Name the characteristics of an ideal investment:
Conservative balance sheet.
History of high returns on capital.
Now let me present an idea that has none of the above.
And just for good measure, it’s a spac.
In less than a decade, WeWork went from a single Soho location to New York City’s biggest tenant and the largest co-working company in the world, with $2.9b in revenue.
The company tried to go public in late 2019 at a valuation of $47 billion (Morgan Stanley had even been promoting a $104b valuation to try and get the IPO), but it all came crashing down.
Although WeWork had incredible growth, the financials didn’t make sense. The company had burned through billions of dollars from SoftBank who’s Vision Fund was financing a land grab strategy in search of the next big unicorn disrupter.
As part of the IPO roadshow, WeWork resorted to its widely lampooned “community adjusted ebitda” to demonstrate some form of profitability which hilariously ignored building and operating expenses as actual costs. Capital markets correctly called bullsh*t and the IPO was pulled.
For many real estate veterans it wasn’t surprising, flex space companies have long been considered doomed to fail. This is mainly due to the massive asset liability mismatch inherent to their business models.
Flex space companies enter longterm leases and rent out to short term tenants. That works fine until an economic slowdown where the flex space operator see tenants walk away from their lease while they remain on the hook. Long time real estate investor Sam Zell warned about this at the time of WeWork’s IPO.
“You’re creating long-term liabilities and short-term assets. Every other time in history when they create that, the results are predictable; they go broke.”
You can see this massive risk potential is in their 2019 S-1 filing where WeWork disclosed $47b of minimum lease payments (although some of it is in remote interest entities.)
And of course this potential risk is exactly what transpired when the pandemic arrived just three months later.
Haemorrhaging cash, the company had to crawl back to SoftBank for more financing, finally pushing out Adam Neumann the charismatic barefoot, rave loving co-founder.
WeWork’s rapid demise from high tech disrupter to poster boy of millennial corporate excess was even chronicled in a Fyre Festival-like Hulu documentary.
But similar to how many analysts in 2010 thought Tesla was doomed to fail as there had been no successful US auto IPOs since Ford back in 1956, it pays to keep an open mind on potential new investments.
There already is a successful publicly traded flex space company with IWG which owns Regus and has seen its stock more than quadruple over the past decade. Although, it’s true that IWG had serious financial trouble at the turn of the millennium, bankruptcy seems increasingly unlikely today as they have transitioned to cancellable leases in entities without recourse to the parent. For more on IWG read Andrew Walker’s write up, (it’s excellent as per usual).
So now spac mania is bringing us WeWork round 2 via the BOWX spac. Although nearly every “re-opening stock” is now above its pre-pandemic high, it’s certainly not with WeWork. The recent deal was announced at a $9b valuation in March; down 81% from the 2019 failed IPO (93% from Morgan Stanley’s projection!)
However, there’s a few attributes that I believe might lead to the stock being under-appreciated today: good vibes, the covid acceleration and the network effect.
Listing ‘good vibes’ as a competitive advantage would surely get me fired as an analyst at any Bay Street firm but I really believe that WeWork’s community is far harder to replicate than most analysts think.
That whole hippy BS that the company pushed on the roadshow about how millennials want more than an office? It actually makes sense to me because…..
I lived it and I loved it!
Yes, I was a pre-pandemic, card carrying WeWork member! (Ontario is still in lockdown but I will go back after)
WeWork’s corporate hippy vibe has long been part of the original founders’ vision.
“Social media companies said that technology would bring us together. I believe technology is pulling us apart.” - Adam Neumann, WeWork Co-Founder
Neumann liked to describe WeWork as ‘the world’s first physical social network’ and marketing aside, I actually think there’s a lot of truth in that statement.
The members at WeWork seem to actually want to be in the office and the building staff go the extra mile. It doesn’t feel like the stereotypical office space that many workers dread when their alarm goes off on a Monday morning.
