A few days ago, WeWork, the coworking firm now known as The We Company, released its S-1 (IPO prospectus) filing to go public. That spurred numerous concerns about the company’s large valuation of $47 billion, given its hefty losses of $1.6 billion on revenues of $1.8 billion and despite its rapid growth of 86% year-over-year (YoY) revenue growth. Its mission statement is to “elevate the world’s consciousness.”
Yes, you read it right! This is not Rajneesh’s ashrams’ mission statement but a company who claims to be disrupting $1tn market and has signed a lease agreement of over $45bn and asking for a valuation of ~$50 billion!
Rushin Shah, based right there in US, discusses in detail this ‘never happened phenomenon’ and he finds the S-1 more of a marketing brochure, filled with nonsense things.
Now the big question is: Is the startup-mania reaching to its final stage!?
Read to get the answer.
The Birth of WeWork
The idea for the WeWork, co-working space provider/real estate manager, was launched in 2008 when present-day CEO Adam Neumann and chief culture officer, Miguel McKelvey founded Green Desk, an eco-friendly co-working space in Brooklyn. In 2010, the duo sold Green Desk with seven-figure profits and established WeWork in New York’s SoHo district with $15 million investment from real estate mogul Joel Schreiber.
WeWork offers coworking spaces to entrepreneurs, Startup companies, freelancers and even larger enterprises. The Company has grown rapidly ever since its establishment, making it one of the largest and most visible coworking chains in the world. It now has more than 5,000 employees and nearly 600 locations worldwide, including outposts in dozens of U.S. cities and 32 countries, like Brazil, Germany, and India.
Right now, in 2019, WeWork is one of the most valuable VC-backed companies in the world and took over the top spot in the US after Uber went public in May. WeWork is valued at $47 billion following a $2 billion investment from SoftBank. That is more than doubled its valuations from its most recent round two years prior and represents a staggering increase of nearly 500x from the $97 million valuations the company reached with its Series A in 2012. After a massive amount of fundraising, the company is aggressively pursuing growth with an abundance of recent acquisitions. WeWork has bought nearly half a dozen companies so far.
Adam Neumann is also an interesting personality. He is more than a founder and CEO at WeWork. He’s also a landlord, a seller of intellectual property and a financial borrower. The name Adam appears 169 times in the S-1 vs. an average of 25 times for founder/CEOs in other unicorns’ S-1s. The financial prospectus shows the interdependence of Neumann and his family that runs deeper than most entrepreneurs to their creations. Certainly, no doubt that Adam Neumann is a phenomenal salesman and a champion of exaggeration.
News has just come in that WeWork has shelved its plans for an initial public offering. The move is the clearest sign yet that investors are increasingly wary of ambitious young companies that have run up huge losses and might not become profitable for years. Without a large infusion of capital, the company is expected to slam the brakes on its breakneck expansion. Analysts estimate that at its recent growth rate, it could run out of cash by the middle of next year. The company had $2.5 billion in cash at the end of June.
The Business Model
The basic concept of WeWork is to sign long-term leases on office space and then releasing them on shorter-term deals to make a decent amount of money. And this arbitrage works in virtually all cases, the per-day cost of a short-term rental is higher than the per-day cost of long-term rental. A two-year hotel lease is cheaper than booking a room every day for two years. People who are renting things out like the certainty that comes with a long-term lockup. Airbnb rentals frequently offer a discount for stays that last longer than a week. While, on the other side, renters value the flexibility that comes with short-term commitments – this is essentially what WeWork’s core business is. It signs relatively cheap long-term leases and then resells them as relatively expensive short-term leases.
WeWork indeed offers some value-added services like designs, meeting spaces, staffing, etc. This is the biggest flaw in the business model. The implication of creating a company that absorbs all of the fixed costs to offer a variable cost service to other companies is massive amounts of up-front investment. There is nothing more fixed than real estate, yet WeWork transforms real estate into a variable cost for all kinds of companies. WeWork needs to build out offices spaces before it can sell desktops or conference rooms. It would be strange if WeWork were not losing tons of money, particularly given its expansion rate.
