Every now and then, you hear of a high-profile business that either fails or “flops” in the sense of losing a massive portion of its value. WeWork flopped for various reasons, including:
- an inflated valuation that couldn’t be supported through the financial reality of the business
- a workable but flawed business model under further strains from Covid-19
- sloppy governance
- mismanaged operations and financials
Inflated valuation from distorted narratives
WeWork sold itself as being a technology business. Being a “tech” business doesn’t mean much on its own without specifics of how technology will be created or used to generate better long-term outcomes. But the narrative of such can help create a higher valuation and make capital-raising easier to ensure adequate liquidity and keep the dream alive.
The venture capital and public equities markets are less concrete because the future range of outcomes is much greater compared to other markets. They’re susceptible to distorted perceptions of value. Stocks can stay too high or too low because of “greater fools” buying or selling them without much regard to their realistic valuations.
One of the big advantages with low interest rates and capital costs is that more companies, including WeWork, can chase growth and market share for long periods of time without worrying about profitability.
This is also good for consumers as a whole. Consider, for example, how much cheaper an Uber is than a taxi.
But it also gets into issues about how low hurdle rates for investment create “zombie companies” whose operating income won’t cover interest expenses.
They also facilitate a shift from labor to capital. When people can take on a side gig of renting out spare seats in their cars, that reduces the need for taxi drivers. They are also independent contractors in the vast majority of jurisdictions. This allows companies to obtain workers without the other forms of compensation that can bloat labor costs (e.g., medical, dental, retirement, expense stipends).
Less goes to labor and more goes to capital. This can lead to displaced workers, wider gaps between the “haves” and “have-nots” and more social frictions if it happens at a pervasive enough scale.
Uber and Lyft, despite their negative earnings and high rates of cash burn, are still collectively worth about $70 billion. Tesla is worth close to $200 billion despite hundreds of millions of dollars in cash burn per quarter (its accounting gimmickry papers over its true financial situation), in the capital-intensive, low-margin business of auto manufacturing.
Long-term, if a company can’t generate more value out of its outputs than its inputs, then it isn’t viable. It’s a drag on productivity and crowds out more productive ventures and hampers the effective allocation of labor and capital. That’s not to say that companies like WeWork, Uber, and Lyft can’t eventually become viable, but their business models will probably look reasonably different to make the economics work.
For now, they are effectively priced as call options on a certain conception of the future.
There’s nonetheless a lot of copycat behavior in investing. A prominent investor can come out and massively sway a stock price. The same is true in the private markets of all forms (early stage to late stage) looking to get in on what’s hot.
With Softbank’s backing ($11 billion), other investors followed.
WeWork Business Model
The reality of the WeWork business model is that it’s very basic. They rent office space, divide it up, and sub-lease it at a higher per-unit cost.
There is no constraint on their growth except for capital, not unlike a bank. Accordingly, they should not lose billions of dollars due to growth. Nor are they or were they doing anything to call themselves a “tech company”; there is nothing tech about the actual business model or what they sell to the end-user.
It’s essentially a bank-like model that predominantly deals with leasing office space. Everything else is narrative.
The economics of the business amounts to average rent multiplied by number of seats taken multiplied by occupancy rate minus rent and expenses.
Yet WeWork’s S-1, the SEC document filing required to go public, scarcely mentions much in the way of specifics on its occupancy rate. Everybody more or less blindly trusted co-founder and former CEO Adam Neumann (ousted in September 2019).
Challenges to the business model
The coronavirus pandemic put a dent in the co-working model (and impacted the S curves of other business adoptions). More people are working from home. Even as lockdowns are repealed, more will request continued work from home arrangements to avoid the time and inconveniences associated with the commute, obtain greater flexibility with their schedules, among other reasons. With computers and modern telecommunications, more industries can viably have many of their workers telecommute.
Occupancy rates have increased, demand will go down, and make the business more difficult.
Neumann had extra voting power (20-to-1 over standard votes) and the level of self-dealing was disconcerting. WeWork leased space in several buildings owned by Neumann, a conflict of interest (i.e., becoming both landlord and tenant). That would not have been allowed as a public company where there is more oversight.
He also trademarked the name “We” and sold it back to the company, paying himself $5.9 million. (This transaction was later reversed after facing criticism.)
In total, he had cashed out more than $700 million from the company.
Neumann surrounded himself with close friends and family members. There was a lack of executive oversight.
There was the matter of taking the basic model of co-working and replicating it. There was plenty of precedent, but had issues executing on it. Then there was managing the company’s international growth plan. Yet, they hadn’t proven able to profitably run a single location. (Forget about expanding to Mars.)
Before the IPO, WeWork was valued at $47 billion. Yet it only had $2.5 billion in cash and cash equivalents and was burning more than $700 million per quarter, a figure that would pick up with its growth ambitions (not to mention lack of mastery over the basic business model).
Without the funds from the IPO, the company would soon be out of money.
On top of that, its accounting was highly gimmicky with such metrics like “community adjusted EBITDA” that were invented nonsense. Such contrivances were purely there to distract from the reality that the present configuration of the company lacked any sound path to profitability.
The WeWork debacle is a function of a bloated valuation, poor execution, feeble governance system, unsound financials, misleading accounting, and an unproven and ultimately ineffective management team that had limited experience in what it was trying to accomplish.
If they had profitable locations, honest accounting that showed a path to profitability, Softbank didn’t inflate the valuation, the growth was paced to show at least a 1-2 year runway of funding, and the governance system was replaced, the IPO could’ve worked.
The valuation would have dropped like a rock in the public markets, but at least the company’s reputation would be closer to Uber or Lyft rather than a mismanaged enterprise used in business school case studies for all the wrong reasons.