Is WeWork the office of the future – or an overvalued confidence trick?

In this Jan. 16, 2018 file photo, Adam Neumann, center, co-founder and CEO of WeWork, attends the opening bell ceremony at Nasdaq in New York. Office space-sharing company WeWork is getting ready to go public, adding to a growing list of tech businesses making such a move this year
WeWork founder Adam Neumann at the Nasdaq opening bell ceremony in January 2018

It is not every day that a corporate document filed with financial regulators begins with a sentence like: "We dedicate this to the energy of we – greater than any one of us but inside each of us."

Still, that is how WeWork, the rapidly growing office rental company with hundreds of elegantly-decorated beachheads in major cities around the world, began the official prospectus for its hotly-anticipated public float later this year

The company has grown from a single office in New York City in 2010 to having 528 locations in 111 cities at the end of the first half of this year. It wasthis year valued at an eye-popping $47bn (£38bn), but it is now targeting a valuation that could fall below $20 billion. 

There is just one tiny snag: WeWork also lost almost $905m in the first six months of this year alone, on revenue of more than $1.5bn, and shows no sign of being profitable soon.

So far, so Silicon Valley (even if WeWork actually comes from New York). Wall Street is now used to dealing with "unicorns" – privately held companies valued at more than $1bn – which grow quickly but burn cash even quicker. A lack of proven profit has not stopped Uber from maintaining a valuation of roughly $57bn, despite its botched public float, nor prevented its rival taxi-hailing firm Lyft from maintaing a value of just under $16bn.

But WeWork, with its unusual corporate structure, its eccentric but controlling founder, its murky path to sustainable income, its cash injections from the Japanese investment giant Softbank and its mystical-sounding "mission" to "elevate the world's consciousness", may be the platonic ideal of questionable mega-unicorns.

At the heart of WeWork's future and its swollen valuation is a simple financial puzzle: how can what appears to be a real estate company be valued like a tech company? 

Its prospectus, filed last year and unveiled to the public on Wednesday, works hard to answer that question, using some form of the word "tech" 123 times. But, ominously, there is nothing in the meat of the paperwork that decisively clears up the mystery.

"It doesn't make any sense," says Calum Battersby, a market analyst at Berenberg bank. "There's the potential that this is profitable in the future, and there's the potential that centres which have been open for two, three or four years can be profitable. But there's no way it reaches a level of profitability that justifies the implied valuation today."

The 44 billion dollar question

WeWork's growth is certainly impressive. According to its prospectus, between June 2018 and June 2019, its membership grew by 97pc and its revenue grew by 101pc. Its losses also ballooned, but by far less – just 25pc – indicating that its revenue is at least beginning to catch up with its expenditure. 

The company claims that its data-driven expertise at scouting and designing new locations, combined with its ability to pack more people into a single space without giving them cabin fever, lets it create new working space at $7,300 per member employee rather than the standard $21,600. (Full disclosure: the Telegraph's Silicon Valley bureau is based in a WeWork in downtown San Francisco.)

Moreover, its share of members who have more than 500 employees – essential if it is to survive the next downturn, during which freelancers and small companies may go under or simply decide to use their sofas and coffee shops instead – has risen to 40pc, from 20pc near the end of 2017.

But the most important clue to the puzzle of WeWork might not be in the company's paperwork at all. Instead, it might lie in the travails of Regus, a comparitively venerable British office rental firm whose business model, on the surface, looks identical.

Regus was founded in 1989 by an English businessman, Mark Dixon, who was frustrated at the lack of flexible office space available for travelling entrepreneurs. The resulting company successfully listed on the London Stock Exchange in 2000.

Both Regus and WeWork engage in straightforward rent arbitrage. They take out long leases on floors in buildings in good locations, slice up those floors into smaller packages of office space and parcel them out at a premium to short-term tenants. The arrangement works especially well for start-ups, who may not know from month to month how they will grow and who don't want to be blocked from expanding or locked into paying for space they don't need.

The problem is that Regus's parent company, IWG, is valued at somewhere around £2.5bn. That is less than one tenth of WeWork's supposed valuation – despite the fact that Regus is already profitable and has more than five times its number of locations. 

So what does WeWork have that Regus doesn't?

WeWork: a name to die for

According to Tom Smith, founder of the online office space marketplace Truss, one answer is that WeWork's very name is now a well-known byword for the service it offers. He says that the company's desks are sought after three times more often on his platform than those of its nearest rival and six times more often those of Regus, even though Regus has more desks.

"Its name has become ubiquitous with co-working," he says. "A lot of the uninitiated have no idea how many other options they have. They just hear co-working and translate that to WeWork. The perception advantage that it has is massive."

