With a mission to "elevate the world's consciousness," WeWork is definitely one of the least definable companies we've covered on Industry Focus. Is it a tech company? A real estate agency? An industrials player? Whatever it is, hosts Dylan Lewis and Nick Sciple are here to share what they know about it. Tune in and learn what the S-1 tells us about WeWork's financial health, what the long-term growth strategy is purported to be and why that quickly falls apart, some of the red flags that WeWork's management have raised, why investors should be skeptical about new "tech" companies like this, and more. This episode pretty clearly falls on the bear side of the debate, but if you have a bull case for WeWork, we want to hear it! Please write in to firstname.lastname@example.org or tweet @MFIndustryFocus and share your thoughts.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on Aug. 16, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, Aug. 16, and we're going to work on WeWork. I'm your host, Dylan Lewis and I've got fellow Industry Focus host, Nick Sciple with me in the studio. Nick, what's going on, man?
Nick Sciple: It's great to be here talking about WeWork! This on the Tech show. Is this a tech company?
Lewis: You know, I was a little confused by this. I have to be honest. We have the Industry Focus Slack channel with you, me, Jason Moser, Shannon Jones, and, of course, the pod father, Chris Hill. And the news came out about the S-1 for WeWork. And Jason Moser was saying that this is a Tech show.
Sciple: Yeah... why don't we talk a little about what this company does, and we can see how it ties in with Tech and how it doesn't?
At its core, this company's mission is to elevate the world's consciousness. Maybe that doesn't sound like tech, that sounds maybe like a more Wednesday show these days. But, it was founded in 2010 by Adam Neumann, who's the CEO, the controlling shareholder today; Miguel McKelvey, and Rebekah Neumann, his wife. What they actually do is what they call a space-as-a-service business model. Most folks are probably familiar with WeWork's shared office space. They make money through rent arbitrage. So they rent a property long-term, and then they will alter that property, put all the beer taps and all those sorts of things that people like in their property, and then they will sublease it out to other folks, start-ups, those sorts of things, and make money that way. They'll make more money on those short-term leases than they pay in their long-term rent. They do make a big deal in their filing about community and culture. Do you want to talk a little bit about that, Dylan?
Lewis: Yeah. You look at the business, and I think it's a lot easier to understand if you know the backgrounds from the founders. Miguel McKelvey has an architectural background. He spent some time working at a firm that did a lot of the American Apparel retail locations, and really helped them with their build out. And I think that he is probably the one that has that creative touch that gives WeWork that distinct aesthetic that so many people have come to appreciate, and that so many different office spaces have mimicked. His background -- he wound up actually being raised in a five-mother community in Eugene, Oregon. A little bit less conventional, maybe, than some people normally grow up. Seems like someone who has really been, from an early age, engendered with this idea that community is very important, and that there are a lot of great both creative and innovative things that come out of a sense of community. It seems like Adam Neumann and his wife Rebekah Neumann are very much on that train. Rebekah Neumann is someone who practices Buddhism, is very much a world traveler, a former stock trader at Solomon Smith Barney. And Adam Neumann, I think, checks a lot of the boxes for what you would tend to expect from a Silicon Valley CEO -- somewhat spiritual, very much in the sense that a company should both do good and make money at some point down the road.
So, you see the focus on community. Sometimes that can be a little bit of a buzzword. In the case of WeWork -- or, The We Company, I guess we should say -- it seems like it's what the company founders really believe in, and what they really want to have be the case at any location they set up. You always have that skepticism when you see a buzzword that much, though.
Sciple: Right, and this space-as-a-service. When you talk about their technology platform, they do have an app that helps folks schedule meetings. They've talked about leveraging technology to maximize the use of their space and those sorts of things. But at its core, this is a commercial real estate company that is differentiated by its brand along those community lines. That's what sets it apart.
Should we talk a little bit about the financials, Dylan?
Lewis: I think we can't not talk about the financials of this company. [laughs] We always do this with the S-1 shows, breaking down companies that will be going public soon. We are so happy to finally have our hands on the numbers because that really gives us a sense of what a business is doing. In the case of WeWork, in some ways, great growth; in other ways, brutal financials.
