What is behind the WeWork crisis?

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Article written by Patricia Cullen

Business Leader investigates the recent challenges WeWork has been facing and also explores the topic of company valuations.

The cautionary saga of WeWork involves a combination of corporate failures and a tenacious CEO who, in the face of conflict, jumped ship before his co-working empire hit the skids.

Founded in 2010, WeWork was at the forefront of the shared workspace industry, and until recently, it was amongst the most valuable start-ups in the US, disrupting the sector at every turn. Operating in 29 countries, 111 cities and 528 locations, and counting businesses like Reddit and PepsiCo as customers, the company played a crucial role in popularising co-working, with a motivated CEO who had ambitions to “change the world”.

The darling of Silicon Valley investors, WeWork was valued at $47bn (£37bn) during its peak, and positioned as the 2nd largest IPO of 2019, trailing only behind Uber. Within 33 days the offering was destroyed amid doubts over governance and valuation, with a more realistic $15bn-$20bn (£12bn-£15.5bn) advised by Wall Street.  Since then, its biggest backer, SoftBank, the Japanese tech conglomerate, is building an emergency funding package valuing WeWork at less than $8bn (£6bn), while JP Morgan Chase is trying to organise financing packages with outside investors and lenders.

Rupert Dean, co-founder of new co-working space, x+why said: “The problem with private company valuations are that they can be easily propped up by just one willing buyer (in this case the Vision Fund) based, not on the fundamentals of the business, but on a “vision” and the allure of the CEO to paint that vision.

“This is not what the public look for anymore. Get-rich-quick schemes are yesterday’s news. The public now look at the underlying business plan, fiscal responsibility and performance as well as positive environmental and social impact – all of which WeWork have lost their way on, and the reason their IPO has been resisted.”

Almost a decade ago it became clear that the traditional office rental market didn’t suit modern companies, and serviced office use in London rose 600% between 2010 and 2015, peaking at 1.4 million sq. ft., of which 558,000 sq. ft. was acquired by WeWork. “The way people work is undergoing a fundamental shift, and more enterprise leaders are recognizing the correlation between physical space and performance,” said Dave Fano, Chief Growth Officer at WeWork. WeWork were initially onto a winning formula, and in a move toward domination in the business sphere, it acquired tech start-ups like Welkio and physical data software company Euclid.

Dean goes on to explain: “You will note, no-one is saying the WeWork’s product is a bad one. There is a large gap between saying something is overvalued and saying the product is flawed. They still fundamentally have a good product and they have still tapped into the changing way in which we work, including happy employees, increased freelancers and a sense of community.”

Approaching 2020, a flat white and a mellow workplace are standard office expectations, and WeWork positioned themselves as the champion of this social change. Before WeWork, the typical rent model was a closed office space. Their first innovation was offering hot desks with flexible rent terms, catering for the growing freelance market.  However, it appears that WeWork had merely copied an old business model of office leasing, modernised it with some tech lingo and fooled venture capital investors into valuing the firm at more than 10 times its nearest competitor.

IWG, an early mover in serviced offices has more sq. ft. and earns more revenue than WeWork, but has a market cap of $3.7bn (£2.8bn), less than 10% of WeWork’s recent valuation. Neumann’s removal may placate the company’s critics, but it won’t correct the risk innate in WeWork’s business model, which includes lease timescales that are far longer than what’s typical in the industry. Concerns about the flexible workspace model include companies taking out long-term leases but only renting to clients on a short-term basis. According to WeWork’s IPO filing, it owes $47.2bn (£37bn) under its leases. “The average length of the initial term of our U.S. leases is approximately 15 years,” WeWork noted in its IPO filing. By contrast, from 2006 to 2017, the average term for leases signed by US publicly traded property investment trusts was 6.8 years, according to Morgan Stanley.

David Belle, author of the Macrodesiac Newsletter and Macro Trader reveals: “It was very telling that they tried to push for WeWork to be classed as a tech firm. Classing yourself as a tech firm in this market gives you a ridiculous multiple. As we’ve seen over the last year or so, big name IPOs haven’t been hugely successful. The way in which Neumann conducts business leaves a lot to be desired, in that he picked the $702m (£545m) debt issuance figure from thin air because he believed the number to be lucky, whilst also leasing the WeWork buildings to his own company.”

Belle continues: “The whole market stinks of misallocation of capital. Low rates lead to equity risk premium compression and this is causing massive risk distortions. At the current price/earnings levels, coupled with the corresponding lofty index levels, the market is thin on confidence and IPO-ing up here is ridiculous.”

However, WeWork isn’t a lost cause yet. Will it perform the biggest U-turn in history? Possibly. Could it go straight to bankruptcy? Maybe. Will the Vision Fund make money? This depends on numerous variable factors. However, WeWork remains a bricks and mortar company, and the impact on the wider industry is forecast to be minimal.

Dean concludes: “While there may be a short term market tremor around flexible real estate it won’t have medium or long term consequences on commercial real estate. This product, hopefully manifested in a less obviously financially greedy way, is here
to stay.”

Belle reiterates: “The problems WeWork faced was largely internal. One thing that may be an issue is the short term hit that many start-ups will face. If anything, being made to find alternative space is a plus for the London commercial property market and may provide a short-term boost to commercial property data. Of course, the business cycle will have a bigger effect on practically everything versus this, however, and the commercial property market will always be based on the strength of consumer and business demand for goods and services.”

With a variety of outcomes still possible, WeWork is still a work in progress.

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