In this episode of Industry Focus: Tech, analysts Dylan Lewis and Nick Sciple check back in on WeWork. In the two months since IF's last show on the real estate/tech/elevated consciousness company, WeWork has been through the wringer. The duo talk about what's happened to WeWork, and what lessons investors can take away from it. Tune in to hear more on:
- What happens to the We Company going forward -- layoffs, leadership changes, and more;
- What this means for SoftBank and its investors;
- Why WeWork's growth story didn't sell; and
- How the We fallout could affect real estate markets around the world.
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. 25, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, October 25th, and we're revisiting the We saga. I'm your host Dylan Lewis, and I've got fellow IF host Nick Sciple with me in studio. Nick, what's going on, man?
Nick Sciple: Not too much. Not too much in the news this week. Happy to talk about WeWork today! It's probably been the most fun story to follow the past couple of months. Probably in years, right? Have you ever seen anything like this?
Lewis: I haven't, not with a company about to go public. The closest I can come with the parallels that we've seen and the massive dip that we've seen in the valuation for this company is what happened to Blue Apron shortly after going public. The difference between what we're seeing with We and what we saw with Blue Apron was who was bearing the brunt of that huge decline in valuation.
We talked about WeWork back in mid-August. A lot has happened since then. We're going to revisit exactly what's going on with that story, talk about where we left things, what's happened since, the ramifications, and also some of the investing lessons. Where exactly did we leave things, Nick?
Sciple: August 14th, WeWork filed its paperwork to go public. That's when the proverbial S hit the F. [laughs] So, August 14th, WeWork filed its paperwork to go public. August 16th, Dylan and I talked about it on this show. I'm sure that started this whole saga. Just a couple of weeks later, September 5th, after folks had gotten the chance to look through the filing, see how difficult the profitability picture was for the company, you started to see the valuation start to dive. September 5th, WeWork started considering cutting its IPO valuation by 50%. Four days later, SoftBank asked for the IPO to be put on hold. Four days after that, WeWork announced corporate governance changes to reduce Adam Neumann's authority. A lot of concerns about his control over the company. Less than two weeks after that, he's gone as CEO. A day after that, they're selling off some of businesses, like, they bought some augmented reality companies. September 30th -- less than two months after the IPO was originally filed -- IPO was postponed indefinitely. Then, this week is the latest in the saga, where SoftBank announced it would take control of WeWork and Adam Neumann would leave the board. [laughs] It escalated pretty quickly, huh?
Lewis: [laughs] Yeah. The internet moves fast. If you're trying to put yourself back in the shoes of where you might have been in mid-September, this is around the same time that all of the headlines about Antonio Brown were coming out, and all the dysfunction at Raiders Camp, and then ultimately, his time with the Patriots, which was short lived. It felt like there were parallel stories there of, every single day you checked the news, there was something about Antonio Brown and there was something about the We Company. You couldn't escape it.
Sciple: Sure. With both of them, there was a lot of, obviously, public following these stories, a lot of fiery details, a lot of controversial details came to light. But as the story continued on, what we didn't know over and over again was worse than what we'd known to that time. So, we started off saying, "OK, Adam Neumann has too much control over this company. He sold the We IP for $5 million, that looks a little funny." Then we hear about him flying in private jets with bricks of marijuana on him, talking about being the world's first trillionaire, talking about controlling this company for 300 years, talking about changing the U.S. Constitution so he can run for president of the United States as an Israeli citizen, someone who was born there. So, yeah, really escalated quickly.
We got this deal this week that has finally bailed out the company. CNBC was reporting that without this cash infusion that came in this week, the company was going to run out of cash. The new valuation of the company's around $8 billion, down from $37 billion with the IPO. SoftBank pumping in $5 billion in loans, $1.5 billion in equity investments, and then buying another billion of stock from existing investors. And then, Neumann got a pretty good package here. You want to talk about that?