Sciple: Right. If you look at the numbers for the first half of 2019, you've got revenue roughly doubling year over year. There's a multi-year trend of doubling revenues. Memberships, which is what the folks who rent office space at a WeWork, have grown by over 100% every year since 2014. Their memberships at the end of Q2 2019 are 527,000 members. Over half of those are outside the U.S. Obviously, some massive growth. They started out more with independent freelancers and those sorts of things, but they've moved more into what they're calling enterprise members, companies with more than 500 employees. That's now 40% of their memberships. So, you see massive growth on the top line, a lot of growth when it comes to their members.
But when you look at the bottom line, maybe not as pretty. Do you want to talk about that, Dylan?
Lewis: Yeah. This company is spending cash in a prolific way. Their expenses, all told, wind up roughly doubling their revenue for the past two years or so. So, they are losing more money than they are bringing in on the top line. And the narrative that we're getting from management here is, "If we bring down our growth, we stop opening so many locations, we will hit the point where we're profitable at some point." I look at the financials, and I'm a little skeptical of that. The main reason for that is, I think for 2018, they had roughly $1.8 billion in revenue, and about $1.5 billion in operating expenses. That does not leave a lot of money left over to do SG&A, marketing, factor in the stock-based compensation, because you know they're going to be going public -- there's a lot of other stuff going in there, and it's not a super high-margin business to begin with.
Sciple: Right. You've still got to purchase real estate and refurbish real estate and operate it, which carries a cost. You've seen their average membership revenue start to decline per person as they've moved internationally. They've had a really big presence in some really attractive commercial real estate markets. They're the largest commercial real estate tenant, I believe, in both London and New York. But yes, they say that as their locations mature, they will reach profitability. They define a mature location as a location that's been open 24 months or more, so two years or more. That's about 30% of their locations today. They say that as those locations mature, they can get a recurring stream of revenues, their costs come down, and they hit profitability. It's worth noting that a couple of years ago, you look at some of their filings, they defined a mature location as around 18 months. So, maybe profitability is not coming as quickly as they had expected in the past.
The other question you have is, if profitability has to come by slowing growth and moving to more mature locations, do we need to give this company a high multiple based on its revenue growth over time, knowing that sooner or later, that has to end for profitability to happen? Any thoughts on that, Dylan?
Lewis: I think that it's seductive to call a lot of companies tech companies. The fact that we are a little confused about where this company lands within the hierarchy of, are they a financials business because they're working in loan arbitrage, kind of; are they an industrials company because they're kind of in the commercial real estate space -- a lot of companies are pitching themselves as tech companies these days, but don't really have the classic tenants of a tech business. When you look at a software company, or you look at a platform company like Facebook, you spend this money upfront to develop the software, develop the platform, and then, with each incremental user, your per user costs go down and you enjoy incredible leverage throughout, no matter how many people you get. When you're looking at a building-based business, whether it's WeWork or WeLive or whatever they wind up doing, there's a certain defined capacity to those buildings, and to grow, you are having to continue to increase your locations. Each building, each location only has so much leverage to it. It doesn't really have a lot of the hallmarks that you'd expect with a tech company.
Sciple: Right. You mentioned some of those other spaces they're moving into. WeLive, which is some housing that they have in both New York and D.C.; WeGrow, which is a private school operated by Rebekah Neumann in New York City; moving into these other areas.
There are some things that are moving in the right direction, however. Their lease terms are lengthening. From December 1st, 2017 to June 1st, 2019, their average lease term has doubled to about 15 months. That's led to an increase in the amount of committed revenue backlog they have as a company. That's grown to $4 billion vs. $0.5 billion on December 31st, 2017. That's important for this company, because as I said earlier, they have these long-term liabilities, these long-term leases, but they only get paid from these short-term leases that they go sublease to other businesses.
