Mr. Neumann, what are you thinking?
Just when I thought this story couldn’t get any weirder, it did. In the last year, WeWork (or should I say “the We Company”) has continued to bewilder me. From its rebranding in early 2019, to its disclosure that its CEO bought properties which he then leased to his real estate startup, to the shoddy financial performance — oh, and most fittingly, they plan to go public by the end of this year — WeWork has received loads of media attention.
News just broke that Adam Neumann, CEO of the company, has cashed out on more than $700 million from the company just before its upcoming IPO. This is less than two weeks after the company announced it plans to issue $4 billion in debt before the public offering.
It seems off-putting to me that a company expected to go public, and recently valued at $47 billion, would feel the need to issue debt at this particular moment. Which begs the question, why is WeWork going public to begin with?
Earlier this year in January, SoftBank originally planned to invest upwards of $20 billion to fund WeWork’s rapid plans for growth and buyout some existing shareholders, but it cut back that investment to only $2 billion after facing opposition from several partners in the firm. After this cutback, WeWork decided it needed to go public as a last resort for continued growth.
It would appear to me that Masayoshi Son is the primary reason WeWork is even surviving at this point, albeit at a $47 billion valuation, and even he has started to have doubts in the business. I’m personally fascinated by the phenomenon we are seeing with so much capital in private markets that some tech unicorns are able to grow into relatively mature companies before even considering a public offering, implying that private markets are flooded with capital these days (a story for another day).
This occurrence is even further prolonged by not just early VC investors, but late stage growth investors (including Softbank) who continue to fund these unicorns, and the founders can cash out a bit at a time at their own pleasure.
However, returning to the initial point of this article, a founder of a company (industry aside) taking out $700 million before its IPO is completely unheard of. Of course there have been some situations that went unannounced, but even the most prominent instances were nowhere near this magnitude. Zynga’s founder Mark Pincus took out over $100 million, and Groupon’s co-founder Eric Lefkofsky sold over $300 million in stock before both companies’ IPOs in 2011, and look how they’ve both performed since then:
This isn’t to say that WeWork will perform similarly; however, it’s definitely not a good look for the company in its run-up to the public offering.
There are more pressing questions that need to be answered about how WeWork is justifying a $47 billion valuation. First, just look at their 2018 financials:
Sure, their revenue is continuing to grow consistently, but they continue to burn through cash. Their net loss for 2018 was $1.9 billion (over 3x their revenue alone that year) and double last year’s loss.
Okay, let’s just look at EBITDA (still a $250 million loss). I guess you could add back sales & marketing ($372 million) and other various “non-recurring expenses” and call it “community-adjusted EBITDA,” but I would argue that sales & marketing is just as recurring as taxes (oh wait) when you operate a business at that scale. But would you look at that: suddenly they look profitable, judging by this novel metric they’ve created. I digress.
Financials, questionably-timed bond offerings, and founder cash-outs aside, is WeWork’s business model really sustainable? I am completely supportive of their mission and a company creating a coworking space, but couldn’t someone else just duplicate this same business model? Say, a real estate firm who owns a ton of office space (there are thousands of REITs and large private equity firms with loads of cash).
The problem is that WeWork is a middleman in a world where middlemen are becoming obsolete due to the very disruptions they are trying to replicate. What is stopping the owners of other office buildings from renovating the space, creating a hip and open floor plan, adding a free beer kegs, and leasing it out to startups? Their rebranding to the We Company early this year was merely a stalling mechanism to shift attention away from the fact that their original business model lacked an economic moat.
You could argue that WeWork has been proactive and is buying its own properties to confront these issues. The problem is that 1) Real estate is capital-intensive, 2) WeWork is losing money and will lack cash, and 3) It takes a long time to actually go out and buy properties and renovate them. Even if they act quickly, it could take over a year between the time WeWork buys the property, renovates it, actually fills it, and finally starts earning rent on it. This would result in capital sitting idle for a year or more, not generating cash for them (which is what they will desperately need).
Now, let’s look a few more years out into the future. Regardless of when it might finally happen, an economic downturn will inevitably occur. When we reach this point, will startups and people working there still be able to afford these glamorous co-working spaces? Most likely not — they will probably shift to remote locations and work from home. Their product offering is a luxury good that has been riding one of the longest economic expansions in US history, but they are in for a surprise, as they still haven’t even come close to generating profits.
On the other side of the capital flows, investors will have to start being more disciplined with their investments in the case of a recession. This means WeWork won’t continue to be essentially subsidized for their losses by Softbank until they turn a profit (unless Son still believes in them).
So we must ask ourselves, is WeWork a real estate company or a tech company? Sure, they can be a visionary, world-changing tech company and receive absurd valuations. Or on the flip side, they could be a real estate company and take out huge sums of debt so they can invest in buying their own properties. But, they can’t be both. They can’t possibly be worth $47 billion dollars if they’re truly a real-estate company, or even a “real estate company with pixie dust,” as the WSJ describes them.
I want to conclude by saying that I respect Adam Neumann. It is remarkable that he has been able to convince investors with his visionary ideals to fund this idea of his at the valuation he has received. And while he only owns about 30% of the stock through We Holdings LLC, each of these shares offer him 10x the voting power, so he isn’t leaving the company anytime soon.
WeWork is, in many ways, a miniature representation of the broader world of tech: rapidly changing, burning through cash, but continuing to defy expectations. While a part of me believes they are going to crash, there’s an even more sensitive part of me that hopes to be proven wrong.
