Updated: Oct 18, 2020
Note: This article was originally published on October 10, 2019
WeWork is the largest tenant in New York real estate market with 5.3 million sq ft of space. It has reinvented the way people collaborate. The company was valued at $47 billion in January 2019, which made it the 4th highest valued startup in the world, and is now valued at $10 billion. In comparison, Regus a competitor to WeWork is valued at $4 Billion and is currently profitable. With $12.8 billion raised from capitalists and investors, primarily SoftBank which owns around 30% of the company, and occupying 500 buildings around the world, the unpredictable plunge, prevented the largest co-working company from going public. Analyzing the result, it makes everyone wonder what led to decline. Could it be a temporary decline as a result of CEO, Adam Neumann’s resignation or is it due to a bigger problem, a flawed and an unworked business model?
“WeWork isn’t really a real estate company. It is a state of consciousness, a generation of interconnected emotionally intelligent entrepreneurs.” — Adam Neumann, ex CEO, WeWork
WeWork positions itself as a new-age tech startup, but its business model is similar to a traditional real estate lessor. To put simply, the model is to lease out most of it buildings and renting out the spaces in the building. This model isn’t unique. IWG, formerly Regus, has been operating the same business model since 1989 and is listed on the London Stock Exchange, so its market cap is known at $3.7 Billion. WeWork works well for startups, for people who want to network and for companies that wish to have a flexible presence in a city without having to deal with long term contracts. A key aspect is that, unlike the landlords, it can charge any amount to the customers, even unreasonably low thanks to the capital it has raised over. Where is the problem though?
A landlord can do what WeWork is doing and make profits but the differentiation factor is that the lease price initially set remains consistent over the term of the lease. WeWork on the other hand, can charge customers any amount. This works well, if the property value rises but it does not, if the property value falls. Hence, the risk factor is high for WeWork and low for the landlord. Another risk is the mismatch between long term lease liabilities and short term revenue contracts. Most of the buildings are leased for 5, 10 or 15 years but as the revenue contracts are for a few months, there is always a risk of the customers leaving for an alternative space. In terms of space structure, most of the WeWork’s spaces are dedicated to communal areas: couches and chit chat spots that do not generate revenue. IWG operates around 20% more usable square feet of office space than WeWork. That’s a big problem for WeWork when you’re the largest tenant in cities like NYC, SF & LA. WeWork has become trendy over the last few years and has not experienced a down yet. Even though that’s the case, WeWork is far from being profitable. Revenue increased from $886m in 2017 to $1.8bn in 2018, but it came with a price, with losses also increasing from $1.2bn to $2.2bn.The economies of scale are absent and the business model has high risks. There have been a lot of red flags which show it isn’t IPO ready yet. The company will likely require about $9 billion in cash simply to fund itself through 2020.
The sheer number of red flags this company throws up is unbelievable. Normally when assessing a company, you have to dig in the footnotes to find the warnings. WeWork just puts them all front and center. It’s almost disconcerting. Makes you question your own intuitions and judgment.”- Joe Weisenthal, Bloomberg
Neumann sold $700 Million worth of stock right before the company went public. This concept is called Secondary Sale, when a shareholder of a private company sells their share to another buyer. Secondary Sale isn’t uncommon. What’s uncommon is the size of this particular sale and the timing. Other companies where the startup founders sold shares Pre-IPO are Zynga, Groupon, Snap Inc & Slack. All of them have tanked over the last few years and had a founder who was looking at an exit option. This essentially means there is a correlation between a founder selling their pre IPO stock and declining company performance post IPO. Neumann also owned the right to the “we” trademark which the firm decided they must own and paid the founder $5.9 Million for the right to a name nearly identical to the name of the firm where he is the founder, and ex CEO and largest shareholder. Neumann owns some of the buildings and leases it out to WeWork at a great profit. The company has lent money to Neumann at interest rates under 1%. These below market interest rates suggest Neumann is getting a clear benefit. The biggest red flag is that a possibility of a recession is looming. If you think WeWork is in trouble now, wait for the recession to hit. WeWork is probably one of the most vulnerable companies, especially with its long term leases which only increases the risk. Real estate experts say that while coworking spaces will surely see customer losses as businesses go under and individuals and startups opt for cheaper overhead. They also stand to gain other customers in a recession as companies downsize and look for flexible office space. There is a tradeoff and it’s not clear yet how exactly that balance will shake out for WeWork, but the stronger the operating model gets the better likelihood they’ll survive a downturn. Source: CBRECoworking office space makes up just 2% of all commercial office real estate in the USA. This means it will not have a drastic impact on the overall real estate industry. It will however, affect the coworking ecosystem and industry. IWG, formerly Regus survived the last recession. It currently thrives as the biggest competitor to WeWork. “In our industry, you always need to be prepared for any major swings in the market,” Michael Berretta, VP of Network Development at IWG, said “However, the good thing about the current demand for coworking is that companies will continue to look for flexible workplace options, regardless of market swings.” One of the biggest factors to keep in mind for any business is to minimize risks. When you grow too quick, the risks only increase. WeWork has been growing rapidly recently. It has more than quadrupled its numbers of locations to 845 in 2019. At the current spending rates and high risks, WeWork could potentially be out of the market by early next year.
In a way, it’s great that WeWork did not go public. Apart from the red flags which shows it isn’t ready to go public, if it did go public, it would have made the winner-take-all venture capital model successful which is currently dominating Silicon Valley. Uber went public a few months back. The valuation was close to $90 Billion. Uber pictured itself as a socially oriented company facing an enormous potential market that it has only started to explore Critics were on both side of the tables. Some loved it. Others hated it. The clash between them is what makes IPOs fun. The best part of Uber is not the magnitude of the losses Uber has sustained, which is more than $10 billion operating losses over the last three years, but that pre-IPO investors have been willing to fund those losses by pouring in capital at an unprecedented scale, in the hope that they will reap the rewards when the stock enters the public markets. The largest shareholder of Uber is SB Cayman 2 Ltd. The investment represented SoftBank Vision Fund, a $100 billion mega-venture capital fund that has changed how the venture financing worked. The fund has been writing enormous checks to startups. Ubers broken IPO helped restore some sanity to the broken venture financing industry. SoftBank wants to make the model work as that’s why it’s essential that the WeWork IPO comes out right.
“Venture capital is supposed to be about finding good investments. SoftBank has made it all about size. The scale of the fund has transfixed the venture capital and investment management industries, as SoftBank makes ever-bigger and more unrealistic promises to sovereign wealth funds hoping for outsized returns.” — Prof. Mihir A. Desai, Harvard Business School & Harvard Law School Professor
There is a lot to learn from WeWork. Entrepreneurs must recognize that building a business is not a short term journey and should always be for the long run. There is never a short term alternative to create a business, built on a foundation of ethics and values. Investors on the other hand most reflect on how they encourage growth rate of startups at the rate of sustainability. There is a fine balance which has to be achieved, without which the startup ecosystem cannot boom organically.
“You, and your success, are meaningful. You can build economic security for yourself and others, and create great things. But humility, and a recognition that nobody in bigger than the market, is profound.” — Scott Galloway, New York University Professor WeWork’s parent company We Co. has picked up on the firm and is working on improving on it. Neumann’s voting power is being reduced along with his family’s control over the company. The strategy has to change remarkably and make significant improvements. I am hoping it works out. I truly am but it’s a long way from making the property value based business a public IPO success.