Just a few months ago, WeWork was riding high. Its business model was designed to take advantage of one of the biggest trends in the economy today -- the rise of freelancers, contractors, and remote workers, and the corresponding decline of people working in traditional offices. All those folks, it was clear, had to set their laptops down somewhere, and they'd sometimes need a place to meet with clients other than in their dining rooms or a coffee shop. Enter the hip co-working spaces of WeWork, and its disruptive, tech-like joie de vivre.
So, when The We Company -- WeWork's parent -- announced it was heading toward an initial public offering to get more funding for its rapid expansion, investors were at first enthusiastic. Onlookers praised its eccentric CEO and waited for its prospectus with bated breath. And then it all fell apart.
In this "What's Up, Alison?" segment of the Motley Fool Answers podcast, co-hosts Robert Brokamp and Alison Southwick dig into the details and explain simply the series of revelations that lead to WeWork's stunning fall from grace.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Oct. 1, 2019.
Robert Brokamp: So, Alison, what's up?
Alison Southwick: Well, I'll tell you what's not up and that's WeWork's valuation. Ugh! So in January, WeWork was valued at $47 billion and they were planning to go public, but as they started disclosing the financials as part of the IPO process, investors disagreed that the company was worth nearly as much.
"OK," the company said, "we'll make some changes and come back at $20 billion. No? Still not interested? No one? Nuts. Ten billion?" No. So they hit pause on going public, and then the CEO was ousted. Wowee, what a ride! So today I'm going to share with you some lessons from the WeWork Dumpster fire of an IPO.
So for those of you who aren't sure what WeWork does, it's actually The We Company, but their main bread and butter is WeWork locations, so I'm probably going to end up saying WeWork most of the time.
Brokamp: I'd agree with that.
Southwick: Thank you! So WeWork essentially takes on long-term leases for office space, renovates the space so it looks really cool, and then short-term subleases it as a co-working space. So if you're an entrepreneur just getting started, it's a nice way to get all the amenities of an office without having to worry about setting it up yourself. Its success has largely been credited to the booming start-up economy; however, bigger companies are also using them. So we actually use a WeWork space in Philly. It's been a great opportunity for us, as we wanted to explore whether we wanted to open up a permanent office in Philly. Do we want to open a permanent office here? Eh, maybe. How about we just start with a WeWork space?
Brokamp: Let's just dip our toes.
Southwick: Right. Companies like Microsoft, Facebook, and Amazon also use them to rent space in cities where they don't want to manage the real estate themselves. In the D.C. area alone -- just in D.C.-Northern Virginia -- do you want to guess how many WeWork spaces we have?
Brokamp: For people who don't know, that's where we all live. But I can't say I've ever seen one. They must be hidden. Are they hidden?
Southwick: No, they're not hidden. There are 12 locations within, let's say, five miles of us at this exact moment, and six opening up soon. Apparently they open two new locations a day, and their growth has made them the largest private tenant of Manhattan office space. That's bananas!
Southwick: So over at the WeWork on Rhode Island Avenue in D.C., for example, it costs about $400 a month to just hang out. Then you can go and sit in the common spaces. Find a table. Find a desk. Use their phone booth. Whatever. For $1,000 you can have your private office where you can stand in one place and probably touch all four walls.
The We Company also has other ventures, like WeLive, which is a condo building in D.C. And WeGrow, which is a school. But again, WeWork is the big one. So that's what they do. What the heck happened, and what can we learn?
The first lesson. Beware the celebrity CEO. To paraphrase Aswath Damodaran, "I don't like this company. I don't like CEOs that spend their time telling me how to live my life rather than talking about running their own business."
Brokamp: By the way, he's a business professor at NYU.
Southwick: He did a YouTube video that's at least a half-hour long looking at WeWork and whether they are really worth what they think they are, so if you love numbers and valuation, I recommend watching that YouTube video.
Brokamp: His website is great. All kinds of great data. All kinds of good stuff.
Southwick: So to be fair, you can be a so-called celebrity CEO and run a profitable company. We love a good founder-led company here at The Motley Fool -- emphasis on the word good. So, this man, though, he is a hoot, and the media is excited to pile on.
Ready? Meet CEO and co-founder Adam Neumann. I believe he's six-foot-five. He's got long locks of hair. Kind of like a skinnier Antonio Banderas, maybe?
Brokamp: I think more like Michael Hutchence, former lead singer of INXS. I think he looks a lot like him. For you fans of '80s bands.
Southwick: I mean, INXS is so good. So good, right? That music holds up.
Southwick: So now you've got a picture of him in your mind. The Wall Street Journal described him as "intensely ambitious and a masterful storyteller with a magnetic personality who can inspire and sell." And New York Magazine has a delightful article about the man, and it's full of fun anecdotes, such as how he holds meetings at two in the morning and still shows up late. He gets stranded in foreign countries after someone stashes weed in a cereal box on the private jet. Oh, and the company. This company loves to party.
