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The WeWork IPO – Stratechery by Ben Thompson

WeWork

There is a cause — beyond the very fact it’s August — that WeWork’s upcoming IPO has driven so much dialogue: it’s a doc outlined by audaciousness, both when it comes to the corporate’s vision and in addition the flagrant disregard for corporate governance norms by its management. And, in fact, large losses despite large quantities of capital raised. I think all of this stuff are associated.

The AWS Example

Think about it’s 2006, and also you go to buyers with a bold new business plan: pc hardware! By no means thoughts that IBM just bought its PC enterprise to Lenovo a yr beforehand, and that servers appeared on the same path to commoditization, notably with the emergence of x86 options from corporations like Dell instead of specialized architectures from conventional suppliers like Solar. It doesn’t sound notably promising.

And but 2006 was the yr that Amazon launched Amazon Net Providers, a computer hardware enterprise that leveraged the commoditization of hardware into a enterprise with operating margins of round 30%. It turned out having one firm manage that commodity hardware for everybody else had several essential benefits that greater than justified those margins:

  • New corporations had on the spot entry to a whole server stack for principally free, because funds tracked usage (which for brand spanking new corporations is zero).
  • Growing corporations didn’t have to acquire funding for or spend the time on in depth build-outs months or years forward of future progress, as an alternative they might pay for brand spanking new capabilities as they wanted them.
  • Established corporations not wanted to have a competency in managing server installations, and will as an alternative give attention to their core competencies whereas outsourcing to cloud suppliers.

In all three instances the elemental shift was from servers as capital investment to variable costs; the benefits have been much less about saving dollars and cents and extra about growing flexibility and optionality. At the very least, that is, to start out: right now AWS has choices that reach far past primary compute and storage to capabilities like server-less (which, paradoxically, requires owning an big number of always-available servers) which might be uniquely potential due to AWS’ scale.

The WeWork Bull Case

AWS, broadly talking, is the WeWork bull case. Think about the phrase, “fastened value”. There’s nothing extra fastened than real estate, yet WeWork’s offering transforms real property right into a variable value for all types of corporations, with benefits that roughly mirror public clouds:

  • New corporations can have on the spot access to a well-appointed workplace area and pay for less than a desk or two, after which develop as wanted.
  • Growing corporations do not have to spend time on in depth build-outs months or years forward of future progress, and as an alternative pay for more room as they need it.
  • Established corporations not have to have an actual property competency everywhere in the world, and may the truth is increase to new territories with far less danger than beforehand required.

Notice that, identical to the general public cloud, worth just isn’t essentially the primary driver for WeWork area. Still, there isn’t any doubt that AWS, for example, pays far less for AWS’ underlying infrastructure than any of their clients would pay on their own. For one, AWS can unfold the cost of knowledge facilities all over the world over an enormous variety of clients; for an additional AWS can discount with hardware suppliers or just design and make its personal elements.

WeWork can obtain comparable good points, to an extent. Within a single location, widespread area, by virtue of being shared by all WeWork members, might be built out far more than anybody member might build out on their very own. Similarly, WeWork’s network of places all over the world present choices that accrue to all members.

WeWork has additionally developed an expertise in using workplace area efficiently, and while some of this is simply a willingness to cram extra individuals into less area, opening triple-digit places a yr signifies that the company is by definition studying and iterating on what works for office area far quicker than anybody else, and that is earlier than the promised software of sensors and machine learning to the challenge.

After which there’s the question as as to if WeWork is, or can turn into, greater than an actual property play at scale: what may be the equivalent of “server-less” in relation to office area — a singular capability that’s uniquely unlocked by one firm offering all the actual estate wants for, properly, everyone?

WeWork’s Losses and Ambition

Given this imaginative and prescient, WeWork’s large losses are, a minimum of in concept, justifiable. The implication of making an organization that absorbs all the fastened prices as a way to supply a variable value service to other corporations is very large amounts of up-front investment. Just as Amazon wanted to first construct out knowledge centers and buy servers earlier than it might promote storage and compute, WeWork needs to construct out workplaces spaces before it could actually sell desktops or conference rooms. In other words, it might be strange if WeWork weren’t dropping a lot of money, notably given its enlargement price; from the S-1:

The corporate additionally consists of this graphic, which by itself isn’t notably useful given the lacking Y-axis:

A WeWork property's path to profitability

What is beneficial is contemplating these two graphics collectively: over 300 places — greater than half — are in the money-losing part of the second graph, which helps clarify why WeWork’s bills are almost double its revenue; ought to the company cease opening places, it seems affordable to anticipate that gap to close rapidly.

