A LEVERED BET ON FLEX

DEMAND: VALUING THE

WE(WORKS) IPO!
Is there a we in WeWorks?
The WeWork IPO

¨ A Big Deal: In a year full of high-profile IPOs, WeWork takes center

stage as it moves towards its offering date, offering a fascinating
insight into corporate narratives, how and why they acquire
credibility (and value) and how quickly all of that can be lost, if
markets lose faith.
¨ Slip, sliding away: When the WeWork IPO was first rumored, there
was talk of the company being priced at $60 billion or more, but a
news story today reporting that the company was looking at a
drastically discounted value of $20 billion, which would make
Softbank, the most recent VC investor in WeWork, an big loser on
the IPO.
¨ My personal bias: I have never liked the company, partly because I
don't trust CEOs who seem more intent delivering life lessons for
the rest of us than about the businesses they run and partly
because of the trail it has left of obfuscation and opaqueness.

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The WeWork Model: Set Up

¨ An old model? Unlike many other tech disruptors, the

WeWork business model is neither new, nor particularly
unique in its basic form, though access to capital and
scaling ambitions have put that model on steroids.
¨ Which has not worked: That said, most traditional real
estate companies that have tried the WeWork business
model historically have abandoned it, for micro and
macro reasons
¨ The Test: of the WeWork model is whether the
advantages it brings to the table, and it does bring some,
can help it succeed, where others have not.

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The Office Space Business: Status Quo

¨ Own and lease: The owner of an office building, who has generally
acquired the building with significant debt, rents the building to
businesses that need office space, and uses the rent payments
received to cover interest expenses on the debt, as well as
operating expenses.
¨ Sensitive to economic shocks: As economies weaken, the demand
for office space contracts, and the resulting drop in occupancy
rates in office buildings exposes the owner to risk.
¨ The keys to success: Buy buildings when real estate prices are low
and secure their tenants into long term leases when rental rates
are high. Use the buffer to protect against downturns.
¨ Boom and bust: Even the most successful real estate developers
have been both billionaires and bankrupt (at least on paper), at
different points of their lives.

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The WeWork Twist

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The WeWork Pitch

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An Example

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The Model Trade offs

¨ The Pluses
¤ The WeWork look, with open work spaces, cool lighting and lots of extras,
which appeals to younger workers. It goes beyond cosmetics, also offering
business networking, support services and consulting connnections.
¤ The WeWork community, where the company supplements its cosmetic
features with add-on services that range from business networking to
consulting services and seminars.
¤ Offer of flexibility to businesses, especially valuable at young companies
that face uncertain futures but also for established companies that are
experimenting with alternate work structures.
¨ The Weakest Links
¤ High leverage, first in the long term lease commitments on buildings, and
next in operating expenses in each building.
¤ A timing mismatch, where the lease payments are for many years into the
future, but its rental revenues are short term.

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Why WeWorks is more exposed than
most..
¨ Own versus lease: Buying comes with two advantages over leasing.
¤ You can decide how much equity to use in buying, allowing you to reduce your financial
leverage, if you feel exposed.
¤ Second, if the property value rises after you bought it, the equity component builds up
implicitly, reducing leverage.
¨ Explosive growth: WeWork does not just have a mismatched model, it is one
that has scaled up at a rate that has never been seen in the real estate
business, going from one property in 2010 to more than 500 locations in
2019, adding more than 100,000 square feet of office space each month.
¨ Tenant Self-selection: By specifically targeting young companies and
businesses that value flexibility, the company has created a selection bias,
where its customers are the ones most likely to pull back on their office
rentals, if things start to look bleak.
¨ Lack of cost discipline: The survivors of this mismatch try to keep fixed cost
commitments low and adjust quickly to changes in the environment. If
WeWork is following this practice, its prospectus seems to contain no mention
of it.

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The WeWork Back Story: Let’s start with
the good news

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And the bad news is..

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With leverage magnifying everything…

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Issuance Details (Still forming..)

¨ Magnitude of Proceeds: While the company has not been explicit about how
much cash it plans to raise in the IPO, the rumor as recently as last week
suggested that it was planning to raise about $3.5 billion from the offering.
¨ Use of Proceeds: In the prospectus (page 56), the company says that it intends to
use the net proceeds for general corporate purposes, including working capital
and capital expenditures. In effect, there seem to be no plans, at least currently,
for any of the existing equity owners of the firm to cash out of the firm, using the
proceeds.
¨ Further Dilution coming: There is a circularity that affects the value per share
used, and resulting share count. That is because the proceeds, since they will stay
in the firm, will increase the value of the firm (and equity) by roughly the amount
raised, and thus the value per share, but the value per share itself will determine
how many additional shares will be issued and thus the share count.
I will do my initial valuation with the rumored $3.5 billion proceeds amount and use
the estimated value per share to adjust share count, but these numbers will need to
be revisited, once there is more concrete information

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Corporate Structure

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And Governance

¨ A Corporate Dictatorship: There are three classes of shares,

with the class A shares that will be offering in the IPO having
one twentieth the voting rights of the class B and class C
shares, leaving control of the company in the hands of Adam
Neumann.
¨ And open about it: The prospectus is brutally direct on this
front, stating that “Adam’s voting control will limit the ability
of other stockholders to influence corporate activities and, as
a result, we may take actions that stockholders other than
Adam do not view as beneficial” and that his ownership stake
will result in WeWork being categorized as a controlled
company, relieving it of the requirement to have independent
directors on its compensation and nominating committees.