There’s two major societal shifts that I think WeWork is capitalizing on.
A post university marriage gap
Shift to a gig economy
A generation ago people would often get married straight out of high school or university, today it’s quickly approaching their 30s.
Millennials are looking for more than an office and WeWork was early on in creating a community that filled this void. (Soul Cycle would be another example).
“There’s a major shift in what young people are looking for in their life and what their expectations are in work. People don’t want to punch the clock and then have their life start when they leave the office, they want their life to be integrated. It’s a mindset shift.” - Miguel McKelvey, WeWork Co-Founder (2018)
Technology has increased our ability to work independently and cocooning has long been widely accepted as a societal trend but I think post pandemic, firms that are able to bring people together will thrive.
No other co-working company has the brand equity of WeWork. The multiple events that are often held at their offices are a great way for millennials to connect and stay outside of their isolated shoebox condos.
Take a look at some of WeWork’s offices, they’re hardcore instagram porn...
I threw that last photo in there, just to show that there are actually private offices with people working, not just lounging around taking pictures!
Honestly, joining WeWork early on felt a bit like a cult as current members were so evangelized that they would recruit other members.
I’ve talked about this with Luis Sanchez on Twitter who works at a WeWork in New York.
“A big reason I chose WeWork to begin with is that a friend of mine had a membership and I went to 1-2 of the events and had a good time. I thought it could be fun, plus a good way to network with people outside of my field.
I looked at joining Spaces (IWG’s WeWork competitor) as it was lower cost but stuck with WeWork because Spaces didn’t have the same community feel when I toured it.”
The Covid Acceleration
I think the pandemic actually massively accelerated the flex space industry and this can be seen in a June 2020 CBRE study.
Pre-covid 63% of firms thought there was no future in remote, that collapsed to just 10% post-pandemic. Now, the majority of firms think that some remote work is likely post-pandemic.
I’ve talked to a number of friends in real estate about the future of the office and it’s safe to say that everybody is unsure. There’s those that say everything will get back to normal, and those that say they will keep allowing employees to work remotely.
I even talked to one flexspace operator that is getting inquiries from smaller firms that are currently working remotely but are now interested in a hybrid model where all the staff come in but only on certain days (like Tuesday/Thursday).
The end result will be somewhere in between and remote work is likely here to stay in some form that is higher post pandemic. Flexspace operators like WeWork are in a beautiful position to capitalize on this trend. However, less so for IWG they seem to struggle with their tech stack. Here’s a typical excerpt from a recent Mosaic transcript.
“If you look at how WeWork has become so successful. It's about the technology behind it. It's about the community behind it. IWG has always been playing catch-up. It's on a 30 year old foundation." - @MosaicRM
Similar to what Airbnb did for residential locations, WeWork should hopefully be able to do for commercial tenants.
Flex space companies have been around for decades but they only recently started taking share as the gig economy has taken off; an effect that is likely to continue with Millennials and Gen Z taking labour share.
And from all the data, it’s pretty clear we are still in the early innings for flexible workspace:
“Although flexible office supply grew by 34% for the year ending Q2 2019, it accounts for just under 2% of total U.S. office inventory.
Flex space could account for 13% (nearly 600 million sq. ft.) of total U.S. office supply by 2030, according to CBRE’s baseline scenario.” - CBRE (2019)
There are numerous structural benefits to using flex space as a corporation. Businesses can physically adapt their office needs to rapidly changing conditions and flex tenants can remove the lease liabilities off their books to reduce stated leverage. (recent accounting changes put operating leases on their balance sheet).
A long standing complaint about flex space companies is the reliability of their tenant base. One person hipsters startups are not the best credit risks since they pay month to month and many can just move to working at a Starbucks, nursing a latte for $5 per day or at home for free.
Thankfully as the flex model has gained increasing acceptance there has been a shift to large, 500+ employee customers who on average commit to 15+ months. I’ve compiled the share of enterprise clients below from the S-1 and spac presentation.