He praises the company for redefining people's expectations in the staid real estate market, saying the finds it hugely convenient to be able to rent space flexibly and use space in WeWorks in other countries when he travels there for business. It is a good sign, he says, that the company's is able to simultaneously serve his own small company just just as well it serves large members like Vodafone.

Members work in a cafeteria and lounge area at the WeWork Cos Inc. 85 Broad Street offices in the Manhattan borough of New York, U.S., on Wednesday, May 22, 2019. WeWork has become the biggest private office tenant in London, Manhattan and Washington DC
A typical WeWork interior in Manhattan, New York City Credit: David 'Dee' Delgado/Bloomberg

"Commercial real estate has for a long time, until WeWork forced their hand, ignored what tenants really want as opposed to what landlords need," he says. "[Neumann] broke through that whole model and now everyone is having to react to tenants having their proper place. That's where the innovation is going to come from – because it sure didn't come from within."

But it's hard to see how simply being better known and better-decorated than the competition can translate to ten times the value. Free beer, chic couches and Instagram-ready wall art does not a Facebook or a Google make. Moreover, there is no reason why other companies cannot, in time, step up their game. 

"Competition is coming from all flanks, from start-ups to large institutional landlords," says Smith. He has seen a 30pc increase in people seeking flexible space in the last year alone, and the number of providers on his service has gone from 69 to 256 in the same time. Indeed, there are signs that Regus is seeing an opportunity too; it has gone from struggling to find a buyer last year to actually rejecting lowball offers, even if at a much lower price than WeWork's.

In other words, neither WeWork's undoubtedly strong brand nor its aesthetic skills actually give it a "moat" – Warren Buffet's term for a unique selling point that would be prohibitively difficult for a company's competitors to simply copy. 

The Amazon of office space

WeWork, however, claims to have a secret weapon. Its buildings, it argues, are not just buildings; they are a "global physical platform" for a whole suite of services, from nurseries to schools to community events to residential dormitories, as well as valuable sources of data which can used to power and target those services.

"We are just beginning to add value-added products and services to our global platform," the prospectus says. "[In future], we will be able to provide additional products and services to our existing membership base by leveraging our physical spaces... we expect sales of these products and services to provide incremental cash flow at higher margins than our existing revenue streams."

There is a precedent for this kind of approach. WeWork executives have compared the company to Amazon (and indeed poached people from it). Amazon's core business of selling physical stuff has razor-thin margins, but it uses that business to fuel numerous other services, from cloud computing to search engine advertising, squeezing extra revenue from each unwitting customer.

Similarly, WeWork's margins on its office spaces are pretty low. It spends $1.23bn on location operating costs in the first half of 2019, and made just $1.35bn from membership fees, according to Bloomberg. Yet over the past two years, it has also acquired a chain of small tech firms with very specific niches: building access software, room booking software, group communications platforms and tracking people through space using Wi-Fi signals, as well as the real-world event-planning app Meetup. 

These buys suggest the company is attempting to create something like an operating system for office buildings – a complete software solution for managing space. Such a product would not only be useful for WeWork’s own buildings; it would be a lucrative commodity in its own right. WeWork has already started renting out these capabilities in the form of a service called "Powered by We", which counts UBS as a client. At present, such services account for 12pc of WeWork's revenue – not great, but not nothing.

Now those claims of "elevating the world's consciousness". and Neumann's comparison of his company to an Israeli kibbutz, start to make at least a little more sense. WeWork locations could algorithmically match members with potential business contacts, draw on data to maximise retention through cleverly-pitched events, ruthlessly optimise the use of conference rooms and floor space, even remember members' preferences and automatically adjust the climate or the height of their desk when they visit a location abroad.

According to Alex Snyder, a senior analyst at the real estate asset manager CenterSquare, WeWork could theoretically grow in the same way Facebook does, exploiting network effects to create a "positive feedback loop". More members means more data, which means better services, which means more locations and members. Each member also increases the allure of the network by filling it with people to network with. 

A well-appointed WeWork
A well-appointed WeWork Credit: WeWork

"The hardware and software that WeWork has created and acquired throughout the years separates it from many of the other co-working providers," says Ash Zandieh, chief intelligence officer of CREtech, an analysis firm specialising in real estate technology, who is optimistic about WeWork's future.

"Like many companies that are in hyper-growth mode, it's in a battle for market share. [That] will crown a clear winner, with fewer incumbents in the future and higher future profits, very similar to the Amazon approach."

