There are 6 billion very good reasons for WeWork to go public this year, despite the fact that Wall Street doesn’t want it
Category : entrepreneur
WeWork may have postponed its initial public offering in the face of investor skepticism, but the commercial real estate giant has plenty of reasons to push through its IPO by the end of the year anyway.
At least 6 billion of them — the coworking company has a $6 billion loan that’s riding on it going public by December 31. Indeed, when WeWork officially delayed the IPO, it said that it still expects to go public by the end of 2019.
But that’s not the company’s only motivation for pressing forward with the offering, real estate and business experts told Business Insider. Plain and simple, WeWork needs more cash to keep growing and even to just stay in business. The lack of a successful IPO could hurt both its bankers and its biggest backer. And the longer it delays an offering, the more likely it is that negative market or economic trends could harm its business and further depress demand for its shares.
“Everybody, except the market, wanted this thing to go public,” said Scott Galloway, a professor of marketing at New York University and former startup founder who has been sharply critical of WeWork’s offering, in a recent conversation with Business Insider.
WeWork representatives did not respond to an email seeking comment.
The company on Tuesday announced that it would postpone its offering until at least next month. The move came after it had faced significant pushback from public investors, who were disturbed by its revelations of spiraling losses, potential conflicts of interest involving CEO Adam Neumann and other executives, and questionable governance structure. Analysts and potential experts also worried about its nominal $47 billion valuation and its potential resilience in an economic downturn.
Read this: Here’s how WeWork answered the 5 biggest questions about its business — and why analysts are still worried about its upcoming IPO
In response, WeWork took several steps to reform its governance, including reducing the number of votes Neumann will have for each of his shares from 20 to 10. It also, reportedly, pitched investors on the idea of it going public with a much reduced valuation. Last week, it was reportedly considering debuting with a market capitalization of as little as $10 billion.
WeWork appeared desperate to go public, for good reason
Those repeated efforts to try to placate and lure in potential investors smacked of desperation, said Jeff Langbaum, a real estate analyst with Bloomberg Intelligence.
“What it sounds like is they were getting to the point where it almost didn’t matter what [WeWork] was worth,” Langbaum said. “They needed to come out.”
Perhaps WeWork’s biggest impetus for pushing on with the IPO despite investor resistance was the prospect of the massive loan. A collection of banks, including JPMorgan Chase and Goldman Sachs, which are leading WeWork’s offering, has agreed to lend WeWork up to $6 billion — up to $3 billion right after the IPO with another $3 billion available by early 2021.
But in order to get access to that financing, WeWork has to raise at least $3 billion in an IPO by December 31 — unless the lenders decide to give it more time.
WeWork has a pressing need for cash. Its IPO filings show that it burned through $2.2 billion last year just operating its business and purchasing property and equipment to fit out its office spaces. Such spending consumed another $1.5 billion in the first six months of this year.
At the end of June, WeWork had $2.5 billion in cash on hand, not including another $575.6 million it’s had to set aside to primarily to help guarantee certain of its leases. At the rate it was going through cash in the first half of this year, it would burn through its unrestricted cash stash by early May.
And that may overstate how quickly it’s likely to consume cash. The vast majority of WeWork’s cash burn in recent years has come not from spending more on the day-to-day costs of running its business than it’s collecting in revenue, but from its ostensibly longer term investments in property and equipment for its office spaces. But the reason that’s so is that the company has been able to defer much of one of the chief costs of running its business — paying rent to its landlords.
In 2017, the company deferred $752,063 in rent. In 2018, that figure went up to $1.3 billion.
‘They need the money’
Landlords often give a discount on the first year or two of rent to tenants who sign long-term deals. They also often give tenants a credit for improvements they make to the spaces they lease. Landlords typically earn back those credits and discounts by charging more in the later years of a lease.
Because of its vast expansion in recent years, WeWork is in the early years of long-term deals on many of its spaces. Its number of locations worldwide jumped from 111 in 2016 to 528 by the end of June. The deferred rent it reported reflects the discounts it’s gotten on signing all those spaces.
The bills for all those spaces are going to start coming due soon. Next year, the company will owe $2.2 billion on its operating leases. It will owe another $2.3 billion in 2021.
“They need the money,” said David Erickson, a senior fellow in finance at the University of Pennsylvania’s Wharton School of business. He continued: “They don’t have a lot of runway.”
To date, WeWork has raised billions of dollars in the private markets, both from selling shares in venture funding rounds and from issuing debt or taking out loans. Even if it doesn’t go public, it might be able to turn to its existing lenders and investors and potentially even from its landlords for more cash, business and real estate experts said.