Lewis: Yeah, yeah. The number that you're going to see with most headlines is a $1.7 billion package, which is true, the sticker figure is true, but you need to dive into it to actually understand what's there. You have a $185 million four-year consulting fee, so he is essentially available, I guess, on retainer for the new leadership at We to consult and give them a sense of where he might be going with the business were he in charge. He has a $500 million credit from SoftBank, which should replace existing bank credit lines. We can get into that in a second. And then, he has the ability to sell $1 billion in shares. So it's not like he's just being handed $1.7 billion dollars in cash. There's some complexity to it. But, it does look like a particularly big number when you consider the whole company at this point is worth about $8 billion.
Sciple: Yeah, this is one of those things where, when you owe the bank $100, it's your problem; when you owe the bank $100 million, it's their problem. I think this was a perfect example of that. SoftBank, through the Vision Fund, owned a significant amount of WeWork shares. JPMorgan, another company that had a significant amount of exposure to WeWork was also in the works to try to bail out this company. Some may argue that SoftBank is pumping good money after bad here. I would be on the side of that. But, it's tough when you've pumped in over $10 billion in capital for now a company valued at $8 billion. It's tough to say, "I was wrong." Masa Son is no exception there.
Lewis: Nick, in looking at the aftermath here, it's tempting to do a winners-losers type of situation. It may be a little early to determine who wins and who loses. With the package that Neumann received, he is clearly the one who's coming out the rosiest, financially, at least. Probably a lot of reputational damage done to him. I'm sure it was a big ego hit for him to no longer be in control of this business that he co-founded and, I think, really identified with in a concrete way.
Why don't we talk a little bit about the business side of this specifically, first? What is next for We at this point?
Sciple: We's new chairman of the board is SoftBank COO Marcelo Claure. He's been very involved in the turnaround effort. Spoke to employees, sent letters out, had a Q&A with them live recently. What he's said is, "We really need to right-size the business, bring costs down." They're going to start doing a significant number of layoffs. Financial Times recently reported they're going to lay off about 4,000 people. For a staff of around 15,000, that's about a third of your global workforce that's getting laid off. I imagine they're going to need to get rid of some underperforming locations and bring costs in those ways as well.
But you actually read through that Q&A with employees. What were your takeaways from that, from Claure's discussion there?
Lewis: To be clear, that was not a public Q&A. It was one that an employee had recorded and then kicked over to, I think it was Recode who did the reporting there and posted a transcript of it. The focus is going to be financial discipline, for sure. It seems to me like they're going to be doing a lot to get rid of distractions, move away from all of these auxiliary We operations and focus on WeWork, which is where the money is being made. I remember when did the S-1 show, we were saying, "They have WeLive, they have WeGrow, these are non-material things. The thing that's probably going to actually make money for this business down the road is WeWork, if anything." So, the focus is going to be there.
For folks that know the name Claure but don't exactly know why they know the name, former CEO of Sprint, COO of SoftBank. He is now going to be the executive chairman of this company. Sprint has done quite well over the last decade or so. He was a pretty big part of that. If you're looking for someone that is not Adam Neumann, he is a very good person to have dealing with management and leading the charge. It's going to be a very different management style, but they don't seem to be ramping down some of the rhetoric of growth and stability. In that big breakout, that Q&A, he said that the plan is to double in the next nine months, which I was a little surprised by. You're talking about laying off 4,000 people, you're talking about all the austerity you need to go through as you're dealing with a big valuation hit and a cash crunch, the idea of doubling in nine months seems a little crazy to me.
Sciple: Yeah. My interpretation when I heard this was, what else is the guy going to say? He's talking to all the employees of a company which has just had its valuation reduced 80%-plus in a matter of a couple of months, employees who had expected, probably, many of them, to become millionaires very shortly after that IPO. Now, over 90% of employee stock options are underwater. They need to retain their quality employees that are still around. Offering some vision into, "These options are going to be worth something at some point in time," leaves some hope there. I can't imagine it's Happy Days around the office there at WeWork. I can't imagine there aren't a lot of folks out there looking for new opportunities outside the company.