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My WeWork Story

¨ Meets an unmet and large need for flexible office: The

demand comes both younger, smaller companies, still
unsure about their future needs, and established
companies, experimenting with new work arrangements.
There is a big market, potentially close to the $900
billion that the company estimates.
¨ With a branded product & economies of scale: The
WeWork Office is differentiated enough to allow them to
have pricing power, and higher margins.
¨ And continued access to capital allowing the company to
both fund growth and potentially live through mild
economic shocks.

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Translate to value inputs

¨ Revenue Growth: I will assume that revenues will grow at 60% a year, for
the next five years, scaling down to stable growth (set equal to the
riskfree rate of 1.6%) after year 10. If this seems conservative, given their
triple digit growth in the most recent year, this translates into revenues of
approximately $80 billion in 2029.
¨ Target Operating Margin: Over the next decade, I expect the company’s
operating margins to improve to 12.50% by year 10. That is much higher
than the average operating margin for real estate operating companies
and higher than 11.04%, the average operating margin from 2014-2018
earned by IWG, the company considered to be closest to WeWork in
terms of operating model.
¨ Reinvestment Needs: The business will stay capital intensive, economies
of scale notwithstanding, requiring significant investments in new
properties. I will assume that each dollar of capital invested into the
business will generate $1.68 in revenues, again drawing on industry
averages.

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Closing the input loop

¨ Possibility of failure: The debt load that WeWork carries

makes its susceptible to economic downturns and shocks
in the real estate market, and the cost of capital, a going
concern measure of risk, is incapable of capturing the
risk of failure embedded in the business model. I will
assume a 20% chance of failure in my valuation, and if it
does occur, that the firm will have to sell its holdings for
60% of fair value.
¨ Debt load: As I noted in the last section, the company
has accumulated a debt load, including lease
commitments, of $23.8 billion.

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Too optimistic? Too pessimistic?

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Following up the what if..

¨ Super charged leverage: If you are puzzled as to why the

equity value changes so much, as growth and margins
change, the answer lies in the super-charged leverage model
that WeWork has created.
¨ Possible, Plausible, Probable: There are possible, perhaps
even plausible, scenarios where the value of WeWork could
exceed $50 billion. There are even more plausible scenarios
where it is worth nothing. The question in investing rests on
what’s probable.
¨ More option than ongoing business: If you invest in WeWork
equity, you are investing less in an ongoing business and
more in an out-of-the-money option, with plausible pathways
to a boom but just as many or even more pathways to a bust.

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The Story Stock

¨ Valuation is a bridge between stories and numbers,

and for young companies, it is the story that drives
the numbers, rather than the other way around.
¨ This is neither good nor bad, but a reflection of a
reality which is that bulk of value at these companies
comes from what they will do in the future, rather
than what they have done in the past.
¨ There is a danger when stories rule, and especially
so if the numbers become props or are ignored, that
the pricing that is attached to a company can lose its
tether to value.
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The Runaway Story

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And pricing consequences…

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Can become the Meltdown Story

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The WeWork Story Shift?

¨ CEO arrogance: Adam Neumann has been remarkably short sighted,

starting with his sale of almost $800 million in shares leading into the IPO,
continuing with his receipt of $5.2 million for giving the company the right
to use the name “We” and the conflicts of interest that are sowed all over
the corporate structure.
¨ Game playing: WeWork’s continued description (with more than a 100
mentions in its prospectus) of itself as a tech company is at odds with its
real estate business model, but investors would perhaps have been willing
to overlook that if the company had not also indulged in accounting game
playing in the past. This is the company that coined Community EBITDA an
abomination, where almost all expenses are added back to get to
adjusted earnings.
¨ Denial: Since even a casual observer can see the mismatch that lies at the
heart of the WeWork business model, it behooves the company to
confront that problem directly. Instead, through 220 pages of a
prospectus, the company bobs and weaves, leaving the question
unanswered.

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An investor/trader cheat sheet

¨ If you are a VC/equity owner in WeWorks: On the one hand, you may want to pull
the IPO and wait for a better moment. On the other, your moment may have
passed and to survive as a private company, WeWork will need more capital (from
you).
¨ As an investor, whether you invest or not will depend on what you think is a
plausible/probable narrative for the company, and the resulting value. I would not
invest in the company, even at the more modest pricing levels ($15-$20 billion),
but if the price collapsed to the single digits, I would buy it for its optionality.
¨ If you are a trader, this stock, if it goes public, will be a pure pricing game, going
up and down based upon momentum. If you are good at sending momentum
shifts, you could take advantage.
¨ If you are a founder/CEO of a company, the lesson to be learned from this IPO is
that no matter how disruptive you may perceive your company to be, in a
business, there are lessons to be learned from looking at how that business has
been run in the past. The saying that those who do not know history are destined
to repeat it seems apt not just in politics and public policy, but also in business.

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