WeWork has been a darling of the venture capital scene for the last several years. The company has normalized co-working and has risen to become the dominant player in that industry. Yet, there are growing signs that the company’s vaunted $20 billion valuation is facing serious strain, with key backers getting worried in light of mounting operational and financial challenges.
Indeed, it appears as if the massive real estate unicorn may be headed for a reckoning.
Middle Eastern rumblings
One of the first warning signs at WeWork came in December. SoftBank Group Corp. (TSE:9984, Financial), a major shareholder, had announced plans to acquire a controlling stake in the co-working company for $16 billion. But the Japanese investment group faced unexpected pushback from its own shareholders, particularly Abu Dhabi’s Mubadala Investment Co. and Saudi Arabia’s sovereign wealth fund. These two investors make up a large part of SoftBank’s $100 billion Vision Fund, so they carry considerable weight in decision-making.
The latest investment would have brought SoftBank’s total investment up to $24 billion and value WeWork at $36 billion. Unsurprisingly, the government-sponsored funds backing the firm have gotten nervous about committing a quarter of the Vision Fund’s total capital to a single startup, especially at such a staggering valuation.
SoftBank goes soft
The oil states’ expressions of displeasure came as a change of pace, since SoftBank and its idiosyncratic boss, Masayoshi Son, have largely been given free rein to pursue opportunities. They did not complain when SoftBank invested $4.4 billion in August at a $20 billion valuation, nor did they raise any public spat when it committed to a further $4 billion in subsequent months, most recently at a valuation of $45 billion.
At least partly as a result of pushback, SoftBank has changed course. In January, the company announced it would be slashing its latest investment in WeWork to just $2 billion. The decision was undoubtedly influenced by the disquiet among top investors, but it was also likely driven by the broader economic and market picture. The volatility of December pummeled SoftBank's stock. Likewise, the conglomerate’s telecom business, which it spun off in an initial public offering, got hammered in its first day of trading.
With financial pressure mounting, growing market turmoil and increasing dissatisfaction among its backers, SoftBank decided to curb its enthusiasm for WeWork,
Fantasy valuation
SoftBank’s backing away from the takeover attempt has brought renewed attention to WeWork’s lofty valuation and growth prospects. Based on what we know about the company’s financials, it is grossly overvalued by any reasonable metric - even assuming huge opportunities for growth and profit down the line.
During the first nine months of 2018, WeWork brought in revenues worth $1.2 billion, but still posted a net loss for the period of the same amount thanks, according the company, to heavy investment in growth that will (hopefully) yield profitable returns down the line. Still, $20 billion is a serious premium just on its face.
Most startups try to defend their valuations aggressively. Bizarrely, WeWork CEO Adam Neumann seems to understand that his company is not valued for what it does per se, as he stated in a 2017 interview:
"No one is investing in a co-working company worth $20 billion. That doesn't exist. Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue."
Investors let that slide back in 2017, but as markets have grown increasingly volatile and uncertain, such views are no longer finding such ready audiences. A Forbes commentary in the wake of Neumann’s comments helped solidify just how far WeWork’s valuation had strayed from reality:
“The company is on track to do an estimated $1.3 billion in revenue in 2017 (with operating margins around 30%), giving it a price-to-sales ratio higher than what a more conventional growth company might garner as a multiple of cash flow. But this ‘energy and spirituality’ premium seems high no matter how you measure it. Son's $20 billion valuation translates to $133,333 per member (even though the ability to walk away at any time is part of the model), each of whom generates $8,000 a year on average. It values each foot of space it rents at $2,000, compared with, say, $325 to buy Class A real estate in a tech hub like Austin.”
Since then, WeWork’s valuation has only risen, if SoftBank is to be believed.
An effort at justification
WeWork’s latest round purportedly values it at $47 billion, a nearly 100% increase from 2017, despite revenues having climbed perhaps 30% over the same period. What Forbes saw as extremely overvalued in late 2017 now looks outright absurd. SoftBank’s $2 billion commitment, which will come from the company itself and not the Vision Fund, will thus make for a huge “up round” on paper, but it has precious little justification in real finance or economics.
In the wake of SoftBank’s climbdown, WeWork has made an effort to justify its lofty valuation and to articulate a growth story. On Jan. 8, the company announced it was rebranding itself as The We Company, with an eye toward being seen as more than a co-working company. This effort looks fairly preposterous on its face, as Bloomberg’s Matt Levine has pointed out with his usual cutting wit:
“The new company will be divided into several main business units: WeWork, WeLive, WeGrow, WeHarvest and WeFeast, wait no only the first three of those are real, but I am looking forward to when they start a line of industrial-chic funeral homes, WeDie. (Free beer at the wake!) Seriously WeGrow (real!) is ‘a still evolving business that currently includes an elementary school and a coding academy.’ And WeWhatever’s founders once (in 2009!) “mapped out plans for everything from WeSleep to WeSail to WeBank.” I can’t keep up with this.”
Trying to backfill a company with new business lines to justify a totally wild valuation is never a good sign.
Red flags multiply
Not only is WeWork’s valuation absurd, its corporate finance decisions look increasingly bizarre. The company’s plans for use of proceeds from the $2 billion SoftBank investment is particularly head-scratching, as The New York Times has reported:
“About $1 billion of the new investments will be used to buy shares from investors and employees, who will get a chance to cash out. Investors and employees who do sell stock to SoftBank will have their shares valued in the mid-$50s, giving WeWork an implied valuation of just over $20 billion.”
So, WeWork is getting a massive up-round valuation and a $2 billion cash injection to help fuel its growth, yet half of that will be used to help employees and shareholders cash out. Talk about a red flag!
Another worrying revelation came this week, when it was reported that Neumann has been profiting as a landlord. His tenant: WeWork. Indeed, Neumann has evidently made millions of dollars leasing properties he controls back to his business. This has, unsurprisingly, sparked questions of conflict of interest.
Verdict
WeWork is the product of this cycle’s love of ultra-growth startup stories. Its valuation has been increasingly unmoored from reality, and the warning signs keep getting more intense. Anyone currently holding a position in WeWork would be wise to cash out now since there is unlikely to be another opportunity soon, nor perhaps ever at this price point.
The one tragedy, from our viewpoint, is the WeWork growth story is unraveling now before it ever had a chance to go public. Still, it might try its hand at an IPO before the real reckoning commences. If so, it would be at the top of list of potential shorts to watch.
Overall, 2019 should be a great year for overvalued, over-hyped companies debuting on public markets. Uber is moving forward with an IPO, which should be a nice opportunity. We hope WeWork finds a way to list before the music stops. It would be a shame to never get a chance at shorting this one. Even so, there will be plenty of great overvalued stocks to bet against in the year ahead.
Disclosure: No positions.
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