Lewis: Yeah. We talked about a cash crunch a little bit before. There were times where there were reports coming out that they were not going to be making it through mid-November based on the cash they currently had, that the company was delaying layoffs because they did not have the cash on hand to pay severance. With SoftBank's backing, it seems like there's some financial stability here. At this point, they are about $18.5 billion in on We Company, when you mix the capital they've made available via equity and some of the other paths. That's a big chunk of change to be committing. There's a mix there of stuff that came from SoftBank's Vision fun, but also stuff that came from SoftBank Corporate. I imagine with that, the cash crunch is less severe than it used to be. Hopefully the company can go back to just focusing on getting things done, growing the business in a sustainable and profitable way. But that was another thing that Claure addressed.
Sciple: I think, the losers here, obviously Neumann. Being able to get out of his stock, was able to liquidate some of his stock earlier in the year even before all this IPO things happened. He said in front of employees maybe a month or so back that they had navigated the private markets to perfection. For his part, I think that's absolutely true.
The other loser here, obviously, Vision Fund investors. Even with this SoftBank bailout from the from the SoftBank balance sheet, their Vision Fund stock is going to have to be written down significantly. That means the Saudi Arabia private Investment Fund, lots of Middle Eastern private investment funds, are big losers here. Whether that's a good or bad thing, that's up to interpretation.
Lewis: It's about $9 billion of the $100 billion Vision Fund. That's a sizable chunk. If you have to write that down... for them to have put more money in in equity than the company is currently worth obviously tells you what that stake is going to look like on their books.
Sciple: Can I jump in on that a little bit?
Lewis: Yeah.
Sciple: We've seen just yesterday, Wall Street Journal reporting SoftBank, in the aftermath of this We Work saga, has maybe gotten a little bit of the profitability religion behind them. There's been reports that Masa Son has told staffers to push companies to generate cash flow now in contravention to what had been the push of the Vision Fund over time to, "We're going all-in on growth, we want to dominate these markets, we're going to give you more money than you asked for so you can capture as much market as you can." They're really backing off that. I think maybe this is true across the entire market, a move away from a big focus on growth at the expense of profitability, toward really showing cash flows in the near term. This is particularly important for SoftBank and the Vision Fund because they've got a lot of these businesses that are in trouble. They've got Wag, the dog walking company, that is in trouble. Fare.com, a car leasing company, laid off 40% of its staff last week. These are issues that are pertinent to investors across the board, but particularly pertinent to the Vision Fund, which owns a lot of these money-losing start-ups that are in high-growth stages.
Lewis: I think it's revisiting exactly what the dynamic has been between SoftBank and WeWork throughout this process. I think Neumann has been the person that a lot of people have blamed for what has happened. If you see the valuation of a business get kneecapped, and become one-sixth or one-seventh of what it was in a matter of two months, you're going to blame management. In reality, I think what Neumann was doing was a lot of the things that SoftBank wanted him to do. CNBC put together this great graphic looking at WeWork's valuation over time. From 2015 to 2019, they went from about a $10 billion company to just near a $50 billion company. Going back to 2015, they were worth more than they're currently worth. Now, from 2016 forward, there was not a funding round that SoftBank wasn't a part of. So, SoftBank, throughout the process, was escalating this company from being a $10 billion to a $15 billion to a $28 billion to a $48 billion business, and that really reflects the investing style of Masayoshi Son.
Sciple: Yeah, exactly. To your point, the management has gotten a lot of the blame here, but SoftBank has enabled this behavior throughout their time as investors. There's no doubt that SoftBank had some manner of representation the board at WeWork. There's no doubt that as a condition of the investment that the Vision Fund made in WeWork, they received the right to examine the books of the company. Whether they actually exercised that right at any point in time is up for question. It does not seem that prudent investing principles were followed in making some of these investments by the company, and SoftBank's Vision Fund investors are bearing loss as a result.
