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| Earlier this year, the company was a unicorn darling ready for a $50 billion IPO. By late 2019, its solvency is now in question. |
Bankers lined up to participate in every way: Lend money to its revered founder and CEO. Arrange debt funding for its operations. Sell the IPO to salivating prospective investors. Lead and underwrite the IPO with fanfare and pats on the back for all.
In one short period this summer through early fall, a giddy market anticipated its public offering; just a few weeks afterward, investors backed off, began to question the value of shares, pondered how the stock would perform in a projected recession, and wondered about the sanity and focus of its CEO. Investors, too, got uncomfortable with the CEO requesting to retain too much voting power. All of a sudden, there appeared to be no predictable timeline for when the company would ever make money.
What is this company that zoomed to start-up and investment-banking heights in early 2019 and is now being regarded by some as near insolvent, fighting for its life in late 2019?
WeWork. (Or We Company, as the holding company that would issue the new stock is called.)
What happened? How could this have happened? What role did banks play in helping to hoist the company to its loft financial heights? What role did they play in thrusting it toward a decline and arguably a questionable existence?
A turning point likely occurred when prudent, common-sense-approach prospective investors took note that other similarly prominent IPOs in the last few years (Uber, notably), which had blazing IPO launches, offered no reasonable timeline for when they will begin to make money. Investors grew anxious when outlandish payments were intended to the CEO (Adam Neumann) and when they learned more about conflicts of interest between the company and the CEO's interests and outside holdings. All the projected earnings growth that was supposed to follow the company's large start-up and expansion-related losses, all of a sudden, had little expectation of occurring on schedule.
Prospective WeWork investors and the market that would follow its stock became uncomfortable about any management-flavored forecast for when the company would begin to make money. Value in a company (or WeWork's pre-IPO assessment of $47 billions) is often based on the company generating long-term, sustainable, and achievable earnings and earnings growth. If the $47 billion were based on the company becoming long-term profitable in five years, investors and doubters began to reason that it would be much longer (maybe 7-10 years). If ever. If that long, surely the company couldn't be worth $47 billion today.
Bankers (from the big, notable investment banks), of course, ride a capital markets wave and momentum. If the timing is right, they push the company toward a pubic offering: Do it now before uncertainty sets in--uncertainty perhaps spurred by continuing uncertainty regarding China-related tariffs or the 2020 presidential election. Do it now before investors become disenchanted with technology-branded young companies or prefer another attractive industry. (Bankers, almost without saying, are motivated by fees, including the tens of millions it would have earned from a public sale of We stock.)
Bankers, however, must do due diligence, investigate the validity of numbers, pore through accounting reports, and project performance, although they do so couched with guarded language and warnings that markets and environment change often and alter valuations frequently. But in their initial $40-billion-plus assessment of the company, they, too, may have been blinded by the charisma and style of CEO-founder Adam Neumann and believed with conviction his projections of unrealistic revenue growth from the company's global presence.
Neumann marketed a new business model, or a nuanced business model of something as old as the commercial real estate business. He allowed the market to treat We as a "technology" play. As fast as it could, WeWork would enter into long-term lease obligations to control properties or consider borrowing long-term debt to purchase buildings. These obligations would be paid out from sublease income (cash flow rental payments from tenants). Sublet rates, of course, would be determined from supply-demand dynamics and should be more than sufficient meet debt and long-term lease obligations and leave enough cash flow left for employee bonuses and earnings for investors.
The tweaked model is that the subleases (a) would be in small pieces (leases to entrepreneurs, small businesses, or even individuals) and (b) could be over shorter terms. Hence, the leases could turn over frequently. Inevitably, there will be times when the space would be vacant (generating no cash flow to pay down debt or lease obligations to larger landlords). While cash outflows (for lease and debt obligations) were fairly fixed and projectable, cash inflow would be uncertain, often volatile and unpredictable.
WeWork and Neuman convinced bankers and its primary pre-IPO investor SoftBank the working world had changed permanently: There would always be sufficient demand from businesses and individuals for this unique, different kind of work space. Workers from different business enterprises would be comfortable and even exciting about sharing work space. They argued this new, evolving working world would lead to surging, predictable cash inflows.
Bankers and SoftBank perceived that to sublease space to a new working generation, the company would need to (a) secure space, (b) build a brand, (c) promote a hip 21st-century culture of working and sharing space, (d) convince investors and lenders that cash flow will rush in, and (e) explain how demand for such novel, progressive work spaces would soar over time.
But what happens when an economy heads downward and entrepreneurs and businesses elect not to renew leases because they no longer anticipate similar business activity or choose another way of managing work space? What happens when entrepreneurs and small businesses cut costs by not renewing leases. The space becomes vacant and cash flows disappear likely more quickly than conventional real estate models.
Until late this summer, bankers and SoftBank rode the hyped model, prepared to lend the group $6 billion and to lead a well-publicized IPO. Bankers eagerly arranged the debt piece, although they structured it to tie it to the offering of IPO shares to ensure there was a meaningful "capital cushion" below the debt they would offer. They also wanted to make sure there would be, at least for now, lots of cash sitting on the balance sheet at the start of the loan. At least interest would be paid on the debt outstanding for the foreseeable future.
Analysts, banks and investors (pre-IPO) presumed that cash proceeds from an IPO and from the debt (in billions of dollars) could help the company endure operating cash-flow deficits until operating-cash-flow-surpluses appeared. The company, they reasoned, was propped up and ready to endure a year or two without earnings.
But almost overnight, many realized that cash (from banks and the IPO) could disappear more rapidly than projected and no one had a good sense for when profits would appear. That cash might not permit it to survive more than a year or so.
Just like that, a company once prepared to ring stock-exchange bells to celebrate a vaunted IPO was now being dissected for possible insolvency. The question was no longer whether or not the company's post-IPO share price could grow steadily, but whether the company could meet current obligations to debt holders, lessors, and employees, whether the company could slip into bankruptcy in a matter of months.
Many bankers, instead of reprimanding themselves for trying to push out a stock which today might have about a tenth of the value at which they were willing to promote it, may be praising themselves for having avoided a possible IPO disaster of an IPO and called it off.
The mission at WeWork these days is not about company promotion, creating happy work environments and boosting shareholder value. At least not this year (or next?). The objective now is about survival and getting through this uncertain, tough period. Founder Neumann has been cast aside and pushed out (for reasons related to and beyond the IPO). SoftBank has invested new cash to ensure the company can get through the next year or so (and to respond to ongoing concerns about the company's solvency). (SoftBank has even regrouped inhouse and is determined to learn lessons from this episode, announcing recently new standards for investments and company governance.)
The banks are also prepared to provide debt financing--likely at much tougher terms, restrictions and covenants than they might have required earlier this year. They all get to buy time to figure out how to massage what had been a glamorous business strategy and how to plan for more patient, realistic business growth.
New managers, new strategies and a realistic assessment of its marketplace could get it right. And its dreamers and founders, in the long term, could be spot on about the changing nature of work spaces and work environments. Time will tell.
Perhaps the company will have learned a lesson about how much better it is if they present themselves to the public with a much more precise timetable toward profitability.
Tracy Williams
See also:
CFN: Snapchat and Its IPO, 2017
CFN: LinkedIn Sells Itself, 2016
CFN: Twitter's Turn to Do an IPO, 2013
CFN: Facebook's Rough IPO Start, 2012
CFN: Is Uber Ready for an IPO? 2018
CFN: Even Shake Shack Goes Public, 2015
CFN: Alibaba's U.S. IPO, 2014
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