WeWork doesn’t work for us

Written by Charlie Bonham - Senior Equity Analyst, HL Select

What you do as an investor is crucial, but what you don’t do is just as important. Within the HL Select team we pass over far more investments than we make.

We’ve seen a number of newsworthy IPOs in 2019 from disruptive businesses that challenge the status quo of well-established industries. Among others we’ve seen Uber and Lyft, the 21^st Century taxi companies, and Beyond Meat, the meatless meat producer, come to market after years growing as private businesses. 

When these IPOs are announced, we often run our ruler over them. Not only because they tend to involve interesting business models but also because it’s often the first time we’re able to see the financial details behind the fanfare of high-profile private companies.

The We Company

Perhaps the most interesting of 2019’s slated IPOs has been WeWork. In a nutshell, WeWork signs long-term leases on buildings, revamps them with trendy sofas, desks, and artwork, throws in Wi-Fi, good coffee, even beer, then rents the space (at a premium) to companies on a short term basis.

However, in a blizzard of negative market commentary WeWork shelved its IPO plans. We agree with the market’s assessment but thought it was worth explaining why.

We’re naturally cautious about IPOs because we like to see a solid track record of performance. The company’s existing owners, often including company management teams, and the bank execs handling the IPO are likely to understand the business’s worth better than an outsider could at listing. Companies and the investment banks also often overly polish companies for public sale.

Having said that, WeWork’s proposed IPO documents revealed more red warning flags than usual.

Financially strong?

Focusing on near term growth and market share is a valid business strategy, and one that WeWork leans on heavily, but we believe any company seeking to raise funds has to have a clear path to profitability, backed up with matching cashflows.

We couldn’t see this for WeWork, which has never made money, and their fondness for citing profit numbers that ignored such “exceptional items” as the cost of building out new office space as well as general and administrative expenses gave us the impression that the company was trying to flatter its financial performance.

Statements in the prospectus like, “We dedicate this to the power of We – greater than any one of us, but inside each of us,” and, “Our mission is to elevate the world’s consciousness”, left us scratching our heads.

Economically resilient?

We invest in companies that are on a strong financial footing. If the economy takes a turn for the worse, we don’t want our companies beholden to their banks. A fundamental issue we had with WeWork was that in a downturn its clients could scale back on space requirements faster than it could back out of its long-term lease obligations.

We look for companies that are run for all shareholders and don’t favour a few large holders. But with WeWork, the CEO was to own a class of share, unavailable to ordinary investors, with 10 times the voting power of the ordinary class. He’d also received over $700m from the company through loans, share sales and property leases. Would the company be run for the equal benefit of all shareholders, or favour the CEO?

Good value?

Lastly, there’s the crucial question of valuation. We recognise that quality, growth companies will invariably cost more to buy than poor quality, shrinking ones – but that’s not to say they’re good value at any price. WeWork’s proposed valuation was sky-high, as if it had created unique new technologies, where in reality, its main activity is simply leasing and refurbishing offices.

We can find other serviced office companies with more space, more revenues and real profit, but lacking a “visionary CEO” with an aversion to proper accounting, they trade for considerably less.

It’s often very tempting as an investor to get carried along with the hype and excitement of the next big thing. We spend a lot of our time considering the ins and outs of many such ideas, but we often conclude it’s best to pass. The list of exceptional businesses at prices we’re prepared to pay just isn’t that long.