Enterprise Customer Share (500+ employees):
March 2017: 20%
June 2019: 40%
Q4 2020: 50+%
Long term target: 65%
With increasing corporate clients the tenant base will become more reliable. In addition, increasing market share with building owners will allow for more favourable lease cancellation terms over time.
The ability to offer multiple locations within a city and abroad will become increasingly important as corporate clients join.
For now, IWG actually has the lead with more than 3x the locations of WeWork but the two companies are very similar on a square footage basis since WeWork focuses on larger, iconic workplaces.
This CBRE chart demonstrates WeWork’s massive size which is key to benefiting from the network effect.
The SPAC Presentation
First off, with any spac you need to have a huge degree of skepticism. This is not the same as an IPO S-1 filing. Companies can get away with limited historical data and hockey stick growth charts up and to the right. I don’t think the vast majority of SPACs will hit their projected financials. And honestly, most of the spacs I’ve come across, I wouldn’t touch with a 10 foot pole.
However, WeWork has already gone through so much of its BS financial phase with Softbank’s billions in hyper growth capex.
The new management team is far more grounded with the new CEO Sandeep Mathrani being described as the Anti-Adam Neumann.
Mathrani joined WeWork in February 2020 and has experience with well established companies like Vornado and GGP where he became CEO in 2010 and was credited as a turnaround artist upon his successful sale of GGP to Brookfield in 2018.
Instead of Adam’s grandiose visions, Mathrani is far more humble and has even been willing to cite having ‘plenty of luck’ in his career.
I’m not trying to completely write off Adam Neumann, I think it’s actually pretty incredible how he was able to convince so many people to become a part of WeWork but the fact is Neumann had to leave from a senior management position.
The S-4 demonstrates just how horribly run this company was under Neumann. In 2018, WeWork had $1.8b in revenue against $3.5b in expenses, a negative 93% EBIT margin that only got worse as the company scaled up.
Although the pandemic was obviously financially devastating, it finally allowed for new management to tackle long standing operational issues.
First off, the spac presentation shows that business held up remarkably better than I would have expected; revenue actually stayed constant.
Now, this is obviously a massive deceleration from the previous years doubling of revenues but it’s still surprising to see given the global lockdowns. The company recently disclosed that March represented the first month where the Company achieved both positive net desk sales and positive net membership gains since February 2020.
What’s even more interesting from the SPAC presentation is that the company was able to take out $1.1b in SG&A, $400 million in operating expenses and a $4.0 billion reduction in aggregate future lease payments! Ordinarily, this would seem implausible but given how Softbank pushed WeWork for absolutely insane hyper growth, it makes complete sense. I mean Neumann would literally flood markets with free rent to achieve Masa’s growth expectations.
I’ve seen some crazy spac presentations over the past year but WeWork’s industry projections are honestly not that too far out there. The investment bankers actually just used CBRE’s Q2 2019 study. The presentation has WeWork at a 25% share of the entire market by 2030, this is actually lower than their current ~31% share.
Now their EBITDA projections are a different story and require a lot more faith.
The presentation has WeWork moving from a projected $900m loss this year to a $2b profit by just 2024. The main factor in the transition is optimism on occupancy.
The company expects occupancy to move from 46% at the end of last year to 70% by the end of this year and 95% by 2024. This past quarter the company disclosed that total occupancy increased to 50% relative to 47% in the prior quarter.
I’m going to be subjective here but I’m convinced that the pandemic will shift companies to more of a flex space model. Therefore, the commercial office vacancy rate can remain elevated for years but since flex space is currently less than 2% of the market, it will bounce back far faster because of the shift. I believe WeWork will be able to hit their occupancy goals ahead of schedule.
It’s anecdotal but I’ve called up a number of locations in the US inquiring as a potential client and although there are still private offices available in large metros like New York they are already fully booked in high demand areas like Miami. Here’s a recent tweet from Andrew Walker that reinforces my belief that occupancy at WeWork is likely to surprise on the upside.
