5th August, 2018

When the business cycle turns, WeWork’s model just won’t work

These are racy times in financial circles. I recently bumped into a veteran mining promoter who has now given up pushing natural resources stocks — instead his latest venture is a medicinal marijuana company. I should have guessed. Punters are so desperate for the Next Big Thing that they will shove money into the most speculative offerings at the most preposterous valuations.

To believe in certain companies, you almost need to be a religious convert. The founder of an American serviced-office business called WeWork, Adam Neumann, says: “Our valuation and size today are much more based on our energy and spirituality than . . . on a multiple of revenue.” Supposedly his firm is worth $20bn (£15bn) and could soon be worth $30bn, and it seems even The Economist has drunk the Kool-Aid: the magazine published a fawning piece about the company recently.

WeWork is privately held, so up-to-date financial statements are not widely accessible. But last year, according to the offer document for a bond sale it held, it had $866m in revenues and lost $933m. It uses a spurious profit measure called “community-adjusted Ebitda”, which usually stands for earnings before interest, taxes, depreciation and amortisation — but in this case included stripping out costs such as marketing and administration, according to the Wall Street Journal. That makes it feel even more like a bubble stock.

WeWork and its three founders were profiled last month in The Times’s Saturday magazine. They talked gobbledegook: “WeWork is a business with a kind of consciousness and real intention behind it . . . The offices are just a backbone for this new consciousness and lifestyle to exist.” I remember a previous business interview in that magazine with the then chief executive of Thomas Cook. A short time afterwards she resigned.

The industry is not new. Regus (now called IWG) has been around for almost 30 years and has workspaces in almost 3,300 locations around the world. Last year revenue was £2.35bn and operating profits were £163m. It pays a dividend and is strongly cash generative. It is the subject of a bidding war and has an enterprise value of just £3bn. IWG is a bit dull but it is pretty solid and subject to the rigour of listed company status.

I was involved at the trendy end of the serviced-offices business during the dotcom era with a company called Metrocube. Just like WeWork, we made our premises cool, so all the internet start-ups would take space with us. It was a great business — we could rent space wholesale and get small businesses to pay for it at retail prices. But once the economy slumped, the groovy tenants downsized, went bust or decamped back to their bedrooms. We remembered that we had long-term cost commitments and short-term income. We were lucky to get out breaking even.

Companies such as WeWork offer free beer, say their staff canteens won’t serve meat and paint big signs saying “Passion” on the walls.

That’s simply trendy froth. The basics have not changed and business is still cyclical. There will be a recession, and then small tenants will reduce their property obligations if they can.

WeWork could well have more property rental commitments than any other company in both New York and London. These long-term obligations will crush it when tenant demand evaporates and there is lots of cheap space available. It is unfortunate that WeWork is not quoted, because I would surely short the shares. It is rare to see so many sell signals in a single company.

More signs that the market is overheated are the crazy valuations for businesses that use crowdfunding to raise capital. Almost every such financing I’ve seen is priced at two, three or even five times what it would fetch from a professional investor. The promoters are taking advantage of a lack of investing expertise among the public. Good luck to them — but many schemes will end in tears when the uninformed punters realise they’ve been had. I predict that returns from the asset class will prove abysmal, especially since investors get few protections or rights in the subscription agreements offered by crowdfunding platforms.

The era of easy money is ending as interest rates go up. The truly mad valuations will evaporate too, as investors become more demanding and rigorous. Financial history will repeat itself and greed will turn to fear, just as night follows day.