The We Company, parent company of WeWork, is reportedly considering lowering its total valuation significantly in a planned initial public offering that could come as early as later in September. The move would be a strong indication that investors are raising the level of scrutiny they are applying to shares of high-flying tech companies as they make the transition to being traded in public equity markets.
In the latest round of private equity financing, WeWork was valued at $47 billion, but speaking on the condition of confidentiality, bankers with knowledge of the proposed deal now say that a public valuation of $20 to $30 billion is more likely.
2019 has been a huge year so far for highly anticipated IPOs, and the results have been mixed. While some companies like Zoom Video (ZM - Free Report) and Beyond Meat (BYND - Free Report) have held onto double and triple digit gains – up 44% and 140%, respectively – Rideshare companies Uber (UBER - Free Report) and Lyft (LYFT - Free Report) have been enormous disappointments. Both currently trade at or near all-time lows.
Over the past nine years, WeWork has become one of the largest tenants of commercial real estate in many major metropolitan areas - including being the single biggest lessor of space in New York City. The company signs long-term leases for large blocks of space, converts them into attractive and high-tech workspaces and subleases space for shorter periods to entrepreneurs and startups.
The average term for the office space WeWork leases is around 15 years, while it’s average sublease is closer to two years. Customers who are mostly small, new businesses value the flexibility of shorter leases as they attempt to grow – presumably hoping to move to larger facilities – but the arrangement does leave WeWork on the hook for the remainder of the longer leases in the events that customers move on and the space is not re-leased.
It’s definitely a high-growth industry. CBRE Group (CBRE - Free Report) estimates that only about 2% of commercial square footage is currently dedicated to flexible leasing arrangements but says that number could grow to 10% over the next decade. Late in 2018, CBRE announced that they would be launching their own flexible office space product to compete with WeWork and the European commercial real estate company IWG, which operates in the US and 120 other countries under the brand name Regus.
WeWork's S-1 statement, filed with the SEC in anticipation of the IPO, highlights several of the risk factors for potential shareholders. The company had $1.8 billion in revenues in 2018, yet posted an operating loss of $1.8 billion – largely due to the high costs of modifying office space with the perks tenants appreciate. Through the first six months of 2019, revenues grew to $1.54 billion but so did losses – to $1.37 billion.
Investors tend to be fairly tolerant of losses at early-stage startups, but critics point out that despite branding themselves as high-tech, WeWork is actually only offering a shiny version of a decidedly low-tech product. Though the company has been extraordinarily successful at gaining significant market share in the flexible space market, the lack of barriers to entry could mean that deep pocketed competitors could offer similar services – as evidenced by CBRE’s new flex offerings.
WeWork has the backing of Japan’s SoftBank Vision Fund which has approximately 10% of its $100 billion dollars in investible funds in WeWork. Lowering the offering price would lower the valuation of SoftBank’s stake considerably, but would also increase the chances of a successful offering and the potential for price appreciation to prospective shareholders.
SoftBank is still considerably underwater on the $7.6 billion they have invested in Uber over the past two years.
Analysts have also been casting a critical eye on WeWork’s proposed corporate structure which grants founder and CEO Adam Neumann majority voting power and gives his wife the discterion to appoint a replacement CEO should he die or become incapacitated - rather than leaving that decision to the board of directors. New shareholders will receive only one fifth of a vote per share owned.
Neumann also raised eyebrows by being a partner in the ownership of some of the properties that WeWork leases from, personally borrowing from the company at low interest rates and paying himself $5.9 million in return for the “We” trademarks.
Though Neumann has taken steps to extricate himself from the appearance of a conflict of interest in property ownership and returned the $5.9 million, even the hint of lax corporate governance is worrying, especially in the context of the bifurcated voting structure that would leave shareholders with limited recourse if they felt the CEO was not putting their interests first.
Even investors for whom a speculative IPO is not appropriate, the WeWork offering should be interesting as a barometer of how the equity markets assess value in highly anticipated deals.
Arguably, the criticisms of WeWork’s potential shortcomings is actually a sign that investors are doing serious due-diligence rather than blindly plowing cash into uncertain ventures. A successful offering at a lower price would signal rationality in the markets – a very healthy sign.
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