But the potential $9 billion in cash at stake with an IPO is important to WeWork for more than just keeping the lights on, they said. WeWork has tried to sell itself as not just another commercial real-estate firm, but as a fast-growing tech company. The distinction is important, because how investors classify WeWork will determine its valuation. The public market tend to pay a marked premium for hot young tech companies over real estate firms.
Crucial to WeWork’s attempt to have the market put its business in the same category as the likes of relatively young cloud software firms like Slack and Zoom has been its rapid rise in revenue. Its sales more than doubled in each of the last two years, and are on track to do so again this year.
But as its cash burn indicates, that growth has been extraordinarily expensive. Its loss nearly doubled last year after more than doubling the year before, and it loses nearly a dollar for every dollar in revenue it sees.
Because there’s little indication that WeWork will staunch those losses anytime soon, the company needs to have access to vast amounts of cash to continue its breakneck growth and be able to sell itself as something more than the average real estate firm, Bloomberg’s Langbaum said.
“If they don’t raise the money [in the IPO], they can’t continue to grow. And if they can’t continue to grow, then there’s a very difficult story for them to sell,” he said. “If they want to be able to grow in the future,” he continued, “they need to get it done.”
A recession could pose big problems for WeWork
But the company likely faces other time pressures for completing the IPO in the near term beyond just the year-end deadline imposed by banks behind the $6 billion credit line. One big one is the potential for a recession, which many economists, investors, and business leaders fear could hit the US economy as soon as next year. Such a downturn could pose a double threat to WeWork’s hopes for going public if its offering got pushed back that far.
The IPO market tends to dry up in recessions. Worse for WeWork, the commercial real estate market tends to be hit especially hard in downturns, said Tom Smith, a cofounder of Truss, an online commercial real-estate marketplace. Due to the short-term nature of the deals its customers sign with it, WeWork’s business could be hurt more than other real-estate firms by a recession.
Potentially investors have already been spooked by the theoretical danger of a recession to WeWork’s business. But in the case of an actual downturn, they’d be able to see how WeWork’s business really does perform in one, Smith said. WeWork could be posed with the prospect of trying to sell shares amid weak demand for new shares overall while having to report worsening business results to potential investors.
“It’s important to have this [IPO] event before a [down] cycle” in the economy, said Smith. “No one knows when that cycle is going to hit,” he continued. “I think [WeWork’s] management really was cognizant of that.”
And there’s another timing factor that WeWork faces, Smith said. One of the longstanding concerns about WeWork’s business has been that it the bulk of its customers are freelancers, startups, solo practitioners, and small businesses — the kinds of people and companies that tend to be most vulnerable in a recession. The company has been trying to address that concern by signing up larger businesses as its customers. At the beginning of June, 40% of its customers were companies that have 500 or more employees, up from just 20% as of March 2017.
But the company lured in many of those customers with sharply discounted deals, said Smith, whose company’s marketplace counts WeWork among its customers. In the second half of last year, particularly, the company was offering remarkable promotions — in some cases, it was charging about half the going market rate for space, Smith said.
Because WeWork generally offers short-term deals, even to its largest customers, those agreements are starting to come up for renewal, he said. The company is hoping to have those customers re-up at market rates, he said. It’s unclear how much success they’ll have. But there are warning signs, he said.
Its partners also need it to go public
Many of the companies who signed those deals were originally in the market for traditional office space. They only signed up for space with WeWork because the promotions were so dramatic, he said.
“They priced it so you couldn’t say no,” Smith said. “But now,” he continued, “you get a renewal offer, and it’s double what you’ve been paying — we’ll see what the reaction is.”
The company’s success or failure in getting those customers to renew should be known in the next three to six months, he said. WeWork would almost certainly like to go public before it has to report anything about that to public investors, he said.
“They want to have monetization before some of these fundamental problems are revealed,” he said.
But WeWork was and is likely getting pressure to go public from the outside too. SoftBank is trying to attract investors in a follow-on to its $100 billion Vision Fund. Having WeWork’s IPO blow up is about the worst marketing pitch it could have, especially after it already has lost a reported $600 million on its Uber stake, Galloway said.
If WeWork went public, it at least could potentially sell some shares and get some of its cash out, he said — though Galloway also said that he doesn’t actually expect WeWork to go public at all, and that the IPO will be completely scrapped.
Still, JPMorgan Chase and other banks have loaned Neumann hundreds of millions of dollars, backed by his shares in WeWork, and have loaned hundreds of millions more to WeWork itself. With WeWork’s valuation under intense pressure, its IPO in doubt, and its cash running short, those loans look increasingly risky, Galloway said.
“You have a ton of parties here who needed to get this done,” he said.
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