Crashing back to earth

There is, however, a big, heavy concrete stumbling block in the way of those ambitions – 528 of them, to be precise. WeWork is nothing without its buildings, and unlike a traditional tech company it cannot grow without renting more of them.

"In a software company, once the software is made, you could just beam it out into the universe ad infinitum at no extra cost," says Snyder. "The variable cost is essentially zero. Whereas WeWork still has a variable cost because of the real estate. It's much, much lower than a traditional real estate company, but it's still there."

Calum Battersby agrees: "It's not scaleable like a tech or software company, where you don't have to add in much more capital or costs to see a higher earning stream in future. If this grows, it's only because it invests a load of capital in paying for long-term leases, fitting them out and then a big sales and marketing expense to fill them."

Indeed, Snyder calculates that in order for WeWork to justify its current valuation, it would only need to draw in about twice as many memberships as it already has and monetise them at a 30pc profit margin. That would create about $2bn in profit each year, on around $7bn in revenue.

Two women sit in a WeWork
Credit: WeWork

Yet that is without counting the costs of WeWork's breakneck expansion. In order to rent out new buildings, WeWork has to keep raising new capital, and each time it does so it dilutes the value of its existing shares. If the company just stopped expanding it could theoretically be profitable now, Snyder says; but its current valuaton would be "absolutely destroyed".

If they could double everything without investing another penny, that would be fine," he concludes. "But they can't." 

Nor is it clear that WeWork can achieve that nice, fat 30pc margin. In its prospectus, the company calculates a "contribution margin" representing its profits from each location, which it puts at a respectable 25pc. But that figure appears to include all the free and discounted rent that WeWork is getting as a first-time renter. Without that, the figure is 10pc.

No wonder the prospectus baldly states: "We do not intend to achieve positive net income for the foreseeable future."

Adam Neumann: visionary or madman?

There are also many concerns about WeWork's founder, Adam Neumann. He is charismatic and optimistic, a party animal who reportedly arrives at company "summer camps" by helicopter and holds late-night meetings that start as late as 11pm and last for hours. 

He believes WeWork is riding a huge social change, powered by a "We Generation" who value community more than ownership. He has banned employees from claiming expenses for meat (though he seems willing to take money from Saudi Arabia and fly the world in a private jet). He has even declared that "WeWork Mars is in our pipeline". 

But Neumann himself owns quite a lot of property, or at least shares in property – and he appears to be channeling company money into it.

"We are party to lease agreements for four commercial properties... in which Adam has an ownership interest," says WeWork's prospectus. In three of those properties, it signed agreements on the very same day that Neumann acquired his stake. It has so far paid those buildings' owners $21m, and is on the hook for $237m.

WeWork says there is no conflict of interest because these properties are managed by its own real estate arm, ARK Capital. Still, the arrangement reportedly raised eyebrows among WeWork's investors. Neumann's family are also closely involved in the company: his wife Rebekah is one of a handful of people authorised to pick his successor if he dies, while two other relatives have done work for it.

Adam Neumann at the TechCrunch Disrupt event in New York City, 2017
Adam Neumann at the TechCrunch Disrupt event in New York City, 2017 Credit: Eduardo Munoz/Reuters

"From an investor standpoint he seems to carry a lot of red flags for a potential public CEO," says David Erickson, a lecturer at the Wharton School of business who managed big public floats for Barclays Bank. "That sounds to me like a conflict of interest... just because he's a great visionary and a builder of business, it doesn't mean he makes the best CEO. 

"He's obviously built an interesting company, but the question is, are investors comfortable that he's the right guy to deliver. If I was a large shareholder, if I was Softbank, I would be suggesting to him: you're a great visionary, I'd love you to be the chairman. But we really need somebody else who can be the face of the company going forward.'"

Does he think Neumann's talk of changing the world will cut much mustard with Wall Street? "There are lots of companies that have platitudes," he quips.

Ultimately, all of these factors suggest a rocky path ahead for WeWork. If its cannot live up to its valuation, it will need to be written down before its public float, which could come as early as September. Failing that, it could suffer a humiliating fall in share price, perhaps worse than that suffered by Uber.

"It's really hard to give them the benefit of the doubt," says Snyder. "Markets don't like companies that aren't already profitable, and they really don't like companies that have to keep coming back to the well for more capital. I would imagine they will be very unwilling to ascribe that valuation."

Still, he says, WeWork could still be a very successful company if it aims lower and sets itself more modest goals. If it does, Neumann's own gigantic ambition, his vision to bring co-working to the stars, may prove its undoing.

"Will they have interest?" asks Snyder. "Absolutely. Is it a good business? Of course. At the right number, would I invest my money? Yes. But not at $47bn." 

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