WEWORK: A DIFFERENT PERSPECTIVE

WeWork has become infamous example of an investment gone wrong, but the company might not have shown us all that it has to offer just yet.

The company’s recent failure to raise money through an IPO has brought to light its current state of affair: unbelievable losses, a runway of just a few months, shady personal deals and voting power of the CEO, the internal decision-making of Softbank and curious stories from former employees. But is any of this a surprise? Not really, the unrealistic valuation of WeWork has been talked about over and over again at every round of funding in the last few years, as well as the strange and very simplistic figures on which the valuation was based, considering the size of the deals, that many analysts can now say “I told you so”.

So why did the company continue receiving investments? Who is to blame? And is there something that we’ve missed?

WeWork was born in 2010 and is headquartered in New York City, offering coworking spaces and offices in numerous locations, first only in the US and now in many countries across the world. The company’s business model involves leasing existing buildings and redesigning them to become modern and trendy workspaces. None is this is very original, as there are countless companies, big and small, doing the same, except for the way the company promotes itself. WeWork wants to be seen as tech company that revolutionises the way we work and live: its recent rebranding unveiled its parent company, the We Company, which also owns WeLive, which are coliving apartments, so far only in DC and NY, and the already defunct WeGrow.

The company attempted to get listed on the stock market at a valuation of $47 billion, and after its internal failures came to light, the company initially delayed its IPO and was instead refinanced by Softbank at a post-money valuation of around $9-10 billion, less than the $12.8 billion that the company raised from investors until Q3 2019, which shows how no value was effectively created from the money invested. WeWork reported a loss of $1.6 billion over a profit of $ 1.8 billion, which takes a special destructive effort to achieve. However, Softbank’s recent takeover of the company and doubling down on its bet on WeWork will involve a 3-year plan to turn around the business,  before a new IPO attempt can take place.

“The The We Company‘s guiding mission will be to elevate the world’s consciousness.”

Ok well, many startups have an ambitious and creative mission. Let’s look at its main business: WeWork. There is a market of increasing independent professionals who use coworking spaces to socialise, companies moving into coworking spaces, as well as a trend towards modernising workspaces, bringing people together, ensuring that the workspaces motivate and inspire teams. The way we work is changing with more independent and flexible work, and a higher need and expectation to socialise during the work day. However, there is also a trend towards more remote and virtual work, and massive competition in almost every city. Sure, WeWork offers a few perks, but the differentiating factors are not always obvious and not everyone is willing to pay for the added advantages compared to other coworking spaces and offices, when these are present. This has become apparent, so that 40% of WeWork’s clients are actually companies with more than 500 employees, which offer more recurring revenue to the company.

The main criticism towards WeWork has been the fact that the company is not a tech company as it claims to be. Many claim that it is not scalable, and therefore it shouldn’t have been financed by VCs, especially not to this extent, and its valuation multiples are those of a tech company, and not multiples suitable to a traditional business with high fixed costs. In fact, fixed costs point to a much longer path to profitability when combined with a fast-growing strategy. There isn’t anything essentially negative about having a traditional business model, as some of the best investments originate from entrepreneurs who modernise traditional industries. The problem is the added personnel, development, sales and technology costs that belong to a scalable startup and that cannot be sustained on a traditional business model where margins are limited. Innovating in a traditional industry can mean:

  • reducing costs by streamlining some activities (WeWork has done so by creating a large network of offices with some centralised activities, but most of the on-site personnel activities cannot be streamlined, and with the added branding the total costs are not reduced)
  • increasing revenue per customer with added services (since competition is high, there has been a limit on how much revenue WeWork can earn per customer, and very few differentiating services have been added that other offices or coworking spaces do not already provide)
  • increasing the value of the company through its tangible or intangible assets (WeWork does not own most of the buildings it leases, and has not built considerable assets to decrease the risk of the business)
  • gaining market power with suppliers or with customers (WeWork hasn’t done this either, as power over suppliers in this market is unlikely to be achieved across multiple countries, but it also hasn’t done enough to lock in its customers in the long term)

