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John Engle
John Engle
Articles (406) 

WeWork: Red Flags Ahead of IPO

Increasing leverage, insider selling, an inflated valuation and a questionable business model add up to an obvious short

August 06, 2019 | About:

WeWork (officially The We Company as of earlier this year) is set to go public next month in one of the most highly anticipated initial public offerings of 2019. The office co-working company is aiming for a valuation of $47 billion, the same valuation it received in its most recent private funding round.

Conventionally, companies preparing to go public will do their utmost to both prevent the emergence of major red flags, and downplay any that might already exist. Not so with WeWork. The upstart real estate firm has seemingly gone out of its way to raise investors’ eyebrows, including those of Bloomberg’s Joe Weisenthal:

The sheer number of red flags this company throws up is unbelievable. Normally when assessing a company, you have to dig in the footnotes to find the warnings. WeWork just puts them all front and center. It's almost disconcerting. Makes you question your own intuitions and judgment.”

Investors can be forgiven for feeling rather perplexed by the numerous bizarre actions and decisions WeWork has taken in the run-up to its public market debut.

Levering up

In early July, WeWork announced that it would be raising fresh debt capital in advance of its IPO. WeWork said it was seeking between $3 billion and $4 billion initially, with the debt facility likely to grow to as much as $10 billion over the next several years.

WeWork’s reasoning was to shore up its cash balance in an effort to bolster investor confidence. The company evidently feared sharing the fate of ride-hailing startup Lyft Inc. (NASDAQ:LYFT), which received a cool welcome to the public market earlier this year. Like Lyft, WeWork is far from being profitable, posting a whopping $1.9 billion loss in 2018.

The additional balance sheet padding, courtesy of the private debt market, was supposed to alleviate concerns that WeWork will have to raise further funds to feed its insatiable hunger for cash. However, when one considers that the company will likely require about $9 billion in cash simply to fund itself through 2020, the debt facility looks a bit inadequate.

CEO dumping stock

Whatever additional enthusiasm that WeWork may have managed to drum up for its IPO with the July debt financing was more than erased by the subsequent revelation that CEO Adam Neumann had sold a chunk of shares, as well as borrowed against another piece of his existing holdings in late July to net himself $700 million in cash.

Founders selling shares during funding rounds is not unusual. It is often the only liquidity opportunity available to shareholders of private companies. However, it is still generally considered a bad sign when company insiders start selling their stock, especially in the run-up to an IPO. When the one doing the selling is the CEO, it looks even worse. A CEO selling stock in advance of his company’s IPO may be worst of all.

WeWork’s private valuation was already suspect. Neumann’s effort to cash out some of his chips before the public markets are able to weigh in smells fishy.

Levering up some more

With its first round of pre-IPO debt financing failing to perk up investor confidence as much as hoped, as well as Neumann’s startling decision to sell a sizable chunk of his stock, WeWork decided that it had to do more. Specifically, it opted to double down on its leverage gambit.

Last week, WeWork announced its intention to secure access to an additional $6 billion in the form of a $2 billion letter-of-credit and a $4 billion delayed-draw term loan. This debt facility is contingent on a “successful” IPO, defined as raising $3 billion from equity sales.

Contingent financing is always a dicey proposition. Given WeWork’s shaky market perception, the decision to gamble significant future financing on a splashy IPO seems risky. Still, WeWork should be able to pull in the necessary cash from equity sales, barring disaster. But the additional debt facility will still be insufficient to meet WeWork’s longer-term capital needs, which are expected to exceed $19 billion through 2026.

Verdict

Even before it announced its plans to go public, WeWork had an impressive collection of black marks to its name. Most prominent of these is the company’s shaky business model, which has yet to prove its sustainability, despite the tailwind of an historically long bull market.

If the economy were to falter, things could get ugly. WeWork’s core business, signing long-term leases with property owners in order to then sublease space to tenants on shorter-term contracts, could fall apart in dramatic fashion.

Ultimately, the conclusion is inescapable: WeWork’s valuation is preposterously high and cannot be justified by any sensible economic or financial metric, even if its core business can be shown to be sustainable through the entire business cycle.

Investors who value their capital will not buy this IPO. Instead, they should consider taking the opposite side of the trade. WeWork appears to be poised for a dramatic fall from grace.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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