Softbank & WeWork – End of work?

Goodbye blue sky.

• Softbank needs to take a good hard look at its processes as the valuation that it is prepared to pay for WeWork has fallen by 83% in a matter of weeks despite no fundamental change in the business outlook for WeWork.
• Softbank looks set to bail out WeWork in a deal that will see it inject a further $5bn, which will take its share in the company to 70%.
• WeWork is a clear example of the problem with valuations that are built on blue sky rather than fundamentals.
• This is exemplified by the fact that Softbank will have ended up paying $15bn for a 70% stake in a company that it itself is valuing at just $8bn.
• The deal will include the exit of the now-infamous CEO who will also be forced to cede control of the company he founded.
• Softbank will also have to immediately write down its 70% investment by $9.4bn or 63% to $5.6bn.
• I think that even that may be too high.
• WeWork’s valuation has been supported by the assumption that the IPO would go ahead which would have triggered further investments that would have given the company time to get its house in order.
• Without these investments, the company appears to be teetering on the edge of bankruptcy as, according to some reports, it is unable to cut its headcount as it cannot afford the $200m in severance payments it would have to immediately make (see here).
• I have stated many times that a company that does not generate cash has an equity value of $0 because it will eventually run out of cash and, in a liquidation, equity holders are at the bottom of the pile.
• Even $8bn can start to look ambitious when this situation is compared to WeWork’s competitor IWG.
• IWG has revenues of $3bn and an EBIT margin of around 4% and a market capitalisation of $4.4bn.
• WeWork’s premium valuation has been based on very rapid growth which was faithfully expected to suddenly become hugely profitable once it reached a certain size.
• However, even a cursory glance at the accounts shows that rapid growth is almost entirely because it has been massively discounting its prices to get the customers in the door.
• The hope was that tenants’ experiences would be so good due to the “technology platform” that they would swallow massive hikes in rent when it came to renewal time.
• Again, it does not take more than a quick look at the accounts and to speak to a few tenants to realise that there is no technology platform and consequently no barriers to entry.
• Hence, when it comes time to renew, clients threaten to leave resulting in further rent cuts to keep them on board.
• How WeWork is ever going to make the margins promised remains a big mystery.
• This is particularly the case as WeWork has long-term commitments for the buildings that it rents out giving it very little scope to renegotiate what it is paying to the building owners for a very long time.
• Hence, I suspect that growth will collapse from here.
• This is because Softbank will force discounts to end immediately meaning that it will no longer be more competitive than its peers resulting in a collapse in new tenant acquisition.
• A restructured WeWork will probably have similar financial characteristics to IWG.
• I think that as a 10-15% growth company with 4-5% EBIT margins, WeWork might be able to command a valuation in the $4bn – $6bn range.
• This is likely to result in Softbank holding onto this investment for a very long time before quietly bringing it to market when the turnaround has been affected and the fuss has long been forgotten.
• This sorry episode is also a searing indictment of Softbank’s valuation and screening methodology which needs to shift towards being based on fundamentals rather than blue sky.
• I suspect that it has also done real damage to its efforts to raise money for its second Vision Fund which could now take much longer than expected.
• I also now expect the IPO window to tighten considerably meaning that it is going to be much harder to take cool and trendy but immature and money-losing companies to market at high valuations.
• I continue to believe that there is nothing wrong with the IPO process itself and that the best way to ensure an orderly and profitable public offering is to stop bringing immature, overpriced and badly governed companies to the public market.