WeWork IPO – Does not work.

I can’t see value even after a 58% cut in the valuation.

• Other than its cool factor, I struggle to see why WeWork is better than its biggest rival IWG, which trades at a tiny fraction of the valuation even after more than halving the mooted IPO valuation.
• The WeWork roadshow is about to start, and this already looks like yet another cool company that has reached scale but remains chronically unable to make any money.
• For the avoidance of doubt, investing 101 says that equity in companies that don’t make profits or have positive cash flow is worth nothing.
• What WeWork does have is revenue growth, but this is coming at a very high price (see here).
• In H1 2019, revenue expanded to $1.54bn or 101% YoY, far greater than rival IWG which managed just 12.3% YoY to $1.60bn but critically IWG makes money, generates cash and pays a dividend (see here).
• In H1 2019 IWG had an EBIT margin of 3.9% and generated $65m in cash while WeWork had EBIT margins of LOSS 89% and bled $199m in cash.
• Furthermore, from WeWork’s accounts, it is clear that the company is buying growth at any cost as it is spending 84% of its turnover on location operating expenses (101% of depreciation and amortisation is included).
• Hence, the company looks like it is operating on negative gross margins.
• This means that WeWork is getting great traction in its co-working spaces because it is offering its clients terms that are too good to be true and cannot be maintained.
• Obviously, the hope is that when the renewals come around, that the tenants will swallow the massive rent increases that will be needed to make this company profitable.
• WeWork built its reputation on being the hip and cool place to hang out and work, but the others have caught on and there is not a great deal of difference in the environments offered by WeWork, IWG and its rivals.
• Furthermore, with so many businesses running their operations in the cloud, it is pretty easy to pack up and move on to another office that is just as cool but offers a better price.
• Hence, I do not see any real barriers to entry meaning that I do not see why WeWork should be any more profitable or cash generative than IWG.
• For 2019, IWG has a PER ratio of 10.2x and should be able to sustain a growth rate of around 10%.
• Given that I can’t see any real edge that would keep WeWork’s margins above those of IWG in a steady-state, I think it is reasonable to apply IWG to WeWork as an example of what WeWork will look like when it stops handing out rebates to buy growth.
• If WeWork trades on par with IWG, then it would need to generate net income of $1.96bn to justify a valuation of $20bn.
• If I assume that WeWork should at least be able to generate net margins of 7% (as IWG), then it needs to generate revenues of $28.0bn in order to earn that level of net profit.
• This is 7x greater than the revenue that I think it can be expected to generate in 2019 and is unlikely to be hit any time in the foreseeable future.
• Hence, I am struggling to see value in WeWork even at the greatly discounted IPO valuation of $20bn.
• This valuation involves Softbank taking a 57% haircut on the investment it made in WeWork just 8 months ago.
• To justify the huge premium (to IWG) the company is asking from investors, it needs to have something that locks its clients into its working spaces or a way to make extra money or lower costs through the data it gathers or its technology.
• Both of these would create barriers and allow better profitably and hence a higher multiple.
• I can’t see any of these and so at the end of the day when WeWork puts up prices, it will see its growth (and probably the share price) crater as clients seek better rents elsewhere.
• WeWork looks set to become the biggest player in this field but whether or not it can make substantially higher margins than average is highly questionable.
• Consequently, I see it converging towards the mean once growth settles down and this is likely to happen when investors start applying pressure on the company to make money.
• Hence, I see yet another high-profile IPO that struggles once the harsh glare of the public market rather than long-term dreams determines its valuation.
• Another one to avoid.