There are still some risks there. When you look at their long-term lease payment obligations, about $47 billion they're obligated to long-term, but they have $4 billion committed today. So there is some risk in this company because they have these short-term sub leases, but obligations to a long-term lease that the company has to pay. If you start to see the economy turn down, or, for any reason, a meaningful departure of tenants, or members, as WeWork calls them, then you have these long-term liabilities that are still out there that the company will have to pay. That is a real risk. What are your thoughts about that, Dylan?
Lewis: I think in some ways, this is a business that is really well positioned to capitalize on the gig economy. Having all of these freelancers, these creative knowledge workers, that are not in offices, are very often capable of working from home, but instead want to find a place where they get that sense of community, there's a little bit of water cooler talk, and you have a chance to see the same people every day and build some relationships, it's appealing. I understand why that seems like the first place that a lot of people would go to for the customer base here.
But to that point about the short-term vs. long-term coverage, that $47 billion, you want to see them add enterprise customers. That will shore up a lot of that coverage, and it will insulate them from a lot of those risks. If you start working with companies and you see that a larger and larger portion of their revenue base is coming from companies rather than individuals, that makes me feel a lot better about the long-term prospects and the fact that they will probably be a little bit less prone to some of the cyclicality that you tend to see in the real estate market.
Sciple: Right. It's really a duration mismatch when it comes to their revenues coming in vs. their long-term liabilities. Seeing that corrected, or seeing a move to more enterprise customers, where there's going to be that reliable recurring revenue -- like we see in enterprise software, you can't give up your enterprise software. You can't give up your office space overnight, either. So, we like to see that trend. They do talk about, as they reach size, their ability to aggregate demand and control the market. We'll see whether that materializes over time.
There are some question marks around this company. And when there's a new company that's moving into a newly developing industry, leadership is really important. When you take a look at the S-1, there are some questions around corporate governance. Introduce us to that there, Dylan.
Lewis: There are times where corporate governance does not matter as much. It's something, when we do these S-1 shows, we kind of gloss over, because we don't see anything crazy in there and there are, frankly, more interesting things to talk about. There are also times -- in the case when we did our breakdown on Snap -- where there were some glaring red flags that we needed to discuss. That's the case here with WeWork. We have a lot of inside dealing, and a lot of that centered around their CEO, Adam Neumann. So, I think that this is a topic that we need to explore a little bit.
You're a little bit more versed in the ins and outs of it, so I'm going to let you take that.
Sciple: First off, there are some good things. You see a dual class voting share where the founder, Adam Neumann, and I think some other insiders, get 20X voting shares relative to what private investors are going to get. However, there's a catch with that. That voting interest will halve if he doesn't give over $1 billion to charity over the next 10 years. That gives you a good feeling, that we're going to give money to charity, and those sorts of things. That makes you feel a little bit better about that extra voting stock. But he does have an over 50% voting interest in the company. His name is mentioned over 169 times in the S-1. Very important.
There are some questions when it comes to a number of related party transactions between Adam Neumann and the company. These came out previously. The company is party to lease agreements in four commercial properties in which he owns an interest. Three of those leases were actually signed the day that he took an interest in the property. So, you have the company paying rent to the CEO and controlling shareholder of the company. They have taken some steps to try to mitigate that through a new fund called ARK, which is a separate management vehicle to separate Neumann from some of the properties he owns. That includes those four properties that they currently have a relationship with, as well as six other properties that he owns. They're going to manage that for the year, and they'll have the opportunity to purchase that.
But then you have some... [groans] he's taken out, ahead of the IPO, the Wall Street Journal reported, $700 million, which tends to not be a great sign, if you see the founder of cashing out nearly $1 billion ahead of the IPO.
Lewis: And that's in company stock, to be clear.
Sciple: Part of it is company stock; part of it is loans based on company stock. But that's one of the largest I think we've ever seen when it comes to a founder ahead of an IPO monetizing their stock. The other questionable, much lower dollar amount was earlier in July, just very recently. The company bought the rights to the We Family trademarks from We Holdings LLC. We Holdings LLC is owned by Adam Neumann, the founder of the company. So, you see the company buying a $6 million trademark to make what appears to be an unnecessary name change from WeWork to The We Company.
