What happened to WeWork? Less than two months ago, the co-working giant was the nation’s most valuable tech startup with plans to go public. Now, IPO plans have been called off, the founder and CEO has stepped down, and the company is trying to borrow $4 billion to stay afloat. It’s one of several start-ups with a high-growth, no-profit story and a lesson for investors about the importance of fundamentals.
The WeWork story is all about fantasy versus reality. In January, the company had been privately valued at $47 billion. That’s a high-flying number for a company that’s never made a profit. But it has a high-flying growth story which investors love. WeWork has quickly expanded its co-working concept around the globe. It wasn’t the first co-working company, but it has become the largest. Founder Adam Neumann fueled that growth story with his lofty talk about changing the world. (1)
One of the WeWork mantras is to build “a world where people make a life and not just a living.” He was anything but conventional with his long hair, 2 a.m. executive meetings, and a party-like office environment where beer and tequila were the norm. You might say his enthusiasm for a different kind of work culture grew to the height of cult status, although some employees reportedly thought it was “over-the-top.”
Wake-Up Call for Investors
He wanted to “elevate the world’s consciousness” but may have done more to elevate investor consciousness when they started taking a closer look at the numbers. Just days before the IPO, the company’s public valuation was slashed from $47 billion to less than $20 billion. Some reports say $10 to $12 billion. That created a lot of uncertainty among potential IPO investors so the IPO collapsed. And now the company has a liquidity problem because it was counting on raising $3 billion in the IPO, and unlocking another $6 billion loan.
As Business Insider reports, the backlash from investors has prompted an overhaul of WeWork operations that includes the ouster of Neumann as CEO. (2) Co-CEOs Artie Minson and Sebastian Gunningham are now running the show as they make an appeal for $4 billion in funds to keep the company afloat, and announce plans for lay-offs and asset sales to help cut expenses.
Reuters reported that WeWork is hoping to get $1 billion from its largest investor SoftBank, and another $3 billion debt deal from JPMorgan, if SoftBank comes through. Details about layoffs are still pending, but Business Insider reports that the company plans to cut 10% to 25% of its workforce. The company has about 12,500 employees so that’s anywhere from about 1,200 employees and 3,100 employees.
Where Did WeWork Go Wrong?
So where did WeWork go wrong? There are plenty of start-ups that become stock market darlings without making a profit. Look at Uber and Lyft. They both went public this year but their stock is getting clobbered. They are down 30% to 40% from the IPO, respectively. There are several smaller start-ups with the same story, along with the failed WeWork offering.
Economist Harry Dent dedicated a recent podcast to the currently flawed IPO market. He says, companies are too focused on growth and not enough on fundamentals. He says, the growth stories are sexy and they attract a lot of speculation about a company’s future potential. But he says, they end up floundering because they have a poor business model. He says, they end up “sacrificing profitability and underpricing their product or service which delivers a lot of value to the customer.” But, of course, that doesn’t deliver a lot of value to the company.
He says that companies don’t care about “making money from their customers. That isn’t the goal. The goal is to make money from the stock investors.” But that isn’t working out very well for some of our recent IPOS, like Uber and Lyft. Investors also became disillusioned with WeWork “before” it went public because they saw a lot of debt and no profit.
Popularity Growth vs. Financial Growth
The IPO frenzy is contagious, however. Who doesn’t want to bet big on a company that the whole world is in love with? But the love fest doesn’t last forever when the money isn’t there to support all that growth. The co-working concept may be a good idea, but WeWork success doesn’t depend on the charisma of its former leader. When it comes down to financial sustainability, you have to look at the math, and it has to add up to financial growth — not just growth in popularity.
Columbia Business School professor, Len Sherman, told the New York Times, “Spending too much too soon on unproven business models only heightens the risk that a company’s race for global domination can become a race to oblivion.”
Where Will WeWork Go from Here?
The Intelligencer published a lengthy and very interesting article on the history of WeWork. It offered this commentary on where the company might go from here, especially if we are hit by recession:
“The company has existed entirely in an expanding economy, and its business has never been tested by a downturn. WeWork argues that in a recession, larger companies will downsize into its spaces while laid-off workers will need them to start their solo careers. But, it’s also very possible that large companies who currently have ancillary spaces in WeWork will identify those as easy costs to cut, and entrepreneurs will revert to coffee shops. A third argument goes that WeWork occupies so much space that many landlords will have no choice but to renegotiate its leases.” (3)
WeWork is also getting a lot of praise for expanding the use of flexible office space and shorter-term leases. Even with all its problems, WeWork has been a driving force for this kind of work environment. According to some, the company has been very instrumental in transforming commercial real estate. WeWork may be able to regroup under new leadership, but it will have to do things differently to survive, and that means a new focus on fundamentals.
Lessons Apply to Real Estate Investing
The same holds true for real estate investments. Many investors today have only owned properties over the past 10 years, during an “up” market. They have no idea what can happen in a “down” market. They also may hold lofty ideas about how C class properties are safe because they are more affordable. Yet they haven’t really researched if that is true. They should get the history on the property they are planning to buy and understand how well it did during the last recession.
When it comes to multifamily property, it’s definitely the new buzz. Lately it seems that everyone I meet at real estate events wants to own an apartment. Many want to syndicate, which means raise money from other people, to acquire the building — even if they’ve never done it before.
Please never invest your money with someone who does not have a track record doing exactly what it is they plan to do with your money. Also, please listen to my interview with Ken McElroy on my other podcast, The Real Wealth Show. He gives great advice on how some people today are going to get wiped out during the next downturn because they are buying property that has too low a cap rate. He says if cap rates increase by just 1%, the NOI (net operating income) needs to increase by 25% just to break even. And if that doesn’t happen, the bank might recall the loan.
Too many people are also buying in high-priced markets thinking they will tap into the appreciation. Unfortunately, that appreciation has already happened and there’s no guarantee it will continue to happen. A lot of people think today’s lower rates will drive prices up further. I don’t think so. Low rates will just get sales going again, but not at extravagant prices. People are being more cautious today for fear of that ever-impending recession.
So remember, just because everyone else is excited about an investment, it doesn’t make it a good one. In fact, that really should scare you. Because the best deals come when everybody is cautious. When people are investing with abandon, more mistakes are made.
Always run your pro forma by your CPA, real estate attorney and a real estate coach if you aren’t an expert yourself. This is the time in any market cycle when the masses buy at the top and get wiped out shortly thereafter.
However, this is also the time to reposition your assets into more conservative-type properties. I recommend staying within the median price range of the area — ideally B class neighborhoods, near a variety of jobs and in the path of progress. Meaning, in the areas where cities are investing their infrastructure in new freeways, schools, downtowns etc. Keep low leverage and high cash flow.
(1) WeWork’s Nightmare IPO: Business Insider
(2) WeWork Lifeline