Lewis: To kick things off with the lessons, I'm going to actually pull a quote from Marcelo Claure in his open Q&A with WeWork employees. "The world is changed. Growth stories don't sell anymore." I think that gets to that point that you were just making. So much of the focus over the last three to four years, maybe even longer, maybe 10 years, in the venture capital world -- where Masayoshi Son has really operated -- has been TAM. "Let's build out that total addressable market, let's build out scale, we'll figure out how to make the money later once we have that leverage of being big, being able to swing around in the markets." We has done that in some ways, with some of the regional markets that they're in. But this business didn't scale the way that a lot of software businesses do, where you're willing to take those short-term losses because the TAM number ultimately makes you profitable down the road. So, yeah, I think looking forward, the growth stories aren't going to sell the way that they have in the past. I think investors are going to be a lot more focused on profitability. The fact that the Vision Fund is already starting to operate that way tells you a lot.
Sciple: Yeah, exactly. Sentiment has certainly changed. I will take a little bit of contention with that statement, just in the fact that I don't think it's that growth stories don't sell. I think it's that businesses that have economic characteristics that don't have runaway scale -- we talked about when we talked about this company a month or two ago that, in a software business, I can make one piece of software and then I can sell infinite licenses of that one piece of software. So, the scalability and growth falls directly to the bottom line. But you look at a company like WeWork that is linking quote-unquote tech with these old line businesses like real estate, it really doesn't scale in the same way. If I want to show growth, I need to buy more buildings, and that costs money. You can't infinitely print more copies of your service. And I think people are becoming aware of the fact that just because a company has some exposure to tech in how it operates its business does not mean that the underlying economic characteristics of the business share those same profitability characteristics across the entire sector. Does that make sense?
Lewis: Yeah, I think you're 100% right. To dig into that a bit more, I think there needs to be a path to profitability for anything that you're investing in. It's not that that needs to be something that will be realized in the next year or two years. You can be buying businesses that are losing money. I own a lot of companies that are not profitable at the moment. But I also own a lot of companies that have really great gross margins, and if they decide to start slowing down on their marketing spend, will become profitable fairly soon. The dynamics were a little different with We. I'm reminded a little bit of the underpants gnomes from South Park when I think about the business models that we've seen and some companies that have gone public recently. For folks that don't watch the show, it's basically, various stages of operating a business and then, just, profit appears. That's the MO of the underpants gnomes. You can't have a question mark with stage two. You need to know what stage two is and how you get to that profitability. If you don't, then I'm not sure that you have an investable business.
Sciple: The other South Park thing that comes to mind is from that old Redskins episode. Start up, cash in, sell out, bro down, right? Seems to have been the Adam Neumann approach. He was surfing and the Maldives as they were preparing the S-1 for this.
One other area, I guess, that we haven't mentioned, but I think important to think about, is the commercial real estate space in general, how that's going to be affected by this downturn in WeWork. Obviously, WeWork, really tightening down the hatches when it comes to expenses. Laying off a number of employees, likely to be getting rid of some underperforming locations, as one would expect. As we talked about in the first show a couple of months back, WeWork is the largest commercial real estate tenant in New York and London. They're significant tenant in a lot of cities across the country. As they've been growing, building out their locations, it's certain that a number of their landlords have provided some assistance in making those renovations building those things out. WeWork is a significant tenant. There are going to be trickle-down effects. As we mentioned, WeWork had mismatched liabilities vs. revenues. Those liabilities that WeWork has to its landlords, arguably, many of them are not going to be paid, and those folks are going to be left with buildings that are not occupied, that they still have to manage the carrying costs for. We're already seeing one example of that today, the Lord & Taylor building in New York City which was set to become WeWork's headquarters. I believe they were going to be the only tenant in that building. WeWork has announced, "We're not going to be able to afford to operate in that building." So, now the folks that had exposure to that piece of real estate no longer have a tenant in this significant property.
