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WeWork To Go Public: Unprofitable IPO Trend Continues

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We are nearing the end of our economic cycle and unprofitable IPOs are sweeping the markets with almost every prominent IPO this year having a negative bottom line before making their shares open to the public. Start-up unicorns like Uber (UBER - Free Report) , Lyft (LYFT - Free Report) , Pinterest (PINS - Free Report) , Slack (WORK - Free Report) and now WeWork (WE).

The Business

WeWork pioneered space-as-a-service and is the largest player in this new wave of commercial real estate. This company began 9 years ago to provide office-space access to start-ups and small businesses who otherwise wouldn’t have been able to afford it. Today WeWork has 527,000 members including 38% of the Global Fortune 500.

The company’s success is a product of a shift in generational business needs. The office space is built to be an environment that nurtures ideas and innovation. Its open layout and aesthetically pleasing architecture allow entrepreneurs to network and discuss ideas. It is also perfect for those who are on the go or work remotely with just a $45 membership giving them access to 200 locations in 53 cities. The cost structure varies depending on business needs.

WeWork has 528 locations across 111 countries, which is an astronomic leap from the 2 New York locations they began with in 2010. Over 50% of occupancies are overseas. This large international presence gives them leverage to attract a larger total addressable market as they expand locations. WeWork’s current TAM is $900 billion, and the company is targeting 179 more cities (280 in total) to expand its TAM to $1.6 trillion.

WeWork is attracting a growing number of business members with over 500 employees, which they refer to as “Enterprise Memberships”. This now makes up 40% of their members compared to the 20% it saw in 2017. This is a great sign for the firm because it illustrates that big businesses are choosing to use WeWork’s space-as-a-service over traditional leases, this is also expanding brand equity.

WeWork is another example of how subscription-based (though the company calls it memberships) is a business model that has become increasing popular and lucrative. Having consistent year-over-year and quarter-over-quarter growth figures that investors can count on make this type of investment very attractive. Membership retention is key and below illustrates WeWork’s ability to do so.

Financials

The biggest concern that I see when evaluating WeWork’s IPO prospectus are the razor thin gross margins that the company is experiencing. WeWork is effectively a massive subleasing agency. WeWork purchases as well as leases office space and transforms it into a culturally progressive work place that incubates innovations. The company also pays for all the facility costs like desks and chair, building upkeep, even paper and ink cartridges. All of this can be very costly.

The primary issue is that the operating expenses make up a large portion of the firm’s total revenue, leaving very little room for overhead. Economies of scale have been able to alleviate some of these concerns, with operating expenses only making up 85% of WeWork’s revenue in the first half of this year compared to the 99% the company experienced in 2016.

The company’s losses have grown over the last 3.5 years as the cost of expansion weighs on the firm’s bottom line. WeWork posted an over $900 million loss on $1.54 billion in revenue in the first half of 2019. Last year the company generated $1.8 billion in sales but lost an astounding $1.9 billion. From the trend I am seeing, it is going to be a long time before WeWork can become profitable as well as a significant amount of scaling.

Take Away

WeWork hasn’t yet announced an IPO date but analysts are anticipating the debut within the next month. In WeWork’s most recent round of funding the company was valued at $47 billion. I would be very apprehensive about jumping into this IPO right off the starting block.

WeWork is a revolutionary company that is not close to turning a profit. With few comparable profit generating businesses to model off of, this stock is going to be difficult to initially value. I am sure that its initial debut will bring some hype being the first space-as-a-service firm to hit the public markets. We saw this with Uber and Lyft who have both fallen significantly below their IPO price.

Wait for the hype to simmer down and the price to equalize before deciding whether WeWork is a right fit for your portfolio.

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