Office landlord The We Company is getting set to come public, with plans for an initial public offering (IPO) maybe as soon as this month (September 2019). But investors need to step back and take a deep breath. With recent rounds of private funding placing a valuation of as much as $47 billion on the lessor, you need to carefully examine the hype. Here's what you need to know before you jump on We's IPO.
How much for that doggy in the window?
On Wall Street, investors place valuations on stocks every second of the trading day. At any moment, you can look at metrics like market cap and price-to-earnings ratio (among many others) to get a feel for what investors are thinking about a company. When a company is private, you don't actually get a clear indication of what it is worth; you have to infer that from other sources, like the private capital it raises. It's kind of a guessing game.
Some of the recent private funding that The We Companies has received suggest that the company has a market value of $47 billion. In and of itself, that number isn't too meaningful, but compare it to a few public landlords, and it starts to provide some clarity. For example, real estate investment trust (REIT) bellwether Realty Income (O 0.27%) has a market cap of just $23 billion. Realty Income is a retail-focused REIT, so maybe that's not a great comparison. Office REIT giant Boston Properties has a market cap that's even smaller at roughly $20 billion. Even Simon Property Group, one of the largest REITs in the world by market cap, has a lower valuation at "just" $45 billion. If you believe the hype around The We Companies, it's worth more than each of these REITs -- in fact, it is even worth more than Realty Income and Boston Properties combined!
That's a problem. All of these REITs have huge portfolios and profitable operations. We Companies doesn't really own all that much property; it mostly leases space from others (what it calls locations) so it can release that space at higher rates. And, more important, it is bleeding red ink and a lot of it. Between 2016 and 2018, the company's pro forma loss per share increased from $2.66 to $9.87. Through the first six months of 2019, the loss amounted to $4.15 per share. The company says the red ink is because it takes time to fix up and lease out space, but $47 billion is a lot to pay for an unprofitable real estate company that doesn't really own much property. And We has no expectation of turning a profit anytime soon, since its near-term plans call for opening more sites.
It's about the future!
We Companies doesn't want investors to look at today's results, however. It wants you to think about the future, in which it is helping to "elevate the way people work, live and grow." That's just one of the fun ways that management describes its operations that has little to no real meaning. The company's core business is still signing long-term leases for space in office buildings, fixing up the space by adding amenities, and then re-leasing it to individuals and small groups at higher rates. It has some large customers as well, but most of its lessees are individuals and small groups.
The problem is that there's an inherent risk between the company's lease obligations and the leases it signs with its own customers. We Companies is taking on long-term leases but letting its customers sign short term leases. To put a number on that, the company has lease obligations of $47 billion and lease commitments from its own tenants of just $4 billion. If the company can keep its offices full, that's not too big a deal. But there's a big difference between those two numbers, and if a recession leads to falling occupancy, We Companies could find itself in very big trouble very quickly. Just for reference, office REITs tend to see occupancy decline during recessions. In fact, this is one of the risks that We Companies has highlighted in its early filings.
The company claims that it has tested its business assumptions using occupancy levels that are robust enough to survive a recession, but real life doesn't always work out the way a company's models predict. Basically, We Companies' business is untested, having only operated during a relatively strong economic environment.
The future is the problem
Which brings up the biggest issue of all: How is the company planning to use the money it raises from the IPO? Basically the goal is to keep expanding. That simply amplifies the risks investors are taking on as the company's long-term lease obligations grow while it adds more space to fix up and then fill with tenants that have short-term leases. Not only is the company likely to keep losing money in the near term, but every new office space it opens increases the risk that the model could blow up during the next recession. And that is a very real risk.
The We Company's most direct competitor, U.K.-based Regus, put its U.S. arm into bankruptcy in 2003 because its short-term lease revenue wasn't enough to cover its expenses, driven by long-term leases, following the 2000 tech bust. There are differences between the two models, but the long-term/short-term mismatch is basically the same.
If you are looking at We, the IPO is only likely to increase the risks as it provides the company with the funds to ramp up its growth. You'd be better off buying any of the three REITs noted above, even though names like Realty Income are valued very highly today. To put some numbers on that, Realty Income's dividend is near its lowest levels ever. And its price to adjusted funds from operations is more than 20 times, a big number for a company that has historically grown AFFO and dividends in the mid-single digits. In the end, though, no matter how the company is described in its IPO, you're likely to be better off overpaying for a profitable, time-tested landlord than risking buying into We's questionable business model and growth plans.