WeUnprofitable

By, Robert J. Moss

Due to IPO later this year, WeWork has often made headlines for all the wrong reasons. But what is WeWork and why has it garnered so much attention?

WeWork was founded in 2010 by Adam Neuman, Chief Executive Officer and Chairman of the Board, Rebekah Neuman (married to Adam), Chief Brand and Impact Officer,  and Miguel McKelvey, Chief Culture Officer. Together, the trio pioneered ‘community’ office space, renting out workstations in beautiful, open-spaced offices to freelancers, startups, and small businesses. With initial offices in San Francisco, Los Angles, Boston, and Seattle, WeWork expanded internationally in 2014. By 2016, they grew their customer base to include large enterprises. Today, WeWork has offices in 111 cities with 528 locations, and 527,000 members.

Management brands their business model as space-as-a-service. WeWork approaches a landlord, usually enters into a 15-year lease, renovates the property to meet their aesthetic with full or partial costs covered by said landlord, and then rents out workstations within the office to their members. These members only sign one-month agreements for their workstations. WeWork adds value through beautiful, community oriented office space that provides flexibility and scalability for its members at a lower cost.

In addition, WeWork also offers various services to compliment these offices. We Co, the holding company that owns WeWork, has other community centric businesses like WeGrow, providing child education, and WeLive, fully-furnished apartment rentals

The financial picture of We Co is muddy. While revenue has quintupled within the last three years, so have their net losses, totaling US$1.9bn in 2018. Location operating expenses, the cost of leases amortized on a straight-line basis according to GAAP, is their largest expense. Management points to non-GAAP measures like contribution margin which excludes non-cash lease costs as a better reference of their margins. Their contribution margin with and without this cost was 12% and 28% in 2018. We Co provides limited detail in their prospectus about their balance sheet. Since 2017 to June, their current ratio has depreciated significantly from 3.7 to 0.9, raising concerns about their liquidity position.  The company also has US$22.0bn in non-current liabilities. WeWork’s cash flow statement provides little detail. Cash used in operating activities was only negative by US$0.1bn, demonstrating stronger earnings quality than the income statement implies.

WeWork’s lack of profitability, given its high valuation, has been a source of condemnation for those bearish on the company. CNBC reported Softank, a Japanese holding company and major investor in WeWork, valued the company at US$47.0bn or 24.7x sales, in its latest round of private funding. However, high valuations and low profitability are common for high-growth technology companies. But WeWork brands itself as an altruistic, innovative, Silicon-Valley-esque company while fundamentally just being a real estate company. 

Others take issue with WeWork’s business model. Their clientele are the type to be most affected by an economic downturn. With WeWork paying 15-year leases and only having monthly agreements with their members, the company has set itself up for a large shortfall in the event of a downturn. Furthermore, little about their core business is proprietary. Anyone can sell fancy co-working office space and competitors like Regus are doing exactly that.

Critics have also raised conflict of interest issues with Adam Neuman, questioning a complex corporate structure that’s alleged to benefit insiders, and mocking non-GAAP performance metrics like community adjusted EBITDA.

However, WeWork, unquestionably, has great office space and a strong brand among customers. “And as of today, we estimate that our market penetration in our 280 target cities globally is approximately 0.2%,” according to management in the prospectus. That leaves a massive addressable market WeWork hopes investors will bet on them to capture more of.

Recently, after weeks of reports WeWork’s valuation might get halved, the Financial Times has reported Softbank is recommending the company delay going public this year.

As investors continue to watch for WeWork’s potential IPO, the question remains whether investors will continue to fund unprofitable businesses for high growth prospects or will WeWork be a step too far for investors?

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