Despite this, WeWork has an interesting and relevant concept, which could have been (or can still be) successful with a different business model, and by building up more competitive advantages over time and a different type of innovation. The reasons why this wasn’t done was:

  • Easy money and lack of monitoring and scrutiny by investors, which didn’t push the company to rethink its strategy early on
  • Investors’ focus on innovative branding instead of actual innovation as a proof of value, which doesn’t work in this specific sector
  • High negotiating power of the CEO, who fits the founder personality that many investors look for
  • Unbalanced focus on growth rather than profit, which could at least shift from 100/0 to 75/25 for startups (or at least have a focused exit strategy where the losses can be managed and turned around at the time of exit or IPO)

In short, the investors played an important role in the recent IPO failure, as easy capital does not create innovation. How Adam Neumann managed the company is in no way justifiable or defensible. Leasing back his own property to the company and trademarking the ‘We’ name to extract more money from WeWork (or now The We Company) is a strong conflict of interest: these are certainly not the actions of someone who is prioritising the company’s interests. However, Adam Neumann did, even if taking it a step too far, what most startup founders try to do: using his own personality and sales skills to raise money, using connections in the industry, increasing his negotiating power, undergo as little scrutiny as possible, making as much money as possible, capitalising on the investors’ hunger for fast-growing companies. These are the rules of the game in a Venture Capital industry that places big bets on companies with unicorn-potential, as is needed to achieve a sufficient return on investment, and is therefore easily swayed by overambitious personalities, big promises and large markets, with the sometimes false premise that it’s impossible to foresee which companies can be truly disruptive and create value. In doing so, however, the fundamentals of many markets are completely ignored.

For funds, reinvesting in companies that have not met expectations is sometimes necessary in order to recover at least part of the investment, and the more a fund has invested, the more it is likely to keep reinvesting into the same company to ensure that an exit is achieved. The company’s brand recognition could also motivate funds to try to avoid a very public failure. Softbank’s recent investment into WeWork is understandable, as not all hope is lost for the company: what is more dubious is the little oversight or decision-making power that the investors have exercised over time, considering the size of the funding rounds.

Most companies have a flawed strategy, that’s why they fail, and that’s why they cannot raise more money. That pushes founders to start up again or fix the company’s strategy until they succeed. Thankfully, exposure to the stock market has provided this much needed feedback now, and is forcing the company’s management into a reality check. So what’s next for The We Company now that Adam Neumann is gone?

Viewing the company as a total failure would be just as narrow-minded as viewing it as a total success.

It is obvious that the popularity of its brand, its office design, its focus on collaborative workspaces and its ambition to transform and become the market leaders in the industry has been received positively by both customers and investors, so it would be wrong to ignore this. There are still a variety of things that the company could do to improve its strategy and profits:

  • Setting a shorter time frame for new development projects to succeed, to ensure a quicker return on investment and reduce business development expenses (in the long-term only), possibly by changing the company’s mission away from elevating consciousness, into something more concrete.
  • Testing less obvious added services that the company can offer to its customers. Since The We Company aims at improving collaboration in the workplace and community living, and since it is increasingly gaining corporate customers, there are a few ideas that the company can test around the provision of technology, access to joint coworking and co-living solutions for companies, as well as added perks that make working life easier, with a focus on what customers are willing to pay for rather than blind innovation.
  • Increasing synergies among acquired companies and additional focused acquisitions aimed at integrating different services (which may only be possible with the money raised after an IPO).
  • Investments into real estate, in exchange for slower growth, to reduce risk and secure a more stable value over time.
  • Investments into more secure intangible assets and stronger competitive advantages.
  • Creating a more cohesive community among its customers, and communities that are easy to access in all of its locations.

What is the valuation of WeWork then? This, in my opinion, depends a lot on the funds raised at IPO and how they will be spent. It also depends on how well they are going to implement the set strategy, which, looking at how the company manages its finances, leaves some doubts.

