As a general rule, you want to avoid cash-burning companies when they go public. The initial public offerings (IPOs) for Lyft and Uber were an example of this. We pointed out the danger in early April, writing that “The Profitless IPO Boom Has Parallels to 1999.”
Since then, both Lyft and Uber (symbols LYFT and UBER respectively) have fallen well below their IPO price. There is ongoing debate as to when these companies will become profitable. Some argue they may never become profitable at all.
And yet Uber and Lyft look sober and respectable in comparison to WeWork, the real estate unicorn hoping to go public in September. WeWork has a huge valuation as of this writing ($47 billion), a host of serious problems, and multiple gigantic red flags.
In Silicon Valley, “unicorn” is a term coined by Aileen Lee, a venture capitalist, to describe privately held tech startups that have achieved a valuation of $1 billion or more. And in some ways, WeWork represents everything that is wrong with the Silicon Valley unicorn bubble. Which makes it ironic that WeWork isn’t a true tech company at all.
WeWork, which was founded in 2010, provides shared workspaces, also known as co-work spaces. This is a real estate business. But WeWork prefers to be thought of as a tech company, because the earnings multiple for tech companies tends to be much higher than the multiple for real estate companies.
This is why, instead of SaaS, which stands for Software-as-a-Service, which is a real thing, WeWork likes to say it does another kind of SaaS, Space-as-a-Service, which is a term WeWork invented. It’s a gimmick. There aren’t any technology advantages in the shared workspace industry.
Dominant technology companies benefit from factors like network effects, infrastructure, and scale. These edges come from advantages built into the business model; a company doesn’t get them just by being big or spending lots of money.
To understand network effects, take Airbnb for example, which has listings all over the world. It is almost impossible to beat Airbnb now because they are global, and this matters a great deal to Airbnb’s hosts and guests.
When someone travels from one city to another, using Airbnb wherever they go, that creates a network effect. The more hosts and guests and cities that are added to the network, the more useful Airbnb becomes.
Facebook also has a network effect in that, for most people, the bulk of their friends and family are already on Facebook. This makes it easy to keep using Facebook.
Or take the advantages of infrastructure and scale. As an e-commerce and cloud services giant, Amazon is hard to challenge because of its vast network of warehouses and logistics infrastructure. Google has a similar advantage in the massive scale of its data centers.
There is also something known as lock-in effect, where customers stay with a service because it is irritating or costly to switch. Computer operating systems are known for this.
WeWork, being in the business of real estate, has none of that. There are no network effects for shared workspaces, and no scale or lock-in effects either. In every city, the coworking options are local, and it is easy to find the cheapest local provider.
This also makes it easy for new competitors to spring up. Jones Lang LaSalle reports that, in the United States, the coworking industry has been growing 23% a year since 2010. The barriers to entry are low because there aren’t any incumbent advantages. If you have an office building in your town, you can start a coworking space.
WeWork has a huge valuation ($47 billion) in part because it is growing like crazy. The company has raised more than $12 billion since it was founded and set up shop in more than 100 cities. Investors are willing to put a huge premium on WeWork shares, at least in theory, because it is growing so fast.
But WeWork has to keep growing at a breakneck pace to maintain expectations. This means burning more cash — likely to the tune of billions — for years to come. In a recession, it will be very hard, if not impossible, to raise the additional billions needed for ongoing growth.
A recession could create disastrous losses for WeWork, adding multiples to the billions it is already losing. The company has more than $40 billion worth of long-term leases (think 10 to 15 years), but annual revenue in the low single-digit billions. If business dries up in a downturn, WeWork could be forced to eat the losses on tens of billions worth of such leases.
WeWork’s corporate structure is specifically designed so that it can walk away from leases, leaving the contract liability with a special purpose vehicle, rather than the parent company, if something goes bad. In theory at least, WeWork’s wild structure (which has a diagram so complicated it is almost impossible to understand) is designed to stiff landlords if need be.
But this just means that, if WeWork kills a bunch of lease contracts to save money, landlords would be furious with them. WeWork’s implied strategy for saving money in a recession (letting their special purpose vehicles renege on leases) would destroy its business reputation.
Another big risk for WeWork is the fact that customer word-of-mouth is one of its biggest assets. It doesn’t have any real technology or infrastructure or intellectual property to fall back on. So if word-of-mouth turns against WeWork for any reason, in the absence of other edges, this could spell doom.
For example, WeWork relies on a word-of-mouth cool factor among millennials and tech workers to give its brand cachet. But Bloomberg reports that WeWork “squeezes people into just half the space of most offices.” Stories like that are dangerous.
What’s more, if WeWork cuts too many corners in terms of the user experience, it’s easy for WeWork’s customers to switch to someone else. In addition to no network effect, this goes back to the fact that coworking space has no lock-in effect. The switching cost for trying a competitor space is close to zero. You just pack your stuff and then show up at a different building.
As if that weren’t enough, the charismatic co-founder and public face of WeWork, Adam Neumann, appears to be milking the company in ways both large and small.
Neumann has reportedly cashed out shares for $700 million — a truly wild sum. It is normal for entrepreneur founders to monetize some of their stake for personal liquidity before a company goes public. But a $700 million cash-out feels more like a full-on raid.
Neumann has also shown bizarre red-flag behavior in his day-to-day dealings with the company he co-founded. For example, WeWork paid Neumann $5.9 million for rights to the word “We,” which Neumann had somehow trademarked and then sold to his own company. This is odd and petty to say the least.
Neumann also took loans from the company in order to buy real estate, which he then monetized by acting as a landlord so the company would pay him rent. This type of behavior, coupled with the “We” fiasco, suggests a desire to extract every nickel.
Coupled with the $700 million cash-out, such behavior from a co-founder is more than eyebrow raising; it is potentially alarming. But WeWork’s corporate structure is designed to give Neumann the control of a king, no matter what happens. His supermajority voting shares, and special rules that give his family control in the event something happens, mean that Neumann and/or his family will maintain control (even if he dies). Small shareholders will have no say in governance at all.
As if all that weren’t enough, WeWork’s $47 billion valuation seems plucked from thin air. It is based on a recent funding round from SoftBank, a firm known for splashing out huge sums on tech investments at eye-popping valuations.
But as a venture capital entity, SoftBank has something known as a “liquidity preference,” which means if something bad happens to WeWork, SoftBank will be first in line to get its money out. That means the valuation implied by a SoftBank funding round is worth little. There is no real “skin in the game.” It is easy and profitable to pump a valuation if you know your capital is protected.
Knowledgeable observers, such as Scott Galloway, a professor of marketing at NYU Stern who has founded multiple startups himself, think the maximum realistic valuation for WeWork is $10 billion, which would be close to an 80% haircut from the suggested $47 billion mark.
And even that $10 billion valuation would have to overlook the fact that WeWork is still losing money hand over fist, that its hypergrowth business strategy calls for losing huge sums far into the future, and that the company has no true long-term advantage over competitors, other than the ability to raise capital and leverage new-age slogans (like “The Power of We”).
In many ways, it is remarkable that WeWork exists in its present form, and a sign of the times that WeWork is even trying to go public at all.
The WeWork business model is so questionable, the valuation so non-justified, and the lead co-founder’s behavior so brazen, it could only be after a decade of easy money, at a point where investment capital is cheaper than tap water, that such an IPO could get the green light.
If ever there existed an IPO custom-made to mark the top of the Silicon Valley “unicorn” bubble, WeWork — the tech company that isn’t a tech company at all — is almost certainly it.