29 October 2019

    WeWork’s IPO fiasco.

    $47 billion valuation to talk of bankruptcy in a few short weeks

    Ashley Gardyne

    Chief Investment Officer

    Ashley Gardyne

    Chief Investment Officer

    The failed WeWork IPO provides some timely investment lessons. It also shows no shortage of opportunists trying to separate investors from their savings.

    The story of shared workspace provider WeWork and its failed initial public offering (IPO) will make a great book. A charismatic CEO that didn’t let reality get in the way of a good story. A business losing money hand over fist, but plugging the gap by raising money from investors at ever-increasing valuations. A complicit board, venture capitalists and investment bankers trying to line their pockets. And ultimately the CEO escaping with over $700 million, while thousands of employees are left wondering if they still have a job.

    From our prospective it provides some basic but very important lessons for investors. 

    An easy funding environment can hide a lot of sins

    With the US IPO market kicking into high gear it is becoming easier for mediocre companies to raise capital.  [75]% of US IPOs this year have been loss-making companies, a level not seen since the dotcom bubble in 1999. At the same time, the hype surrounding well-known companies like Uber are drawing investors to the IPO market.

    WeWork is a company that captured the imagination of the media. As we have seen with Uber, Beyond Meat, or even cannabis stocks, investors love a growth story. WeWork operates in a large market and the trend towards coworking and flexible office space provides a lot of growth potential. WeWork has been growing revenues at over 100% per annum and its CEO had been touted by some as a visionary.

    But WeWork is a poor business, run recklessly. It has a high risk business model and there are valid questions as to whether it can ever be profitable. Its high growth has come from raising capital cheaply (both equity and debt), signing onerous leases and rapidly opening new locations. The business model involves taking on long-term leases from landlords in order and rent out short-term space to individual tenants. Those tenants may disappear in a downturn, but WeWork’s lease obligations won’t. On top of that there is lots of existing competition and no barriers to entry in the shared-office industry.

    A bad business, enabled by dishonest people

    In some respects WeWork operates like a Ponzi scheme. If its questionable business model and reckless risk-taking wasn’t enough to scare away investors, then there were plenty of other red flags that should have.

    The business is losing over $1.6 billion dollars a year and is expected to lose money for years to come. In order to plug the hole created by these losses they have had to continually raise money from new investors. Initially from savvy venture capital funds at reasonable valuations, then at higher valuations from Softbank, and then from bond investors. Then, in their most recent act, they have tried to plug the funding gap by selling shares to the public at an egregious valuation.

    WeWork’s last valuation prior to its planned IPO was set at $47 billion, when Softbank increased its investment in early 2019. This valuation was not set by the market, or by an independent board of directors, instead it was set by the investors in WeWork themselves. By contributing more capital at higher valuations they could write-up the value of the investment they were reporting to their investors.

    The high valuation also created an anchor that they thought would help ensure their investment bankers set a high price for the IPO. It almost worked - with Goldman Sachs said to have valued the business at $65 billion in order to win a role running the IPO.

    The final alarm-bell should have been the founder and CEO Adam Neumann cashing out over $700m from WeWork through stock sales and loans just months before the planned IPO.

    A glossy prospectus that has been reviewed by regulators and endorsed by an investment bank doesn’t mean a company isn’t a terrible investment, or even a fraud.

    Buyer beware

    There are too many lessons from the WeWork saga to cover in detail. But the lessons are timely given the current low interest rate environment is pushing many investors to consider putting more money in the share market. At the most basic level the lesson from the WeWork saga is to do your own research and don’t get caught up in the hype of an interesting story. If something seems fishy, or too good to be true, then it probably is.

    Thankfully in this case public market investors were saved by the IPO failing. But other equality questionable IPOs may slip through the net. Be careful out there.