The company offers four levels of membership: Hot desks, dedicated desks, private offices, and custom build-outs. The cheapest option for single workers (generally freelancers) is the hot desk, when users pick a primary WeWork location, show up whenever they wish, pick any available seat in a common area and start working immediately. For those who want a little more stability, WeWork offers dedicated desks that they lease to one client or one business only. All size of businesses can opt for private offices, which come equipped with furniture and can accommodate dozens of workers as businesses grow. WeWork has a strong national and international brand for featuring hip, modern offices so clients can feel reasonably confident about what they’ll be buying without doing an extensive search. The most personalized option is a custom build-out, which presents maximum freedom for groups that want to customize their workspace with features like CEO suites, conference rooms or labs. WeWork tear apart buildings and then transforms them. It has already done this for companies like Facebook, Microsoft, HSBC, Deloitte and many more.
In short, WeWork is a low-commitment partner for many businesses. This is extremely convenient for customers and it explains why WeWork has grown quickly. Leasing more and more office space in more and more markets, renovating it, and then sub-leasing it to individuals, small businesses, and increasing big ones too. But just because something is good for customers doesn’t mean it’s good for investors.
Lots of businesses lose money in recessions and it is quite understandable. But WeWork isn’t even making any provision for this eventuality. Real landlords try to lock up tenants with long-term leases precisely to maximize their ability to ride out recessions. WeWork, instead of doing that, is exploiting landlords’ desire to lock things down by leasing properties at affordable prices and then subleasing them in the short-term for higher prices. That effect transfers recession risk from the owners of office buildings to WeWork and eventually to its shareholders. But WeWork isn’t building up cash reserves that can help it ride out a recession instead it is borrowing money from capital markets to fund capital expenditure programs (CAPEX).
This entire business model of losing money and chasing growth suggests that the whole company would just go bust in a downturn. And some of the company’s new ventures like WeGrow (private schools) and WeLive (apartments and hotels) is an implicit acknowledgment that the underlying business is shaky.
Is WeWork a Tech Company?
The word “technology” appears 110 times in its prospectus and its claims of being a tech company and thus WeWork is demanding a tech-type high valuation. A modern-day real estate company which is purchasing long-term leases from landlords and renting them out as short-term leases to tenants, how the hell it can be a tech company? WeWork is not transforming or disrupting any industries, it can’t achieve a scale at breakneck speeds, it doesn’t make any profits, and it does require significant capital investments to sustain its growth. How can WeWork compare itself with Google, Facebook, and Amazon?
WeWork has positioned itself as a star of the sharing economy, a “technology platform” that connects consumers to office space, just like Uber and Airbnb connect them to cars and homes, respectively. But how can an infrastructure-dependent real estate company scale like a lower overhead software startup? How can a company that signs 15-year leases but sells monthly memberships expect to survive a recession? How could WeWork survive in two bubbling markets, that is, tech and commercial real estate (and, sooner or later, there is always a bubble in one of these two markets)? WeWork is an office rental company. Period! Even if it becomes the largest and most successful player in the business, it will have significant operating expenses (OPEX) like rent, utilities, maintenance and repairs, insurance, etc. and, therefore, it will always be operating on a wafer-thin profit margin.
The Absurdity of WeWork’s Corporate Governance
Generally speaking, the startup world is hardly a model for good corporate governance, but WeWork has taken the absurdity entirely to the next level! WeWork paid its own CEO, Adam Neumann, $5.9 million for purchasing the “We” trademark. A few months ago, The We Company undergo restructuring through which it created a limited liability company (LLC) to hold the assets; investors, however, will buy into a corporation that holds a share of the LLC, while other LLC partners hold the rest, reducing their tax burden. WeWork previously gave Neumann loans to buy properties that WeWork then rented! WeWork has hired several of Neumann’s relatives, and Neumann’s wife would be one of three members of a committee tasked to replace Neumann if he were to die or become permanently disabled over the next decade. Neumann has three different types of shares that guarantee him majority voting power; those shares retain their rights if sold or given away, instead of converting to common shares. Recent reports indicate that Neumann has cashed out $700 million of his holdings via sales and loans. Everything taken together hints at a completely unaccountable CEO looting company!