As I lay out at a high level some of those questionable transactions, Dylan, what are your thoughts as an investor?
Lewis: Yeah, I think it's a little weird that the CEO of a company would not just create the name and give that to the company, or have it be property of the company from the get-go. I think it's a little bizarre for someone to separately create it and then be paid for it, especially because it's so clearly related to the core business that he's in charge of.
Sciple: Right. And to be fair, it says in the filing that they used a third party to determine the valuation for that. But when you see some of these loans being made to him, some of his family employed there, his wife, obviously is employed there, as is his brother in law... He has a controlling stake in the company, making these decisions. It does [raise] some questions.
The other thing is, you look at the corporate structure for the business. Really hard to make sense of right now. What they're doing is using an up-C structure. This is a model that typically allows insiders to get a more tax efficient IPO. It allows them to take a partnership interest in the company vs. taking shares. If you look at their chart, it's really hard to make sense of, and I'm not going to try to describe it to you today. But the nature of those partnership interests, until some of those final numbers get filled in, when we get updated numbers from the S-1, we don't really know exactly what public shareholders are going to be getting.
So, a lot of question marks there, when you really have to trust the management when it comes to this business model.
Lewis: Yeah. Really, you don't want to have to go through a maze of ownership or stock-based loans or anything like that to just get a sense of what someone's exposure is to the business and how the business funnels money. You want it to be nice and simple. You want a company to go public, and have the people that are running that business not really do anything all that eventful. You don't want anything monkeying with the lockup periods like we've seen with Beyond Meat, which I haven't really been a big fan of; and you don't want to see people selling shares before they go public. I know that there are perfectly valid reasons for that. You want to make sure that people that have a ton of money tied to the equity of a business also have liquidity. Obviously, people need cash. I know, in the case of the CEO, he is not taking a salary in the conventional sense. I don't think his wife is, either. So, obviously, they need money coming in one way or the other. I don't know that they need hundreds of millions of dollars in stock-based loans to make that happen. It's not what you want to see. And when you already have some numbers that make it pretty clear businesses aren't going to be profitable anytime soon, it's just another strike against the company for me.
Sciple: Yeah. You look at the company, particularly when it comes to the valuation, there's a "show me" that needs to be there. Their most recent private valuation was around $47 billion. They've taken in over $10 billion from SoftBank since 2017. That's really driven up that valuation. You compare that a publicly traded comp, IWG plc also has a flexible office space offering called Spaces. We have one of those on the third floor in our building. Very nice office space. They made $3 billion in revenue last year. Made $460 million. It's a $4.5 billion market cap. You compare that to WeWork -- as I said, private market valuation of $47 billion. 2018, they made $1.8 billion in revenue. As we mentioned, they lost money. Again, we compare that to a company that has higher revenue, a much lower market cap... you really have to believe in the culture of this business, in management's growth trajectory, to buy shares today. There are some question marks when it comes to the business model. There are some question marks when it comes to corporate governance. For me, it's going to be a wait and see, sit on the sidelines company. But reasonable minds can disagree.
Lewis: Yeah, I think it's safe to say that they are the Kleenex of the co-working space, right? They are the business name that people recognize in this industry. The hope is that they have enough moat there with that brand. And it's really a brand-based mode. I don't know that they have anything else in place. Maybe you could say the real estate agreements that they have in some of the most desirable markets could be a moat. The bigger they get, the more clout they have in a market. But, we walk past that Spaces space all the time in our own building, and it looks awfully a lot like what we would expect with a WeWork. It's super hip, cement floors, nice, modern furniture. The thing that WeWork seems to play up to insulate itself from competition is the community vibe. That's why they spent so much time talking about it in their prospectus. I hope that's enough for them to be able to fend off competition. I'm not convinced right now.
Sciple: Real estate is a space that's been around for a very long time. Obviously, this co-working model is a new business model that has really been disruptive. I just question whether the folks who are in the space, who have a lot of experience managing properties, whether they can't curtail some of WeWork's growth, or just take away some of that market share. And when you look at its current valuation relative to where similar publicly traded comparison companies are, it's just hard for me to get really excited about it. And then you throw the corporate governance stuff over the top, and... I want to watch this one from the sidelines. Have a little bit of fun watching. Folks will probably argue back and forth.
