‘Tis the season for disappointing tech IPOs. Pinterest (PINS, Financial), Lyft (LYFT, Financial) and Uber (UBER, Financial) have all drastically underperformed investor expectations, with all three currently trading either at or below their respective IPO prices. In such a hostile environment, it may seem strange that coworking giant WeWork seems determined to press on with its own initial public offering. But that is only if you look at it like a traditional company -- one that is supposed to generate profits and positive cash flows.
Public offerings have increasingly become a way for private investors to cash out of bloated unicorns and unload their holdings onto the unsuspecting public, rather than as a way to raise capital for growth and investment in the business itself. Of course, this is not the first time that we have seen this happen -- in the dot-com boom of the late 1990s, plenty of loss-making tech companies went public, only to crater spectacularly not long afterwards. With losses continuing to mount, and private money becoming more scarce, WeWork’s only real option is to tap the public markets.
Questionable accounting
So if the company’s financials continue to deteriorate, how is management going to sell this to the public markets? Investors have been eagerly buying up cash-burning tech companies for the last few years, so the mere fact of widening losses is unlikely to scare away too many people. However, WeWork also relies on some creative non-GAAP accounting measures to pretty up its financial statements.
Specifically, it uses something called "community-adjusted Ebitda," which miraculously turned a $193 million GAAP loss into a $233 non-GAAP profit in 2017. The basic principle of this alchemy is that it adds back costs that the company considers immaterial to operations or non-recurring, including almost all sales and marketing expenses. Needless to say, this practice has raised many an eyebrow among more sober-minded analysts.
Creative corporate governance
Despite claims that it has invented some radically new, tech-savvy business model, what WeWork actually does is old-fashioned lease arbitrage -- leasing real estate and renting it out for more money to a secondary tenant. This has led to some interesting conflicts of interest, with CEO Adam Neumann being found acting as a landlord to his own business.
More recently, WeWork itself has announced its intention to move into the landlord business. It is launching a real estate investment fund called ARK, starting with $2.9 billion in cash. The plan is to own the buildings that house WeWork’s coworking spaces, and hoping that the brand will be powerful enough to attract other tenants. While having one arm of the business rent to another is of course not illegal, it does significantly complicate the cash flow chart, potentially making it easier for WeWork to engage in more non-GAAP shenanigans.
Summary
Would-be investors in WeWork would do well to examine the company’s DIY accounting and see for themselves how it diverges from the generally accepted standards. A lot has changed over the last century, but financial statements have remain virtually unchanged. There is no reason to think that an overvalued commercial real estate company has come up with a better system.
Disclosure: The author owns no stocks mentioned.
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