But I'm honestly not bothered by the fact that he smokes weed on private jets, or that he doesn't wear shoes around the office. He can smoke all the barefoot weed he wants if he can run a good company. And he's certainly inspired a lot of people.
We'll get into the economics of the business later, but Adam and his wife, who's been very involved in the company and by his side the whole time -- and they're big personalities. Their cult-like personalities, some say, are what helped inspire people and grow the company, but it also derailed the IPO. And also financial shenanigans.
Brokamp: The shenanigans are crazy.
Southwick: The shenanigans are crazy. So the fun thing about going public is suddenly you have to disclose a lot of financial information, and WeWork had a few skeletons in their closet that made investors say, "No, thanks." For example, this is so good. WeWork paid Neumann nearly $6 million to change the name to The We Company, a trademark that Neumann just so happened to own. Isn't it amazing?
Brokamp: I think that summarizes the whole problem with his self-dealing. It's amazing.
Southwick: Absolutely. So when investors called them out on this in the S-1 -- I guess they did it in the S-1 -- they amended the S-1 and said he gave the money back. How gutsy is that? You know what we need to do? We need to change the name of the company, and it just so happens I have a great name. And now you're going to have to pay me for that name. Anyway, let's move on because that was like shenanigans No. 1.
Apparently Neumann invested in buildings and then had WeWork sublease space in them, which obviously presented a conflict of interest. On top of that, Bloomberg said that the S-2 filing showed that he was also borrowing money from WeWork at little or no interest. So he was borrowing money from the same company that he was also charging to rent space from him.
How much money? Well, in 2016 Neumann borrowed $7 million from WeWork at the annual interest rate of 0.64%.
Southwick: So nice. I want that deal. Also, Neumann took out a much larger loan from WeWork. A few months ago the company lent him $362 million in April at 2.89% interest to help him exercise some options to buy stock.
Southwick: I know. He also reportedly cashed out of $700 million in stock ahead of the IPO, with the S-2 saying that his late sale was late 2017.
Why was the guy able to do all this stuff? All this self-dealing?
Well, aside from being charming and motivating, he also has controlling shares. He has been able to maintain control because the share class he owns has 20 votes to every one vote that other shareholders get. So when people saw this in the S-1... I keep saying S-2. I need to say S-1, don't I?
Brokamp: Sure, but most people don't know the difference, so go ahead. Say S-10. It's all fine. It's all good.
Southwick: OK, I don't know which "S" I'm in, but in the S's. There's some numbers here. So WeWork amended the S-1 and they reduced the voting power to 10 votes for every one regular share of voting power, but that's still pretty ridonkulous, right?
So as I'm researching this -- reading all the articles and listening to all the podcasts -- it's easy to forget that there's actually another co-founder named Miguel McKelvey, who later became the company's chief creative officer in charge of design. Arguably, the design of these spaces is WeWork's biggest edge. It's hard to find a lot about him, but he did an interview on the How I Built This podcast and he sounds like a legit nice person.
And so I recommend listening to this podcast. Again, it's How I Built This podcast with Miguel McKelvey, because the interview takes place when the company's doing well -- like a couple of years ago -- and so the narrative at the time is, "Oh, wow. Look at these audacious guys who had an idea and a passion to go after it."
Brokamp: And they did make a lot of money. Their revenue is something like $2 billion.
Southwick: Yes, they did do well, whereas the narrative now is look at these clueless, hubristic hucksters. It's just funny how the media will turn on you, right? Because you know that people love more than an underdog story is, of course, an underdog story that turns into a fall-from-grace story which is what this has been. There's been an evolution here.
Brokamp: But it is because of, No. 1, the valuation that they tried to come out with, with the IPO, and No. 2, the CEO. If you took those two away, it actually would be a pretty straightforward success story. Sorry, that's my hot take.
Southwick: That's not a hot take. I think you're right. Let's head to lesson No. 2. Are you really a tech company?
Brokamp: I love this. This is a good one, too.
Southwick: So real estate is an old business. It can certainly be profitable, but is real estate investing really going to excite VC investors? Well, what if I tell you it's a tech company that's disrupting real estate? Ooh! I see you. Now you're on board. And that's what WeWork promised. They weren't just going to disrupt real estate, though. They were going to be a tech company that was going to disrupt education, and housing, and gyms. But the thing is they aren't a tech company. They're a real estate company.
But wait! What if I tell you that we are a community company committed to maximum global impact, as WeWork said in the regulatory filing, and our mission is to elevate the world's consciousness. Eh? Who's on board?
Brokamp: I'll pay $40 billion for that.
Southwick: Rick is literally wearing a shirt right now that says, "Elevate humanity through business."
Brokamp: There we go. So Rick is on board.
Southwick: Wow! You totally are on board.
Rick Engdahl: It was a giveaway at the Conscious Capitalism meeting.
Southwick: [Laughs] It's so good.
Engdahl: That's probably where they stole the statement from.
Southwick: I shouldn't make so much fun of them because you know what? It is nice when businesses want to make the world around them a better place. OK. I'll give you that. But, come on! You're renting office space, and it's really great-looking office space. How fun. How exciting. How collaborative. But OK, maybe slow your roll there on elevating the world's consciousness.