I think a major bull point that is being over looked is that WeWork does not need to remain capex heavy long term. At its heart, it’s an asset platform that is simply integrating businesses with landlords. If WeWork can partner more with buildings for the capex and offer additional high margin services to its customer base, then the 2019 IPO bull case narrative could return.
Is the stock cheap?
Given the pandemic and state of reorganization, you need to have faith that the business model makes sense long term. (The analyst that gets this one right will be the one that nails the broader qualitative points).
But how big could the upside be?
If you actually want to believe the spac presentation and take WeWork’s revenue at its 2024 projection of $7b in revenue (use at your own discretion, since its currently just $3.2b) and their projected 28.6% EBITDA margin, then the company would bring in $2b of EBITDA.
Given today’s EV of $11.1b that would place WeWork at:
IWG trades at 9.5x EBITDA but has only ever been a high single digit grower, so WeWork’s multiple would likely be far higher if they were to pull off this incredible transition to profitability.
At a global franchiser, asset light, multiple of 25x ebitda similar to Hilton or Marriott, the EV would be worth $50b, a near 5x from today’s price. (Again this isn’t my valuation since the D&A is a very real expense at WeWork but just a demonstration of the bull case if the narrative on the stock changes)
I do think as WeWork transitions to JVs, franchising and management agreements, margins should ultimately surprise long term. However, even at IWG’s 16% margin and 9.5x EBITDA ratio the EV would be $19b; still nearly a double.
One further bullish point, the S-4 reveals that management will only receive all of their performance based grants if the company delivers a massive $1.3b of unlevered operated free cash flow. Management also has to the end of 2024 to get the stock above $25 per share for full vesting.
It’s funny, I’ve been tweeting about high quality megacaps like $FB and $AAPL so hard recently and now I’m writing up a cash incinerating spac. But our mandate is to go where I see value and although the stock has run up since our initial purchase, I like the risk/reward dynamic here.
WeWork is so universally hated and widely considered destined for bankruptcy that I think it creates an interesting opportunity. At a $10.1b market cap you are buying in at a lower price than SoftBank’s total investment.
Even the company’s biggest critics like Jed Rothstein, the oscar nominated WeWork documentary maker who covered the insanity of the Adam Neumann era, thinks the company is “very well positioned” to benefit from the shift in commercial real estate post pandemic.
“I think it’s probably got good prospects now,” Galloway says. “It doesn’t have a messiah, it has a manager as CEO, with a background, shocker, in real estate. And in the last year, the market has come to them. If you’re looking at what tenants want in a post-Covid world, they’re going to want more flexibility. They’re going to want a space that’s more communal.”
But bull case aside I want to reinforce there is a material degree of risk to this investment.
I once tweeted that WeWork was the ultimate reopening play. And I still think that’s true, but it’s a double edged sword.
Last quarter, free cash flow was negative $663 million. Upon closing of the SPAC, the company will have $3b of liquidity.
So, WeWork is also the ultimate reopening play because the economy HAS to reopen or the company will run out of cash!
As always, do your own work and tweet me any thoughts.
DM if you prefer to discuss privately.
Disclosure: Long $BOWX
This post is intended for informational purposes and should not be construed as an offering or the solicitation of an offer to purchase an interest in Tidefall Capital Management LP (the “Fund”). Past performance should not be mistaken for and should not be construed as an indicator of future performance and there is no assurance that the investment objectives of the Fund will be achieved. An investment in the Fund involves a high degree of risk. The information contained in this post is not, and should not be construed as, legal, accounting, investment or tax advice. The contents of this post are based upon sources of information believed to be reliable but no warranty or representation, expressed or implied, is given as to their accuracy or completeness. All opinions and estimates contained in this report constitute the Manager’s judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. The Manager asserts that the reader is solely liable for their interpretation and use of any information contained in this post.