In a world where accessing capital is as easy as it has ever been, it is those companies able to harness investors obsession with growth that demand the highest valuations. Increasingly, traditional companies like manufacturers, are seeking to affiliate themselves with technology buzzwords like big data, artificial intelligence and the internet of things. Yet, recent months have shown that astute investors are either tiring of high growth companies or have are more closely questioning their lofty growth predictions. We Work isn’t alone, but it’s a company worth taking a closer look at in light of last month’s events.
Moreover, an analysis of We Work wouldn’t be complete without introducing Softbank, one of the key backers of technology companies around the world.
What does We Work do?
We Work has a simple business model. They enter leases for entire buildings or floors in sought after areas of major global cities, refit or renovate these spaces and then seek to less them out to many smaller companies, entrepreneurs and creative types.
Their offering includes private offices and common meeting spaces, but the group generally owns no assets outside of the modern fit outs they deliver. So the business model is simple, rent spaces, create cool offices then sub lease these at a profit. The last part of this model being the hard part, as We Work haemorrhaged $220k per hour in 2018. In fact, the companies losses of $1.9bn exceeding their increasing revenue of $1.8bn, hence the need for constant capital injections.
The company was not unlike any other ‘technology’ company, albeit technology seemed to play only a small role. They were seeking to growth their scale sufficiently enough to eventually eek out strong profits in various ways with accounting and financial services two of these. The company attracts tenants out of home and cafes by offering printing services, free refreshments, coffee, office cleaning and hosting networking events in an effort to bring people together. This all makes sense in an increasingly casualised employment sector but in our eyes, it is very simply a property leasing company.
The company is not unlike ServCorp who provide serviced offices, with the difference being ServCorp tends to lease existing office buildings, provide secretarial services and charges higher prices to do so. In our view, the We Work model may be fundamentally flawed. As the type of tenants that typically inhabit these spaces work for themselves, or are involved in venture capital companies, the majority of which are likely to fail.
Consider for instance the sector of financial advice. Financial advisers are dealing with sensitive information, both financial and emotional, on a daily basis. They must also securely store confidential client information behind several layers of protection. Whilst the private offices offered by We Work may be suitable for the former requirement, most would find it difficult to meet the secondary option. That is without considering the security of a shared internet connection.
Taking this a step further, the We Work approach typically does not attract the highest quality tenants; they attract those seeking to keep costs low and unwilling to commit to longer term leases. The very nature of these businesses is that if their business is under pressure they can simply walk away, flexibility not afforded to those leasing their own premises or employing staff.
So what went wrong?
Put simply, investors and fund managers saw through the technology haze. Upon receiving the prospectus for We Work, it was obvious to many investors that the company was still some way from profitability and required many things to go right in order for this to be achieve. In our experience, the technology sector is great at one thing, capturing the emotion of investors and employees alike, who see through their issues and only have eyes for the future.
In a time where passive or index management is dominating active decision makers, We Work reiterated their important role in the market. Active managers effectively decide whether companies like We Work and Latitude Financial become listed companies. It is these active managers that provide the capital that allows these new companies to list on stock exchanges and if it isn’t forthcoming, than the listing doesn’t happen. In comparison, a passive investor will buy any investment that enters their relevant index.
The company was seeking to list at a valuation of $48bn, but according to reports had some $49bn in rent payable in the coming months and insufficient cash to fund their operations for the next 12 months. Business Insider reported that We Work’s high profile CEO had actually trademarked the term ‘We’ and sold it to his company for close to $6m; red flags should no doubt have been seen then. Yet the business continued and eventually required a $9.5bn buyout from its majority shareholder Softbank. This saw the value of the company fall from close to $50bn to just $9.5bn in just a few hours.
After agreeing to the deal, Softbank paid some $1bn to the outgoing CEO and announced a ‘right-sizing’ of the business model. In plain English, right sizing means the company and management made poor decisions with shareholders capital that now need to be rectified. In We Work’s case, they appear to have taken on too many new offices and were having trouble leasing these out profitably. If this is the case in what is a generally supportive economic environment, it’s worrying what impact a recession would have on their business model.
As part of this right sizing, the new board axe 4,000 staff or 30% of the global workforce, and offered to buy back shares issued to employees based on an $8bn valuation for the company; most of these shares were issued at substantially higher levels.
As union funds and individual investors alike increase their allocation to high risk private equity and venture capital investments like We Work, many are questioning the longevity of this strategy. Most of these business will inevitably fail, it is simply par for course for this sector, so the question must be is now a good time to be increasing allocations?