All right, let's take a look at the numbers. The headline could be that they are losing $2 for every $1 in revenue. That's a fun stat. Last year WeWork reported revenue of $1.82 billion, which was more than double that of the prior year. Awesome, but its net loss also nearly doubled to $1.6 billion.
Brokamp: Well, that's nice. That's nice.
Southwick: That's nice. As TechCrunch.com put it: "WeWork is growing like mad, but it's hard to tell what its gross margins are. This makes its revenue quality hard to parse. What wasn't hard to figure out was that WeWork is tectonically unprofitable on operating and net basis, and that the company's operations consume cash while its investing activities torch the stuff."
Which, OK, fine. Startups tend to burn through a lot of money to grow into profitability, but this is a business with questionable at best margins, so the revenue is growing great, but it will potentially never outpace the losses.
But wait! WeWork also has a lot of debt, including a $702 million bond that's due in 2025. And speaking of those investments that are torching money, Neumann -- apparently an avid surfer -- of course, made the company invest $13 million in a wave pool company. That's just a small throwaway anecdote. Anyway, as Scott Galloway said on the Recode podcast Pivot, "Uber was 'drunk and disruptive', WeWork was just 'drunk.'" Who would fund these people? Well, that gets us to our final lesson: Be careful when SoftBank says you're not crazy enough, even though we've already established that you're already pretty crazy.
So meet Masayoshi Son, chairman and CEO of SoftBank Group Corp., a Japanese conglomerate. In 2016 SoftBank launched the Vision Fund, a $100 billion venture fund. Massive! Forty-five billion of which came from Saudi Arabia. The Vision Fund strategy -- I'm obviously oversimplifying because these are very sophisticated investors -- but generally, their strategy was to take a ton of money, sink it into relatively late-stage companies like DoorDash, Slack, Uber, etc. and blitz-scale them, and then step three is to profit.
Masayoshi Son, or Masa Son -- apparently some people call him that, maybe his friends; we're pretty tight -- he admits that what he looks for are insatiable entrepreneurs. At WeWork, as they said in the FTB Beyond money podcast, Masa Son met his match with the ultimate hustler.
So here's how the deal went down from the New York Magazine piece: "Son met Neumann at the WeWork headquarters and told him he had precisely 12 minutes for a tour, after which he invited Neumann to join him in his car, where Son sketched out a deal on his iPad to invest $4.4 billion in WeWork. Son told Neumann to make WeWork 10 times bigger than your original plan and to recognize that, in a fight, being crazy is better than being smart, and that WeWork wasn't being crazy enough. Son thought WeWork could be worth a few hundred billion dollars."
Apparently, Masa Son thought that WeWork was like Amazon at the stage when Amazon only sold books, and somehow WeWork was going to sell everything community-related. Anyway, at this point in my homework, I didn't have time to unravel how and when SoftBank and separately SoftBank's Vision Fund doubled down on their WeWork investment, but now SoftBank and the Vision Fund own nearly one-third of We.
They made moves at a $47 billion valuation. They invested at a $20 billion valuation, and then they are about to become majority shareholders when, in December, Masayoshi Son tells Neumann that the deal for SoftBank to invest $16 billion in WeWork -- including $4 billion it had already promised -- well, the deal was dead.
So WeWork, Uber, Slack, DoorDash were all supposed to go public and make tons of money for the Vision Fund, in time for SoftBank to start convincing investors to pour money into their second Vision Fund of over $100 billion, which is right about now. So Uber and Slack -- well we know how they're doing, and there's some schadenfreude to be had in the VC world, I think, about how SoftBank's Vision Fund is performing.
If SoftBank had given them more money, that would have probably bought WeWork more time and given them a little bit more runway, but WeWork is running out of runway to get profitable, thus the pressure to IPO, and here we are today.
So, what happens now?
Well, Adam Neumann stepped down as CEO, and there are rumors that WeWork is going to lay off one third of their employees. They already started looking into it. From what I read, experts think that co-working is only going to become more popular, and that the threat for WeWork, though, is that there's a big difference between the average length of the leases it enters into -- roughly 15 years in the U.S. -- and the time its customers typically agree to lease the space, which is like less than two years. So should the economy go south, the hit to entrepreneurs and small businesses, and ultimately to WeWork, could be pretty hard. The short-term subleases would dry up and, meanwhile, they're still obligated to pay their long-term leases.
So like I said, I listened to a lot of podcasts and read a lot of articles. I recommend reading the New York Magazine articles. The Wall Street Journal has also done a lot of good reporting on this, if you want to learn more. I also enjoyed listening to the Financial Times Behind the Money podcast episode about this, and then Recode's Pivot podcast was fun with Scott Galloway, but there are a lot of swear words in that one, so don't listen to it with your kids.
Anyway, a few weeks ago -- before everything fell apart -- on a call with the whole company Neumann said they had, "played the private market game to perfection." As for the public markets, he said, "the company was still learning the rules of the game." And that, Bro, is what's up.