Another fun little fact there. Adam Neumann had a stake in that building, which I'm sure has been divested to the ARK investment fund at WeWork. So, now WeWork has to deal with that ownership issue, now that their primary tenant is gone. So, that's another thing to think about with this downturn.
Lewis: One last investing lesson from all this as we wrap is, this is probably one of the best examples you can come up with of a situation that highlights how important it is to be your own advocate as an investor, and to really understand what you're buying and why you're buying it. If you look at all of the big institutions that you'd expect to be giving you a stamp of approval on a deal, JPMorgan was willing to ship WeWork out to investors at $47 billion. The New York Stock Exchange and the NASDAQ were actively competing for business, and they wanted to be listing We shares. All these places where you'd say, "Oh, they've done the due diligence," they're not looking out for you. They're looking to move this deal along. JPMorgan, it seems, had distanced itself quite a bit from putting any more of its own capital into We or exposing itself any more to We than it needed to. But, they were happy to ship that deal along to the average investor, and then let it deal out in the public markets. So, remind yourself that just because you have these big bookrunners on some of these deals, doesn't mean it's actually a great deal.
Sciple: Yeah. At the end of the day, a lot of these folks are in it for the commissions and to profit from their business. One anecdote that you heard about with this story was the competition between the New York Stock Exchange and NASDAQ for who was going to list WeWork. They were competing about who could give Adam Neumann the most concessions so he would list on their platform. I think what it ended up shaking out as is, the NASDAQ was changing some policies in their cafeteria in order to get him to list on that platform. Yeah, the big takeaway is, you need to read these filings and understand what's going on. They don't put these out there out of charity, they put them out there because they're required to by law. When this filing was sent out there, they hoped you didn't read this filing, and they hoped that you bought this stock at $47 billion in valuation. Here's the thing: it was never worth $47 billion. Ever. We talked earlier about WeWork bidding against themselves. There was no point in time, anywhere along the spectrum, that WeWork's earnings justified anywhere near a $47 billion valuation. And if you didn't do your due diligence reading these required regulatory filings, you would have been stuck holding the bag.
Thankfully in this instance, the process worked. Those disclosures worked. People read the documents. People realized what they were being sold was not worth what it was being offered at. And they've had to rerate the shares. But it just goes to show why you need to do your own due diligence. Don't trust big banks or the company to protect your self-interest. You have to protect your own.
Lewis: With Tesla and We on back-to-back shows with Nick Sciple, I guess listeners have been treated to some hot takes this week on Industry Focus. To wrap things up, I want to see if our producer, Austin Morgan, has any hot takes for what will happen in game three tonight of the World Series. As I'm asking this question, Mac Greer, huge Houston Astros fan, also happens to be behind the booth, so we might get some particularly spicy takes. He's flashing that Astros shirt right in Austin's face. Austin's wearing his Nats jersey. Let's see what they have to say.
Austin Morgan: I'm thinking, the way the Nats are hitting, and all the drama going on in the Astros front office, there was some bad energy in the Astros clubhouse, I'm feeling a sweep. I do think the Nats will take it in D.C. this weekend.
Lewis: Ooh! Mac, you have anything to say to that?
Mac Greer: You can always dream!
Lewis: [laughs] Well, I'll be watching the game.
Morgan: Aníbal Sánchez tonight, I'm thinking a strong seven innings. Maybe give up a run or two, but Greinke, garbage. There we go!
Lewis: I would love to see it! I'm a big fan of parades. If there's one in D.C., that'd be pretty fun. I'll be watching the game, Nick. Will you be watching the game?
Sciple: I'll be watching, for sure! Hopefully Greinke maintains his current level of performance -- poor.
Lewis: [laughs] Alright, listeners, keep the Nats in your thoughts! If you have any questions for the show, reach out over at [email protected], or you can tweet us @MFIndustryFocus. That's going to do it for today's episode! 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. Thanks to Austin Morgan for all his work behind the glass today! Go Nats! For Nick Sciple, I'm Dylan Lewis. Thanks for listening and Fool on!