Still, it’s uncertain that WeWork will sluggish the speed with which is opens places given the corporate’s view of its complete addressable market. From the S-1:

Within the 111 cities through which we had places as of June 1, 2019, we estimate that there are roughly 149 million potential members. For U.S. cities, we define potential members by the estimated variety of desk jobs based mostly on knowledge from the Statistics of U.S. Businesses survey by the U.S. Census Bureau. For non-U.S. cities, we contemplate anyone in choose occupations outlined by the Worldwide Labor Group — including managers, professionals, technicians and associate professionals and clerical help staff — to be potential members, because we assume that these people need workspace through which they have entry to a desk and other providers. We view this as our addressable market due to the broad variety of professions and industries amongst our members, the breadth of our solutions obtainable to individuals and organizations of various varieties and our monitor document of creating new solutions in response to our members’ needs.

We anticipate to increase aggressively in our present cities in addition to launch in up to 169 further cities. We evaluate enlargement in new cities based mostly on a number of standards, primarily our assessment of the potential member demand in addition to the strategic value of having that city as a part of our location portfolio. Based mostly on knowledge from Demographia and the Group for Economic Cooperation and Improvement, we now have recognized our market alternative to be 280 target cities with an estimated potential member population of approximately 255 million individuals in combination.

When making use of our common income per WeWork membership for the six months ended June 30, 2019 to our potential member inhabitants of 149 million individuals in our present 111 cities, we estimate an addressable market alternative of $945 billion. Among our complete potential member inhabitants of approximately 255 million individuals throughout our 280 goal cities globally, we estimate an addressable market opportunity of $1.6 trillion.

Did you catch that? WeWork is claiming almost every desk job around the globe as its market, a move that by definition means shifting beyond being an actual estate firm. From the S-1:

Our membership choices are designed to accommodate our members’ distinct area wants. We offer normal, configured and on-demand memberships inside our spaces. We additionally supply Powered by We, a premium answer configured to a corporation’s wants and deployed on the group’s location. Powered by We leverages our analysis, design and supply capabilities to beautify and optimize an present workplace, whereas additionally providing a corporation increased efficiencies and an choice to invigorate its spaces by means of our group offerings. The know-how we deploy consists of software program and hardware solutions that deliver improved insights and an easier-to-use office experience for workers.

WeWork's breadth of offerings

The sheer scale of this ambition once more calls again to AWS. It was in 2013 that Amazon’s administration first said that AWS might end up being the corporate’s largest enterprise; at that time AWS offered a mere 4% of Amazon’s income (however 33% of the profit). In 2018, although, AWS had grown by over 1000% and was up to 11% of Amazon’s income (and 59% of the profit), and that share could be very a lot expected to grow, whilst AWS faces a competitor in Microsoft Azure that is growing even quicker, in large part because present enterprises are shifting to the cloud, not simply startups.

WeWork, meanwhile, utilizing its expansive definition of its addressable market, claims that it has realized only zero.2% of their complete alternative globally, and zero.6% of their opportunity in their ten largest cities. To be truthful, one may be skeptical that present enterprises particularly might be hesitant to turn over administration of their present workplaces to WeWork, which might dramatically curtail the opportunity; then again, giant enterprises now make up 40% of WeWork’s revenue (and rising), and more importantly, WeWork doesn’t have any vital competitors.

WeWork’s (Lack of) Competitors

This point round competitors is a vital one, and one of the more compelling causes to be bullish on WeWork’s alternative.

The apparent competitor is a company referred to as IWG, with three,306 places and 445okay workstations at the end of 2018. WeWork, as compared, had 528 places and 604okay workstations as of June 30, 2019. Observe the date mismatch — this isn’t an ideal comparability — but that solely makes the purpose that these are two very totally different corporations: WeWork had solely 466okay workstations on the end of 2018; a yr earlier, when the Wall Road Journal identified that WeWork’s then-valuation was 5x IWG’s (it is now 13x), WeWork had a mere 150okay, while IWG had 414okay.

In different words, WeWork is massively extra concentrated than IWG (i.e. fewer places with more workstations), and rising exponentially quicker; unsurprisingly, and relatedly, IWG is earning money (£154 million final yr). That, although, further makes the purpose: IWG, for higher or worse, is constrained by the income it makes; WeWork, however, is probably greatest understood as a clear beneficiary of a world of seemingly limitless capital. It is troublesome to see IWG competing in the long term, or, frankly, anyone else: who is going to fund a WeWork competitor, as an alternative of simply pouring extra money into WeWork itself?

Capital and Recessions

This query of capital is probably the most important one dealing with WeWork: from the company’s inception on critics have (pretty) questioned what is going to occur in a recession. It’s one thing to sign long leases at low charges and lease out workplace area at greater charges when the financial system is rising; what happens when the financial system is shrinking and people long-term leases aren’t going anyplace, while WeWork clients very nicely may be?

