WeWork: The rise and collapse of the ‘throw enough money and it will work’ business model

WeWork eventually gained a listing on the New York Stock Exchange in October 2021, via a SPAC (special purpose acquisition company) merger, bypassing the traditional listing process. It was valued at some US$9 billion. Despite shedding many of its past excesses and restructuring some debts into equity, the company struggled to turn a profit. Last month, WeWork warned that it might be on the verge of bankruptcy as it continued to burn through rapidly falling cash reserves. Its market value has fallen below US$100 million and it must now implement a 40-to-1 share consolidation to prevent de-listing.

From being one of the most hyped start-ups and hotly anticipated IPOs — the botched 2019 listing was no doubt one of the biggest debacles on Wall Street in recent memory (even inspiring a miniseries on Apple TV+) — to the spectacular collapse in valuations and, now, possibly bankruptcy, what went so wrong?

For sure, chance and timing are key factors. The Covid-19 pandemic may have forever changed the way people work. At the very least, it has had a significant impact on office occupancy, during lockdowns and even now, after economies fully reopened. Now that they have had a taste of it, employees are demanding increased flexibility, perpetuating the work-from-home trend that was necessitated during the pandemic. Indeed, even the largest companies are having trouble persuading their workers to return to offices full time and attracting talent, if they do not offer a hybrid work option. This drastic change has resulted in companies cutting back their office space requirements, rising vacancy rates and falling rents. It is estimated that the US has nearly 20% unoccupied office space. There is a growing concern on Wall Street that the commercial real estate sector could implode as loan defaults rise against the backdrop of higher-for-longer interest rates.

In short, the post-pandemic world has decimated a good chunk of the workspace demand that WeWork relies upon. Remember, the company makes a profit by taking on long-term leases (up to 15 years from property owners), furnishing and then subletting the space on a short-term basis — gaining from the term mismatch and value-added services such as printing, broadband connectivity and cleaning. This means that much of its costs are fixed (long-term leases) while revenue fluctuates with demand and occupancy rates. And revenue growth is slowing rapidly, up just 3.6% year on year in 2Q2023, and, critically, falling 4% in the US, which accounts for 41% of sales. WeWork reported a net loss of nearly US$700 million ($947 million) in 1H2023 and continues to burn cash at an alarming clip. The company issued a warning: “Our losses and negative cash flows from operating activities raise substantial doubt about our ability to continue as a going concern.”

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Pandemic impact aside, we have always been sceptical of WeWork’s business model. Granted, it does fill a niche, offering flexible workspaces on a short-term basis (daily or monthly) that is particularly appealing to business travellers and freelancers as well as start-ups and small businesses (since there is no need for the high upfront costs of setting up their own offices and catering for future expansion needs). Depending on the type of membership, customers can even opt for “global access” within the WeWork network, much like gym memberships.

But, clearly, it is not a business model built to withstand any downturn, which is inevitable as part of economic/business cycles. Some have called it a real estate company, but it is, in reality, less than. It is a real estate “tenant”, not owner. It provides commercial real estate solutions. Most real estate companies own properties they can sell for cash to pay off debts in the worst-case scenario. WeWork has committed lease obligations it has to pay for — totalling nearly US$25 billion currently — regardless of whether they are occupied or vacant. Worse, many of its members are also the most vulnerable in an economic slowdown or recession — and memberships can be cancelled on short notice.

The pandemic merely exposed the weakness of its business model — think of the sharp drop in demand as a recession played out in fast-forward mode. We are doubtful WeWork is viable in the long run, even if the pandemic may have hastened its demise. Indeed, the faster and larger it grows, the more inevitable is failure. Why? Because its risk of term mismatch will grow exponentially. How, then, did WeWork garner its eye-popping US$47 billion valuation back in 2019?

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Hype of TAM

The fundamental problem, we think, is the way the market values high-growth, primarily tech, companies and start-ups, especially those that are loss-making. In the absence of profits, price-to-sales (PS) has become the valuation metric of choice. For forecasting sales growth, analysts sell the idea of total addressable market (TAM), which represents total market demand and revenue opportunity available to the company. The larger the TAM, the bigger the growth potential and, therefore, the higher the valuation.

Tech companies are often perceived to have larger TAM than traditional players in the same industries, with justifications. Technology has broad applicability across many industries and, with continuous innovation, companies can, and do, create new products and new demand markets over time, hence growing their TAM from the additional sales — in addition to disrupting the existing market. In the case of WeWork, it met demand — from workers in the gig economy, freelancers, solo entrepreneurs and micro-small businesses — created by technological innovation and enabled by high-speed internet connectivity.

Furthermore, tech companies have global reach through the use of the internet. With rapid digitalisation, adoption and new applications are expected to expand for the foreseeable future. Many tech companies also have scalability, where they can expand sales with a less-than-proportionate increase in costs, which translates into rising margins. And some, notably social media platforms, have network effects that create formidable moats and competitive advantages.

But pinning down a company’s TAM can be tricky. A proficient and imaginative analyst can often spin a good enough story to lift valuations higher than the underlying fundamentals can support, often without regard to competition, geography and market accessibility or inherent limitations within the company itself. What is often not highlighted is the market share that can be realistically captured — usually far, far smaller than the TAM the company is marketed on, not to mention the associated costs.

