We have been looking forward to the We Company prospectus for months; this is the signature public equity transaction of the year regardless of how it prices. The setup is, at best, mixed:
- Prior 2019 landmark transactions like Lyft and Uber have been very disappointing performers.
- And yet a host of other, small, deals have generally gone quite well.
- The success/failure of this offering will go a long way to judging if the venture capital community really understands what public investors are looking for and how we value important disruptive companies. The stakes are high indeed.
After reading the WE prospectus today, we have 3 points to highlight to you:
#1: WeWork followed Clayton Christensen’s “disruptive innovation” playbook better than most companies in the current cycle.
- Real innovative disruption starts at the low end of a market and works its way up the price/quality ladder. Doing so buys time against established competition, which typically is happy to cede less profitable segments.
- The disruptor has a unique value proposition that allows it to be profitable at the low end – something that existing competitors are either unable or unwilling to replicate. This edge is also what makes it successful as it climbs the value chain.
- WeWork wasn’t the first to offer short-term rental of office space, but its offerings were much more attractive than the competition’s. Throw in a startup company boom populated by millennials that kicked off just as WeWork was hitting its stride (2011 – 2015), and it was able to create a new form factor for office space. Cool, inviting and communal.
- True to the Christensen paradigm, WeWork then moved up the value chain by signing larger companies. As of June 2019, 40% of its memberships are from companies with +50 employees.
Bottom line: on this important score, WeWork did things correctly.
#2: The biggest difference between WeWork and other recently public disruptors: it is very asset intensive.
- As of June 2019, WE’s balance sheet shows $6.7 billion in property, plant and equipment and $15.1 billion of lease assets, for a total of $21.8 billion.
- Assuming 2019 whole-year revenues of roughly $4 billion, that is just a 0.2 sales/assets ratio.
- Compare that to Uber, with $2.8 billion in PP&E/leases and about $14.0 billion in current year revenues. That is a sales/asset ratio of 5.0.
- The difference is, of course, the business model. WE must lease space in order to essentially resell it. Uber’s drivers own/lease their vehicles, not Uber itself.
Bottom line: whatever you read in the prospectus, WE is a real estate company first and everything else second. In order to earn its cost of capital, it will have to generate very large profits/cash flow to offset its asset intensity.
#3: The biggest wild card for WeWork going forward is economic cyclicality.
- WE started in 2010, in the wake of the Great Recession. Office space was cheap, US startups were getting their first rounds, and American unemployment was grinding its way lower.
- Now, more than half of WeWork’s members are outside the US, located in 111 cities around the world.
- On the plus side of the ledger for WE’s business model: their offering is cheaper than a standard office lease. Whenever the next US/global recession hits, companies may choose to cut costs by relocating to WeWork space.
- On the downside, recessions come with reduced employment levels. Existing customers may choose to cut back their usage at WE locations.
Bottom line: we believe this issue will be what determines where WE’s IPO prices, or if it even happens at all. Like many of the disruptive companies that have come public this year, WE has never lived through a recession. And, like UBER and LYFT, its core offering was built during the longest US economic expansion in history. How management will navigate a recession is unknown.
Summing up: having marketed our share of IPOs over the years, we think WE’s offering is going to be a tough slog for underwriters. Yes, this is a cleverly disruptive company. But it is also an asset-intensive cyclical company as well. Stocks of such businesses tend to perform well at the start of an economic cycle. At the end… Not so much.
To read the WE S-1: https://www.sec.gov/Archives/edgar/data/1533523/000119312519220499/d781982ds1.htm#fin781982_8