This can be a truthful concern and virtually definitely the most important purpose to be skeptical of WeWork within the brief run, however the company does have counter-arguments:

  • First, WeWork argues that in a downturn increased flexibility and decrease costs (relative to traditional office area) might in reality appeal to new clients.
  • Second, WeWork claims its growing enterprise buyer base has almost doubled lease commitments to 15 months with a committed revenue backlog of $four.zero billion; this is nonetheless far shorter than WeWork’s principally 15-year leases, but perhaps lengthy sufficient to stabilize the company via a recession.
  • Third, WeWork notes that a recession — offered the corporate has enough capital — would truly permit it to accelerate its buildout as lease and development costs come down.

The company also has one other, somewhat unsavory, advantage in a recession: its opaque company structure. Whereas there are various downsides to the fact that the “We Firm” is a set of entities, one of many huge advantages is that landlords could have a troublesome time implementing any leases that WeWork abandons. From the Monetary Occasions:

There are limits to what landlords can do to implement rental commitments. The company, like others in the shared office sector, creates special objective automobiles for its leases, which means landlords shouldn’t have direct recourse to the mum or dad firm if it fails to pay lease.

Up to now, corporations in the sector have modified the terms of their leases when downturns hit. Regus, now IWG, renegotiated leases in 2002 when the top of the tech growth minimize into its buyer base. Extra lately, an IWG subsidiary that leased a website near Heathrow airport applied for voluntary liquidation.

To counter such considerations, WeWork has assured a portion of its rental funds, although a small fraction of the general obligation. About $4.5bn of lease payments are backed by corporate ensures and $1.1bn by bank ensures, in response to the group’s pre-IPO submitting. It has paid greater than $268.3m in cash deposits to landlords and used another $183.9m of surety bonds, a form of insurance.

These ensures are only $1.6 billion greater than WeWork’s dedicated income backlog.

WeWork’s Corporate Governance

Frankly, there’s a lot to love concerning the WeWork opportunity. Sure, a $47 billion valuation appears approach too excessive, notably given the very fact the corporate is on tempo to make solely about $440 million in gross revenue this yr (i.e. excluding all buildout and corporate costs), and given the large recession danger. On the similar time, this can be a real enterprise that provides actual advantages to corporations of all sizes, and those advantages are solely rising as the character of work modifications to favor more workplace work usually and extra distant work specifically. And, critically, there isn’t a real competition.

The problem is that the “unsavoriness” I referred to above is hardly restricted to the truth that WeWork can stiff its landlords in an emergency. The tech business usually talking is hardly a mannequin for good corporate governance, however WeWork takes the absurdity a completely totally different degree. For instance:

  • WeWork paid its own CEO, Adam Neumann, $5.9 million for the “We” trademark when the company reorganized itself earlier this yr.
  • That reorganization created a restricted legal responsibility company to hold the belongings; buyers, nevertheless, will buy into an organization that holds a share of the LLC, while other LLC partners hold the remaining, decreasing their tax burden.
  • WeWork previously gave Neumann loans to buy properties that WeWork then rented.
  • WeWork has hired several of Neumann’s family members, and Neumann’s wife can be one in every of three members of a committee tasked to exchange Neumann if he have been to die or turn out to be completely disabled over the subsequent decade.
  • Neumann has three several types of shares that guarantee him majority voting energy; these shares retain their rights if bought or given away, as an alternative of changing to widespread shares.

Byrne Hobart has made the case that a few of the real estate transactions with Neumann are justifiable, but given how dangerous every thing else on this listing is, not assuming the worst is a generous interpretation; meanwhile, Neumann has already reportedly cashed out $700 million of his holdings by way of sales and loans. All the things taken together hints at a totally unaccountable government looting an organization that’s operating as shortly as it might from large losses which will very nicely be deadly each time the subsequent recession hits.

The Capital Glut

Actually, I might argue that the WeWork bull case and bear case have extra in widespread than it seems: both are the logical conclusion of successfully unlimited capital. The bull case is that WeWork has seized the chance introduced by that capital to make a credible play to be the workplace of selection for corporations everywhere in the world, successfully intermediating and commoditizing traditional landlords. It is completely audacious, and for that purpose freed from competition. The bear case, in the meantime, is that limitless capital has resulted in an entire lack of accountability and a predictable litany of abuses, each when it comes to corporate risk-taking and private rent-seeking.

Perhaps the actual question, then, is what has pushed the capital glut that has both helped WeWork’s enterprise and harmed WeWork’s company governance? Is it merely the present financial cycle, which suggests a recession won’t only strain WeWork’s funds but in addition turn off the spigot of cash? Or has there been a elementary shift in the international financial system, because the elevated influence of know-how, with its capital-intensive business model that throws off big amounts of money, drives increasingly more international output?

Briefly, there’s a case that WeWork is both a symptom of software-eating-the-world, in addition to an enabler and driver of the identical, which would imply the corporate would still have access to the capital it wants even in a recession. Buyers would just have to simply accept the very fact they may have completely no influence on how it’s used, and that, beyond the sky-high valuation and the actual considerations a few period mismatch in a recession, is a very good purpose to stay away.