WeWork: A $47bn House of Cards Ready to Fall?
With big investments the probability for big failures rise, that is a part of the Venture Capital world but it has been surprising to see the blitz of news articles over the past few days ‘celebrating’ the demise and almost writing obituaries on WeWork and its business.
So around Christmas last year, Adam Neumann CEO of WeWork had received an eye-popping offer of $20bn from Masayoshi Son, founder of Softbank and its existing investor. That sum of money had the power to help Adam execute his boldest ambition for the business and buy out all his existing investors. Alas, that was not to be as the December market turmoil led Softbank’s stock to plummet 20%. The $20bn offer was downsized to 1/10th to $2bn at a revised valuation of $47bn.
The reduced numbers pose big challenges for Neumann and his team and it is likely to be a constraining factor in the business model where in growth till now has been fueled on the back of ever increasing capital raise and spend in billions to expand globally. For instance, in the first 9 months of 2018, WeWork generated $1.25bn in revenue but lost almost $1.22bn. Moreover, the need to raise capital despite raising billions has also prompted it to explore the debt market and raise $500mn in the junk bond market at interest rates of 8% in April 2018. In its bond documents filings, some startling numbers were also uncovered. The company owes $18bn in rent. And although its revenue doubled to $822m expenses more than doubled to $1.8bn which meant net losses came to $934m in 2017. Of course as e-commerce introduced Gross Merchandise Volume (GMV) as a vanity metric, WeWork has its own special metric called ‘Adjusted EBITDA before Growth Investments’ (which essentially takes out all expenses relevant to the business such as taxes, interest, depreciation, amortization and sales & marketing costs) on the basis of which the company generated $49m in 2017.
Coinciding ironically with the new fundraise, the company is also shifting directions and renaming itself to WeCompany. It hopes that this will allow it to open opportunities and expand beyond its core focus in commercial real estate. Plans are on to have three business units- WeWork the main office rental business, WeLive a shared residential unit (really hope this works!) and WeGrow an evolving business with elementary school and a coding academy. The two new verticals will be introduced this year.
While talking about the change, Neumann and his co-founder Miguel McKelvey were optimistic and mentioned that their vision extends beyond this since they had planned for literally everything from WeSleep to WeSail to WeBank as per their first pitch deck made in 2009. They are also hopeful to launch WeBank soon. Neumann especially is of the opinion that the company has reached to that scale where they can execute on their initial plans.
However, if we dig deeper it becomes clear on why the company might be looking to expand beyond its core business model which is super risky and essentially sits on a ‘time bomb’ with increasingly high chances to explode during a recession. There are larger questions also being raised on whether the company’s strategy of raise more, spend more will work in the market environment which is becoming subdued. On the supply side, WeWork enters into long-term leases on its office space for 10 or 20-year terms. On the demand side, its clientele mostly comprises of startups and gig economy workers with an uncertain lease period who typically rent premises month to month and have the option to take the first flight when the economy goes south. Further as the economy increasingly moves towards signs of a recession in near future as interest rates creep higher and real estate prices flatten WeWork will still have to pay $5bn in 2022 and $13bn in 2023 which creates a classic ‘run on the bank’ disaster scenario if their clientele desert but its lease payments remain due.
Neumann remains optimistic and says that nothing will throw WeWork off pace. Moreover, he also feels that lower lease prices and subdued markets can indeed create new market opportunities. That indeed could ring true because if WeWork is unable to pay rent it can pivot to a ‘property manager’ model (similar to the Hilton Hotels) while still being able to survive albeit after taking a big hit.
The next 12–18 months will really be the litmus test for the company where it tries to reduce its burn in the core business, push up rentals while managing the arduous task of launching new verticals against the backdrop of a real economic downturn. In 2017 Scott Galloway, a marketing professor at NYU Stern School of Business had argued that WeWork is unarguably the most overvalued company in the world and it might be about time his prediction come true for the startup.
Will Neumann and Son have the last laugh on this or will it be a $47bn ‘house of cards’ as critics have derided or has it become ‘Too Big to Fail’ necessitating its tenants to come to its rescue? Only time will tell as the ‘do or die’ stage nears for the company to justify its crazy $47 bn valuation. With a 2019 IPO on the cards and other tech startups such as Lyft, Uber, Airbnb also knocking the IPO doors the chances are bleak although it will be exciting to see how the year unfolds!
The views and opinions expressed in this article are those of the author and do not necessarily reflect those of any institute or organization he is associated with.
If you liked this article, you may want to check my previous ones at: https://medium.com/@keshavbagri10