Multiples at IPO for some tech companies are generally very high, often higher than typical acquisition multiples, and therefore the WeWork valuation would be very different in an IPO transaction that it would be in a typical acquisition. Most people focus on the value of the core company at IPO, and the losses should definitely raise some eyebrows when they indicate bad management, but it’s not always the case. If the company can use the funds raised, not just to grow, but to make acquisitions of other companies that perfectly complement the company’s core business, then a significant value can be created from synergies that originate from the joint company. This is the case of more scalable businesses like Facebook, or Google. For companies like WeWork and Uber, instead, the value of synergies that can be created from the acquisition of new companies is present, but limited. Multiples at IPO are generally high, also due to the fact that the valuation is set behind closed doors by investment banks and it is sold to the public market, that may not have all the information available, as well as being influenced by the hype and the need for significant funds to be raised.

Ignoring forward revenue, Facebook raised money at IPO at a valuation corresponding to roughly 28x EV/ Revenue. WeWork’s proposed IPO valuation corresponds to roughly 26x of its 2018 revenue. It’s not far off, and Facebook managed to meet the expectations implied in its valuation. However, Facebook was did not have losses of $2 billion a year, it had built up more value through its intangible assets and it is a much more scalable company. WeWork is unlikely to get to profitability as fast just by increasing growth, as the company has much higher fixed costs. It needs the right kind of growth to drastically increase margins and it has less flexibility in how this growth can be achieved, compared to the typical tech company. Uber had a valuation at IPO of roughly 7x EV/Revenue, a much different number and more in line with the typical fast-growing startup. However, I believe the scalability potential of WeWork to be higher than that of Uber, which could indicate an acceptable valuation for WeWork to reach up to 10x EV/Revenue.

I am usually a fan of detailed financial plans and discounted cash flows. However, multiples give us a quick view of how a company is valued compared to the rest of the market, even though it is a simplistic view and it does not incorporate future prospects. Often you see multiples based on speculative forward revenue figures, whereas it makes much more sense to calculate multiples on current yearly revenue or trailing revenue figures of companies growing at the same pace. The issue with any valuation of unicorns, is that their disruptive business model makes it difficult to compare them to anything else, and revenue, especially pre- and post-IPO can change dramatically. However, a clear strategy and financial oversight of companies listing on public stock markets, is a fair expectation.

WeWork has boldly followed a fast-growing strategy as a non-tech company, which very few would have done with the same motivation and long-term vision. Having done this, however, the company could be well-place to implement a new business model on a large scale, and actually become a tech company, or at least a company with medium-scalability. However, potential is not reality, and at the time of IPO, WeWork had neither unveiled a better strategy, nor shown the necessary reliability to be trusted with spending the funds raised in value-generating projects.

Speculating on what its IPO valuation should be, without knowing what its future strategy is, would not make much sense, but it’s unlikely to be over 20x revenue. Its current valuation is a more realistic 5.5x EV/ Revenue. If we speculate that the company could potentially get listed with a multiple of up to 10x EV/ Revenue (based on realised yearly or trailing revenue), provided that it demonstrated a (still absent) path to sustainable profitability and a strategy that is based on real market expectations and added value (meaning that the money raised should not be used just for organic growth or to cover the losses, but to invest in new value-generating projects). Considering WeWork’s trailing 12 months revenue, which could reach $ 4 billion if it continues on its current growth path, the valuation could reach between roughly $40 billion in the near future (or higher in 2–3 years), in the range of its initial proposed IPO valuation, however only by providing proof of its improved strategic direction and better financial oversight, as well as avoiding a slow-down in its growth figures.

Whether the public and investors will forgive its recent blunders and the company can regain a positive image after months of bad press, which could lead to a discount on its future IPO, is all to be seen. The company’s future now is uncertain and whether its investors will continue backing The We Company and leading the new management to a new IPO, is also unknown. What is important, though, is that the fate of these unicorns can reflect on the funding trends and the strategy of many future companies to come, and that each of them, Facebook, WeWork, Uber and many others have all had many smaller successes and failures that we should take into consideration and that serve as the blueprint to value future potential unicorns.

Tip: watch this analysis of how WeWork could generate money in the future

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