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Will WeWork Be the Most Contentious IPO of 2019?

The We Company, the holding company behind office-sharing giant WeWork, prepares for their IPO. So far, the company hasn’t revealed its official pricing information, but following its most recent funding round – a $2 billion investment from SoftBank in January – the company’s value amounts to $47 billion. At this valuation, WeWork would be the 2nd largest IPO of 2019, trailing only Uber.

WeWork is an American company providing flexible and shared workspaces for start-ups, freelancers and small businesses. A start-up providing other start-ups with office space is valued at $47 billion… Doesn’t it sound funny? It probably does… But before you make up your mind and decide to invest in WeWork’s successful vision, there’s been mixed views on if it really ‘stacks up’ as an investment opportunity.

WeWork has attracted a significant amount of investment, particularly from the aforementioned prominent VC firm SoftBank, who has invested over $10billion into WeWork.

In 2018, WeWork’s revenue doubled to $1.8billion from $886 million a year earlier. Their members (people that pay on a monthly basis to use WeWork facilities) have also increased from 186,000 to 401,000, making up 88% of their revenue.

This all sounds good, but WeWork is a capital / liability intensive business model. They take on the ‘hard costs’ that both startups and traditional businesses typically have i.e. office space, utilities etc.

This speaks volumes to why the co-working trend has taken off. WeWork, like other co-working spaces, provide more affordable/achievable workspaces in the biggest cities around the world like London, New York, Sydney, and plenty more!

So why does WeWork surpass others in the co-working space in terms of valuation?

For example, the International Workspace Group (IWG), which was founded in 1989 in Belgium, operating mostly under the Regus brand, offers similar services, earns more revenue and more importantly – earns a profit. Yet IWG has a market cap (total market value) of just $3.7 billion, which is less than 10% of WeWork’s valuation. Well… it really is a weird world we live in when it comes to startup valuations... but, WeWork has really captured the attention of the largest demographic in the world, millennials.

WeWork is a brand, like buying an Apple iPhone, WeWork projects an image, a lifestyle that’s not just about high-end but affordable workspaces, it’s about the community and network that comes with it.

One of the hardest parts of growing a business is creating a culture and an environment people want to work in. Although some may deem WeWork as expensive, comparative to a number of other co-working spaces, WeWork has a ‘brand’ that is largely unrivalled when it comes to the preferences of entrepreneurial millennials.

Larger companies are also seeing the value of WeWork / shared workspaces from a cost perspective, relocating some of their staff to WeWork offices, but they’re also seeing the value of tapping into a community of up and coming, potential unicorns.

In fact, over the last year, the number of WeWork’s clients with more than 1,000 employees (enterprise clients) have doubled with some big names now being WeWork members including Salesforce, Starbucks, Microsoft, Facebook, and Bank of America. These enterprise members now account for 32% of WeWork’s total members.

WeWork is effectively a real estate company, with real estate being one of the more conservative asset classes. However, owning is where the money is made in real estate, not renting. WeWork has figured this out and has already started buying properties via their real estate investment fund called WeWork Property Advisors in partnership with the Rhone Group - taking a good leaf out of fast food giant McDonald’s book. - McDonald’s is now one of the largest owners of commercial real estate in the world! There’s a reason why landlords grow rich in their sleep ;) hello capital appreciation!

Although WeWork had a net loss in 2018 of $1.9 billion, up from $933 million in 2017. By one metric, which WeWork calls “community adjusted” earnings before interest, taxes, depreciation and amortization, the company is becoming more profitable by a margin of 28% last year, up from 27% a year earlier.

Although very capital intensive now, if / when WeWork do make a profit, buying property can effectively reduce their tax bill at the same time as building their asset value.

As a simple explanation, companies are taxed on their profits. So, if WeWork is buying property with those profits, it can be deemed an expense. So instead of being taxed on the asset value, they’re taxed on the rental income, and later, the capital gain on the sale of the property. i.e. $1 million in profit that’s used to buy $1 million in property may only be subject to $52,000 in tax on the rental income which equates to a 5.2% yield. (Gross yield = annual rental income (weekly rental x 52) / property value x 100) - that’s a big tax savings on $1 million in profit.

But, for now, WeWork is predominantly a tenant that subleases to members, so their business model is fairly risky. Commercial leases, particularly long-term leases can last 10-15 years which require WeWork to pay hundreds of millions of dollars in rent, even during economic downturns and downcycles in the real estate market, if the company struggles to fill the buildings with members.

Moreover, after the 10-15-year lease term expires, a landlord could hike up their rental prices knowing WeWork may be unlikely / unable to move commercial premises.

Over the course of a decade-long lease, there may be phases when small businesses and entrepreneurs find WeWork to be unaffordable, or competitors with lower rent obligations are able to provide a similar offering for less money to these customers.

When you look at their business in this way, WeWork’s big selling point of office space flexibility is also one of the greatest threats to the long-term stability of its business.

Yes, an increasing base of enterprise clients means there’s more security for WeWork and in addition to this, WeWork is shifting from leases to co-management deals - a similar structure to hotels - and look how successful they are / were until Airbnb stepped in. In this scenario, like the hotel industry, landlords might pay for the renovation and build out of offices and/or split membership profits 50/50, similar to the management agreement popularised by the hotel industry.

It’s also worth pointing out that according to research conducted by Emergent Research, the co-working industry more broadly is also changing, moving away from individual entrepreneurs and towards small businesses and companies employing fewer than 100 people.

But do they have enough of a case to make them a viable investment opportunity i.e. does the risk outweigh the potential for a return on this investment?

Just today, Market Insider reported that WeWork may reduce their valuation by more than half to $20 billion or they may postpone their IPO entirely.

This could be a sign of WeWork struggling to justify their valuation to investors in their IPO, but WeWork’s own co-founder and CEO Adam Neumann, told Forbes in 2017:

“No one is investing in a co-working company worth $20 billion. That doesn’t exist... Our valuation and size today are much more based on our energy and spirituality than it is on a multiple of revenue.”

One thing is for sure: we’ll be hearing about WeWork many times in the coming weeks and regardless of whether you are going to be investing when they IPO or you think it’s business model is waiting to implode, it might be interesting to add them to your ‘Watchlist’.

Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.

Disclaimer: At Evarvest we believe in making investing and investment education more accessible, but we don’t provide investment advice and individual investors should make their own decisions. While we try our best, we cannot ensure the accuracy of the information we provide.

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