Lessons from the WeWork fiasco

WeWork is a case study and an object lesson for investors not to buy into stories without looking for the reality behind the hype. Until April 2019, WeWork was a “unicorn” with great valuations and excellent public relations. It had charismatic leadership and lofty mission statements. It had funding from the biggest venture capitalists (VC). It was hailed as an innovative tech-driven company. 

Then the story started unravelling. When the company filed for an initial public offering (IPO), analysts took critical looks at the numbers and the business model. It was not only impossible to justify the valuations; the founders had huge conflicts of interest. Respected business school professors said that the accounting practices were terrible. Nor did the business model seem innovative. As of now, the IPO is not happening. The CEO-founder has been “demoted”. There is a chance the company will turn into a gigantic loss for the VCs who backed it. 

WeWork is a shared workspace play. It claims to be a “Space as a Service” company, adapting the tech acronym about “Software as a Service”. It signs long-term leases and sublets on flexi-terms. There are other companies in that segment, but WeWork has scale. When it filed for its IPO in April 2019, it had over 5,000 employees, with $48 billion of long-term leases tied up across 32 countries. 

It was also valued at $47 billion when it filed. JPMorgan Chase and Goldman Sachs were handling the IPO, and valuations ranging up to $90-billion were being spoken of. The biggest chunk of VC funding came from Softbank, including funding from its $100-billon Vision Fund, which includes large Saudi investments. The $47-billion valuation was based on the last round of funding in Jan 2019, when Softbank put in $2 billion. 

The scrutiny of the prospectus and financials revealed huge conflicts of interest, mostly involving CEO-founder Adam Neumann. Neumann had borrowed money ($360 million) from the company (which he returned later). He had a $500 million line of credit from the company, secured by his shareholding. That is, he pledged his shares in the company, to the company, to borrow from the company. 

Pre-IPO Neumann has already sold equity from his personal stake for $700 million. He wanted a 20:1 lock on voting rights post-IPO with his shares carrying 20 votes each. He personally owned the “We” tradema­rk, and the company paid millions to license it from him before he relinquished it. The company had also leased at least four buildings that Neumann owned. If he died, his widow (and co-founder) would nominate his successor, bypassing the board. 

The financials showed 2018 losses at $1.9 billion on revenue of $1.8 billion – losses exceeded revenues. According to an analysis by the Financial Times, WeWork loses $219,000 every hour of every day. The company was committed to paying a cumulative $48 billion of long-term leases. It expected to log about $4 billion in 2019 revenues. It would need to grow at very high compounded rates for many years just to service the leases, never mind covering other costs. 

WeWork had also invented an accounting concept, which is called “community-adjusted Ebitda”, and later renamed “Contrib­ution Mar­gin”. WeWork said this me­a­sured net income be­fore not only interest, taxes, depreciation, and am­ortisation, as in normal Ebitda or operating profits. 

It also excluded “building-and community-level operating expenses.” That catch-all phrase means that it excluded normal expenses, like rentals and tenancy expenses, utilities, salaries of staff, and the cost of amenities and interior décor. Essentially, it counted most of its revenues as income under “community-adjusted Ebitda”. 

The IPO was seeking valuations of 25x revenues when other shared workspace players traded at 0.5x to 1x. Even Amazon, a highly successful tech company, has 4x revenues as valuations. Even as such details surfaced, the IPO was withdrawn. Neumann stepped down as CEO. The valuation has fallen by at least 80 per cent in the past six weeks. There are now grim stories about WeWork refusing to take on new leases, and getting set to sack most employees. 

Why am I discussing this company, which few Indians would have thought of investing in? It shows that “creative accounting” and blatant conflicts of interest occur everywhere. Even the world’s largest VCs and investment bankers fall for good stories. In an environment like India, investors must be extra careful about buying into catchy acronyms and hype.