Lewis: I think one of the lessons here -- we joked about whether this belongs on the Tech show. I think that when people see companies going public, particularly these high-flying unicorns, it's good to have a certain level of skepticism about whether a company that is billing itself as a tech company truly is a tech company. I'll go back to the financials just briefly, I harped on this before -- $1.8 billion in revenue in 2018, $1.5 billion in operating expenses alone. That puts you in a spot where there's just not a lot left over to pay your other expenses, and it isn't like magically, you're going to become super profitable with operating leverage down the road. I'm willing to give a super scalable business, like software, a high valuation, because you know that at some point, that company's probably going to have 80% or 70% margins on an operating basis. That's not the case with WeWork. And I don't see anything right now that they could possibly get close to that. So, come in and question whether some of these companies that are saying they're tech are truly tech, because the way I see it right now, it's not. They want to benefit from that comparison from a valuation perspective. I don't think they deserve to.
Sciple: Yeah. I will say, one part of the business that's interesting to me, they have this Powered by We business where they will come in and alter properties for enterprises. You can see how that would be a little bit of a less capital-intensive model. They can manage the properties for businesses. We can see the growth, see the company pivot to that. I can see how that can be more scalable and drive more profits. But as you say, they're a technology company, but really, to deliver their technology, still have to own, refurbish, and manage real estate, which is a low-margin, capital-intensive business.
Lewis: Yeah. I think we're in agreement here. I would love to get a good bull take on WeWork, so if any of our listeners are really into this business, they've done some homework and they think they have a compelling bull thesis -- or any of our writers for fool.com. I've talked to a couple of people who are a little bit more mixed on it. I'd love a strong bull case here just because so much of the coverage we've seen has been negative, I think mostly because of some of the financial issues we were talking about, and the corporate governance issues that have us concerned. Please write into the show, email@example.com, or you can get us @MFIndustryFocus. Nick, thanks for hopping on today's show!
Sciple: You know, it feels fun to talk about tech! I'm all high-tech over here! It's fun!
Lewis: [laughs] And it's nice to do a show with you! We do those roundtables here and there, where we get everyone in the booth, but it's fun to have someone in the studio here. The Skype relationship does get tiring at times.
Sciple: Yeah. Bring the side-of-desk banter in the studio.
Lewis: We are working right now on WeWork, Nick, but what are you up to this weekend?
Sciple: We're going to the Nats game tonight, and then, I don't know. We'll see.
Lewis: Producer Austin Morgan has a little bit more context -- we are, as Fools, going. I think there's about 100 of us going to the Nats game. They're playing the Brew Crew, and, as I understand, it's a pretty big game.
Austin Morgan: Yeah. This weekend, big series. The Nats are a game up on Milwaukee for the wild card going into the weekend. Hopefully by the end of the weekend, they're four games up.
Lewis: Games start to really matter in August and September.
Morgan: Big time.
Lewis: We will be rooting, and we will hopefully be dry. Rain in the forecast. We'll see what happens. If you're a Nats fan, write in. Maybe, if you're at the game, let us know.
Morgan: I've got money on Christian Yelich and Juan Soto both hitting home runs tonight.
Lewis: Why is that?
Morgan: Just because they're awesome.
Lewis: [laughs] I like to think that our producer, Austin Morgan, our man behind the glass who makes everything happen, is also awesome. Thank you for the baseball commentary!
I think that does it for today's show, Nick!
Sciple: Let's do it again sometime!
Lewis: Let's do it again sometime! Listeners, that's it for this episode of Industry Focus. Like I said, if you want to reach us on email, firstname.lastname@example.org, or you can tweet us @MFIndustryFocus. If you want more of our stuff, we've got tons of content over on YouTube, and you can subscribe to the podcast on iTunes or wherever you get your podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Nick Sciple, I'm Dylan Lewis. Thanks for listening and Fool on!