The We Company recently released its IPO prospectus. And it proved to be a particularly interesting one to dissect.
A brief disclaimer before we begin: let’s both agree that for practical purposes from hereon out I’ll refer to “The We Company” as its aforementioned name of “WeWork” for the remainder of this article. Many agree that “The We Company” can’t be said aloud without triggering a reactionary laugh. But far worse is trying to write “We” as a proper noun without creating complete chaos. We is a company with promise but we have yet to see profit materialize. What is happening with that sentence? I rest my case.
We (no pun intended) are now in a position to resume.
WeWork, valued close to $50 billion, is one of the most hotly anticipated IPOs this year, second only to Uber. Since it’s IPO prospectus was released, a lot of commentary circled around the fact that its prospectus positions it as a tech company. Twitter was alight with outrage that its S-1 filing used the word “tech” almost 125 compared to tech counterparts, like Facebook, which clocked in at just over 100.
But assessing the soundness of a business is much more difficult that cherry-picking a funny fact from its prospectus.
Before diving into the economics, let’s look at WeWork’s business at a conceptual level. At its most basic level, the concept of WeWork does actually aim to solve a painful problem. Real estate, especially in large cosmopolitan cities, is notoriously costly and difficult to manage. And WeWork, in theory, does aim to solve that particular pain point.
If you’re a business and you want your staff to co-locate in a space, you have two options. You could either rent a space, or you could buy one instead. If you rent, the length of leases for corporations tend to be multi-year agreements with little negotiating leverage and a very expensive operating expense. Alternatively, you could choose to buy, but that ties up funds in capex, funds that you may or may not even have. Either way, your operating or investing cash flow take a hit.
You don’t need to look far to understand how detrimental real estate expense can be to a business. Look at your local bodega or local bookstore that can no longer afford rent. Personal expenses aren’t any different. One of the biggest financial questions people ask themselves is whether to rent or buy.
All of this to show: 1) Real estate is a meaningful problem, and 2) WeWork at least deserves some credit for identifying that it’s a problem and attempting to fix it.
Economics And Business Model
But an idea isn’t worth very much if it doesn’t work in practice. WeWork has an arguably strong value proposition, but the business case and economics are much less clear. And from a business perspective, there is reason for concern.
- “Community adjusted EBITDA”: The company had previously created a new metric to assess its financial health called “community adjusted EBITDA.” There are reasons to self-develop a financial metric, but it has to be a good reason and well-understood. This metric, understandably, didn’t seem to resonate or stick with the market, so instead, it seems, according to the prospectus, it has moved to contribution margin.
- Contribution margin: In its prospectus, the company points to contribution margin to illustrate the health of the company, citing its goal to hit 30% contribution margin. But contribution margin is a useful measure for short-term decision-making, not necessarily the long-term health of a company. The underlying assumption is that variable cost is constant over the long-run, but that assumption feels less sturdy when variables costs are subject to real estate cost increases. But let’s take a look at the costs.
- Debt & Cash: A big part of the WeWork business model is to take long-term leases and lease them out to other businesses on much shorter leases. Their balance sheet indicates ~$22 billion in long term liabilities as of June 30, 2019 and yet they are relatively illiquid with only $2.4 billion in cash. The cash flow statement isn’t doing much to inspire confidence either, as it reported negative cash flow in 2018 of $176 million.
- OPEX: Opex isn’t very compelling, either. Operating expenses are growing at almost the exact same rate as revenue. If you have to pay more to get more, you aren’t scaling. If we dive into operating expenses, sales and marketing and growth and new market development expenses are the two cost categories that are growing at the highest rate.
|Select opex categories (not exhaustive)|
|Location operating expenses||433,167||814,782||1,521,129||87%|
|Sales & marketing expenses||43,428||143,424||378,729||195%|
|Growth & new market development expenses||35,731||109,719||477,273||265%|
|Depreciation & amortization||88,952||162,892||313,514||87%|
- OPEX – Sales & Marketing: The Growth & New Market Development expenses encompasses the cost of finding new locations, negotiating lease terms, and design and construction expenses. Sales and marketing expenses account for the cost of finding customers to fill the space. And while there is some evidence to suggest that Location Operating Expenses — the expense to rent and upkeep existing spaces — is decreasing as a percentage of sales, it is also because it has put more dollars into these sales and growth buckets. There is very little evidence that WeWork is successfully scaling the business. They can add all the new spaces they want, but the path to profitability remains unclear.
Peculiar Business Practices
I’m afraid that isn’t the end of the story. Arguably, the most worrying data-points are those that are dip into the question of ethics.
- When a founder sells shares of his own business, it immediately begs the question: why? I would be very cautious about buying into a business in which the founder is getting out.
- When a founder leases a set of buildings he owned to the company he founded, you start to wonder whether the founder is servicing the company or the company is servicing the founder.
- When a founder trademarks his own idea, like the name of a company, even if it’s a bad idea, and then sells it to the company under which he is already employed, that enters it’s own category of peculiar business practices. Imagine if you decided to charge your company tomorrow for every new idea you had over and above your current salary.
The most interesting question to ask of a business is how much do customers love your product or service. I began asking around to everyone I knew who works at WeWork to learn about their experience. Their answers were surprisingly tepid. The general sentiment could be summed up as “fine.”
One person told me the decor was just too jarring. One complained about the reverberation and echo of the glass walls — that working at a WeWork is like working in conjoined fishbowls where nothing is private. They ultimately resorted to taking confidential calls from home, instead. Another, interestingly, said that while the environment is meant to foster collaboration, in practice it does quite the opposite. It’s irritating to be on a call next to someone else who is also on a call. Each person ends up resenting the other as they shoot off occasional death stares. All of them complained, and not a single one sang praise.
Customers and prospectus alike suggest WeWork has yet to prove that it can bear out its promise both on paper and in practice.