Republished courtesy of the National Post
by Tom Bradley
I’m fascinated by WeWork. This innovative, shared-office provider is the latest poster child for companies that are disrupting established industries. Think of it as the Uber, Airbnb or Spotify of workspace.
Its prospectus has enough superlatives to make you drool: “Through iterative product development at scale and significant investment in technology infrastructure, we have demonstrated that we can build better solutions for less money. We are changing the way people work globally and, in the process, we have disrupted the largest asset class in the world — real estate.”
The company has a charismatic founder (Adam Neumann), strong backing from the world’s boldest technology investor (Softbank’s Masayoshi Son) and has been growing at a dizzying pace (from 23 to 528 locations in less than five years).
Equally dizzying, however, is the company’s valuation, which has risen with each round of private financing. The last share purchase by Son’s Vision Fund valued the company, which didn’t exist a decade ago, at US$47 billion.
Hitting a wall
I’m writing about WeWork now because the rocket ride has come to an abrupt halt. The company was set to go public, with its shares expected to begin trading this month. But this week, the initial public offering was withdrawn.
Reasons for the sudden turnaround are many. Neumann’s shine didn’t hold up under increased scrutiny and he was forced to resign. Fund managers balked at the mismatch between the company’s long-term liabilities (office leases) and customers’ short-term commitments. They were also concerned about the high valuation.
In trying to figure out where WeWork goes from here, it’s important to understand the background.
As a private company, WeWork was given a free pass to grow with little regard for profits or balance sheet (it lost US$900 million in the first half of this year). Neumann was able to position it as a technology company, and private equity investors were enthusiastic buyers (US$8-billion worth). They didn’t want to miss out if WeWork did indeed revolutionize the workspace.
“As we build and open more locations within existing markets, expand to new markets and scale our suite of products and services, we increase the value of our platform to our members and create additional capacity for incremental monetization of our platform,” the prospectus reads.
This is a tune we’ve heard before. When debt and equity capital is plentiful, emerging companies that are growing rapidly can turn their early success into a virtuous circle.
Growth allows them to raise money at a high valuation. Cheap capital fuels further revenue growth. Investors start to believe that the company can ‘scale’ and dominate its category. More capital follows. More growth. And so on.
Ideally, companies ride the wave to a place where they’re profitable and no longer require outside capital. Unfortunately, they don’t always get there.
WeWork may prove to be a live example of what happens when the tap turns off before the company is self-sustaining. Without new equity from the IPO (and more limited debt financing as a result), the company will need to raise money elsewhere or quickly rein in its sizeable losses.
If there’s no new capital, the pace of expansion will slow (or stop), and revenue growth will fall commensurately. And without rapid growth, WeWork risks getting compared to, and valued like, other real estate companies, not industry-changing disruptors.
WeWork is committed to becoming a public company and “elevating the world’s consciousness.” When it comes back to market, investors will be asking hard questions.
Can the company be a disruptor and turn a low-margin, cyclical business into a growth industry?
Is it growing the revenue pie, or just cutting it up differently?
If WeWork is expanding faster than its competitors, will they respond? What’s it able to do that the others aren’t?
Do WeWork’s office leases and customer mix translate into better or worse profit margins? How many of the 528 leases will turn out to be duds (a company can’t grow that fast and not make mistakes)?
Can the business model survive a recession when corporate customers go into cost-cutting mode and capital gets tighter?
And the clincher: Is WeWork the next Amazon — or the next Valeant?
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