For instance, one could say the TAM for Tesla is the total number of cars sold each year globally. And, in fact, its current market valuation suggests that Tesla can sell more cars than the world’s eight largest automakers combined, without starting a price war and not taking into account the availability of charging infrastructure in different countries, other market limitations or its own production capacity. One could also argue the same TAM for Uber, if ridesharing could replace all car ownership. By the same token, the TAM for cryptocurrencies would be worth tens of trillions of dollars, for the entire market for money, by replacing all the fiat money transactions in the world today.

WeWork and Neumann are obviously very good at storytelling. WeWork was marketed as a tech company, deserving of tech valuations — even though there is very little technology involved. It signs up long-term leases, spruces up the buildings and rents out workspaces on a short-term basis. The “technology” is basically the platform, accessed via the company’s website and mobile app. Yes, the platform — which aggregates and matches demand and supply — does improve efficiency and reduce friction. And the company may have some (very limited) economies of scale: for instance, in negotiating with land- lords and strong branding that potentially lowers customer acquisition costs.

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Here’s the thing. The industry has no real barrier to entry. There is no specific restrictive legislation or regulation. There is nothing to stop, say, the property owner from creating coworking space and renting it out exactly as WeWork does. And, in fact, some do, though most prefer longer-term leases for larger spaces (than a desk) to reduce the risks. The idea of sharing workspace is not new either. We have business centres that cater for on-demand needs and there are existing coworking players. For instance, London-listed IWG, which was founded in 1989, more than two decades before WeWork (2010). WeWork clearly has no intellectual property.

In its 2019 IPO filing, WeWork claims its TAM is every desk job in all the 280 cities around the world that it intends to expand to, with potential memberships totalling 255 million. Based on its then average revenue per membership (derived from its reported 527,000 members as at June 2019), it extrapolated the TAM to US$1.6 trillion.

Its unique selling propositions to capture all of this demand (TAM)? Creating a sense of community and networking opportunity in a “cool environment”, with free croissants, muffins, gourmet coffee, kombucha and beer, and gym and yoga studios, to boot. And, most critically, cash to burn.

The company successfully wowed investors, at least prior to its IPO debacle — with explosive demand and revenue growth, which seemingly backed up its claim in penetrating said TAM. And herein lies yet another fundamental problem when it comes to valuing many high-growth companies and start-ups. Valuation metrics such as PS promote a growth-at-all-costs strategy, focusing primarily on the top line.

It is a no-brainer to throw money to expand aggressively and gain market share — with heavily subsidised, cheap or even free products and services — when you have a seemingly unlimited flow of cash and no concern of margins and profits. And in the pre-pandemic world of excessive liquidity and ultra-low interest rates, there is no shortage of private equity and venture capital firms chasing — and shoving cash at — over-hyped start-ups and high-growth companies with a good story.

The growth-at-all-costs strategy also serves the funds well. The private capital market is a fantastic money-making machine. Each additional dollar raised from new funding rounds is priced higher than the last, justified by strong top-line growth — creating an ever-higher overall valuation for the company and all existing investors. Case in point: SoftBank’s investment of just US$2 billion in January 2019 more than doubled WeWork’s valuation from US$21.1 billion to US$47 billion. In short, shareholder money is used to heavily subsidise products/services, generate exponential revenue growth, which then justifies higher valuations and attracts more equity capital. See the circularity in this logic? Why was WeWork’s clearly weak business model not called out sooner? Well, as we said, the private capital market is a money-making machine, where a few major players can act in concert, injecting cash to create unrealistically high valuations.

The public capital market, though, is far more discerning. Public markets are efficient in the long run. Price discovery happens quickly, owing to greater liquidity and a significantly larger number of players — investors (with differing objectives, such as short-sellers and activist shareholders), analysts, journalists and market commentators — and much higher levels of regulatory oversight, disclosures, transparency and governance.

Ultimately, stocks with business models that do not make sense or are unsustainable, cannot generate positive operating cash flows or turn a profit will fail. And this is what happened to WeWork. What is the difference, you say, with Uber, for instance? Uber has economies of scale, in that the greater the number of cars within its network, the faster the response time to customers wanting a ride. As ridership grows, cost per ride falls, generating profits and the ability to reduce prices. And, of course, ultimately autonomous vehicles will yield huge returns, as the single-highest cost item is human. If humans are still nec- essary, they could then be turned into sales functions for other products.

We have written this article as a prelude to a series of articles on stock valuations. We are sure our readers will want to know our views and how we would value Nvidia, for example. We plan to start with the basics, the “how to value” and what parameters are necessary, which are facts and what are assumptions. And we will follow up with some examples, of global and local companies — in particular, those on which we hold contrarian views to the market or, at least, to the majority of the analyst community.

The Malaysian Portfolio gained 3.2% last week. We disposed of all our shares in Hartalega Holdings and KUB, raising cash holdings in the portfolio to almost 79%. As we wrote a couple of weeks ago, cash will be king again. We also sold our entire stake in the Star Media Group. We are disappointed with its dismal financial performance. Net profit in 2Q2023 fell by more than half — to less than RM0.8 million, from RM1.8 million in the previous corresponding quarter — as operating expenses grew faster than revenue. We would be keen to see whether salaries and bonuses of senior management are reduced accordingly.

Last week’s gains boosted total portfolio returns to 157.6% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 20.6%, by a long, long way.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.