Why so desperate for an IPO?
There are a few reasons to launch an IPO but the biggest one is to take on new investment. Second, IPOs also let insiders’ cash out. S-1 reveals that before 2019 Adam had not received any equity awards but as the company got larger Adam received options to purchase more than 42 million shares and that’s the precise reason behind WeWork going for an IPO. This led to the $362.1 million loans Adam got in April from The We Company to exercise his stock options. Adam swapped out a portion of those options which valued at more than $360 million in a complicated transaction with WeWork that gave him a financial instrument tied to future WeWork profits! Can you imagine what is going on? WeWork granted options to Adam and also gave him a loan to exercise those options!
Fear of Missing Out (FOMO)
Startups don’t turn into unicorns without a good story attached. For WeWork the story revolves around creating a space for the new generation of young workers (mainly millennials) who want to be creators and collaborators, not just office staffs. It’s that promise of personal fulfillment that allows CEO Adam Neumann to claim that his company is on the path of “elevating the world’s consciousness!” Investors are bullish on this story. WeWork’s investors include many global investors, including SoftBank, private equity firm Hony Capital, and real estate developer Greenland Holdings.
In August 2017, SoftBank and its founder, Masayoshi Son, poured a massive $4.4 billion investment into WeWork. This included $3 billion for WeWork itself, namely through primary investment and the purchase of existing shares, and $1.4 billion dedicated to WeWork’s expansion into the Asian market: WeWork China, WeWork Japan, and WeWork Pacific. In August 2018, WeWork announced yet another $1 billion in funds from SoftBank. WeWork had approximately raised nearly $7 billion in private equity and venture capital (PEVC) funding since its founding. Adam Neumann and WeWork have mastered the art of storytelling that locks down massive rounds and earned the valuation of Silicon Valley’s startups! At $47 billion price tag, WeWork is one of the most valuable startups to emerge from the tech boom.
One of the reasons behind this sky-high valuation of WeWork is SoftBank – a name which appears 51 times in WeWork’s S-1. The strategy of SoftBank and its $100 billion Vision Fund is to put enormous sums into the most successful tech start-ups in a given category. These investments are huge and often push the companies to surpass their competition in both valuation and scale. SoftBank’s total investment in WeWork including its Vision Fund is around $10 billion. What many people don’t know is that SoftBank’s investment is at a “pref,” meaning their money is the first money out, limiting the downside and last round private valuations are harmful metrics that create the illusion of prosperity!
WeWork is the poster startup of a funding climate fueled by fear of missing out (FOMO) and driven to extremes, where valuations can double in a matter of months and where investors who are so desperately afraid of missing out on the next unicorn will ride the horse. And that’s why narratives are extremely important in investments. Investors are not solely evaluating the company’s story; they are also evaluating entrepreneurs’ ability to convey that story! If Neumann can convince SoftBank that rented offices are the next Google, he can convince freelancers to pay $450 a month for a desk, and then he can also convince Microsoft or Deloitte that they need to start co-working next to these creators!
When you’re growing at hyper-speed, current results offer a clearer picture of potential. Real estate investors, for example, pay more attention to cash flow because it reflects what a company will be able to generate. But in the world of startup-mania where capital is extremely cheap, investors tend to look away from short-term profitability and instead gaze upon the mammoth size of the potential market ($1 trillion in the case of WeWork) due to compelling storytelling of entrepreneurs’ like Adam Neumann.
WeWork can make a credible claim to all these characteristics, but the story is so compelling because it is unfolding in front of us and no one ever got mega-rich on a safe bet. The idea of WeWork might work, imagine the fundamental shift from capital investment to variable costs and the benefits were no more about saving dollars and cents but increasing more flexibility and optionality, but everyone is overestimating market share and pushing assumptions to sky-high. Companies like WeWork could find successful business models and still not grow into their valuations. This paradox might be reaching to its extreme as WeWork is getting ready for Nasdaq listing.