development of the property. And WeWork has guaranteed the lease payments of the tenant, one of its subsidiaries—meaning that WeWork is guaranteeing lease payments to itself as well as the payments to its debtors. Frequently, these relationships are opaque at best, making it difficult for investors to understand.
WeWork is a complex business, as expected. The problem is that its IPO filing is more complex than it needs to be. The company has created new financial metrics that make it very difficult to understand reality. A cynic might say that the company is intentionally making it difficult to understand, which makes one wonder what isn’t being disclosed. Given the company’s history of conflicts of interest, this isn’t an unfounded concern.
As a public company, WeWork would benefit greatly from greater transparency and clarity. This isn’t easy for a complex real estate business. But if the company truly wants to “elevate the world’s consciousness,” it might need to start by being more straight up.
We feel like a broken record, writing about the issues of founder-controlled IPOs (here, here, here, and here.) But WeWork takes founder control to a new stratosphere. WeWork is entirely controlled by its cofounder, Adam Neumann. And the relationship between cofounder and company is messy—very messy. Let’s walk through a few important details:
- Neumann (unusually, he goes by his first name in the IPO) has voting control through super voting shares. This gives him complete control of the board and, therefore, all operations.
- Neumann’s control won’t change if he leaves the company. In fact, his heirs will continue to control the company if he dies and his wife, Rebekah, will decide who takes his place as CEO along with two other board members (whose position on the board would be controlled by her).
- Neumann has a history of running the company for his own personal benefit, including taking out personal loans at 0.2% interest rates, leasing buildings to the company that were purchased with company loans, and personally holding the company’s trademark until just before the IPO—selling it to his own company for $5.9 million.
- The company’s bankers are also twisted up in the conflicts of interest by owning equity, underwriting the IPO, providing debt to the company, and providing debt to Neumann individually. The personal debt isn’t trivial either. Neumann has a $500 million credit line and $98 million in other loans from the company’s bankers.
- Neumann’s control over the company doesn’t end with his own shares. The company’s management team has been granted equity interests (another form of a stock option) in the company’s super-voting Class C shares. Here’s the catch: the management team has given Neumann irrevocable proxy voting for those Class C shares, insuring that Neumann maintains all of the votes of the super-voting shares!
- Neumann has also left open some opportunities for new ways to treat himself differently. The company says that it will not provide a dividend for normal Class A public shareholders. But it is silent about Neumann’s special Class C shares.
WeWork is Neumann’s company. He can make whatever financial decision he wants. He could pay himself a dividend through his Class C shares. He could grant himself as many new shares as he wants (and replace any board members who don’t agree with him). Neumann can also make any operational decisions he wants. In 2018, WeWork stopped providing meat at corporate functions and stopped reimbursing employees for meat at business meals. What if Neumann decided to remove meat from WeWork facilities—or leveraged its investment in Laird SuperFoods to go vegan, replacing milk with Laird’s milk substitute? Would those changes benefit the company as a whole and its shareholders?
As investors, the biggest issue with Neumann’s control is that there isn’t a reliable way to predict how the company will be run. In a normal company, a primary goal is to maximize the value to shareholders. WeWork, however, will be run however Neumann wants it to be run. Neumann may make decisions that will maximize the value of all shareholders, or maximize the value of his holdings alone. Or he may make decisions that will elevate the world’s consciousness instead of creating shareholder value for anyone. The company is explicit that he has complete control, stating Neumann “has control over key decision-making as a result of his control over a majority of the total voting power of our outstanding capital stock.” The company seems to think that Neumann’s control puts the company’s interest in sync with shareholders, stating “As a founder-led company, we believe that this voting structure aligns our interests in creating shareholder value.”
We disagree. Voting control held by one person only aligns the company’s interests in creating stockholder value for the individual. All other investors will be along for the ride. We don’t doubt Neumann’s mission to elevate the consciousness of the world. But his proven history of favoring his personal financial interests over that of his company’s makes him a poor fiduciary for outside investors.