How WeWork defied what I learned in B-School this summer.
As I sat down to reflect on what I had learned at Stanford over the summer, I was bombarded with news notifications suggesting that WeWork was imploding and its CEO was at the center. It is clear that we are witnessing one of the largest destructions of shareholder value in the history of corporate America. In Jan 2019, WeWork raised $4B from Softbank at a valuation of $47B and today, it’s struggling to get even a $15B valuation for its IPO. Some are hailing this as the Pets.com of the current tech boom, while others think it is a bump in the road.
For me, it’s an epic case study on how an entrepreneur and some of the smartest investors in the world built an amazing brand and then failed to preserve its equity. Allow me to highlight some lessons I learned at school this summer and how WeWork’s founder Adam Neuman, the board and the various investors defied each of them, now facing a crisis that has the potential to set-off the spook-alarm for Softbank and the market in general.
Here we go:
In financial accounting, a metric often used to measure a company’s profitability is EBITDA. However, WeWork has taken its innovative spirit to another level by reinventing metrics such as “Community-based EBITDA,” which is profitability before the BITDA, including taking out expenses related to real-estate, the majority of the cost required to deliver its service. Maybe a more explicit name could have been “EBEE, earnings before every expense”. I know our accounting professor would balk at the idea of accepting such a metric.
The fundamental business math doesn’t look any better either. In 2018, the company lost $1.7B on revenue of $1.9B. Now that’s not unusual for tech start-ups to lose money while they are investing and scaling the business, WeWork has shown no sign of trimming the losses as it scales the business, reflecting its poor unit economics. In contrast, it’s smaller competitor, Regus (IWG) has a positive contribution of each desk that it leases out. Since gross margins are a pretty good proxy for how good or bad a business is, We Work looks pretty lousy considering these economics.
The Bulls may argue that the future is rosy. But how likely is that scenario? WeWork has $47 billion in long-term obligations (leases) and only $4B of revenue commitments against those leases, which could result in a huge exposure during an imminent slow down/recession. This is the problem of mismatched durations that can get real estate companies in trouble. Oh, did I mention that WeWork still considers itself as a tech company and not a real estate company? Go figure.
Finally, the valuation of $47B is mind-boggling and totally unjustifiable. In order to justify its valuation of $47B, WeWork must achieve 30% NOPAT margins (while it is currently at ~ -30%) and grow revenue by 30% compounded annually for the next nine years — pretty unlikely scenario. An independent research firm conducted a detailed analysis and benchmarking. WeWork was also trading at 26x revenues, way superior to Amazon, which trades at 4x revenues. And there seem to be no scale effects, as losses have kept pace with the revenue growth. So the valuation of $47B defied all logic and theory.
Given these facts, it’s not a shocker that there are no takers for even a $20B valuation and the company has decided to postpone its IPO.
In Ethics, I learned that Moral Intuitions can guide our decision making during times of an ethical dilemma. One can definitely question Neuman’s moral intuition since the related party transactions at WeWork feel like the kind you see in the Trump administration. Adam owns 10 buildings, which he bought from the money he borrowed from the company at a below-market rate, and leased 4 of these buildings to the company at a nice profit — Wait, can you even do that? Adam also sold the rights to the “We” trademark for $5.9 million. The rights to a name nearly the same as the name of the company where he’s the founder/CEO/shareholder.
We also discussed the new position of the Business Council which reflects the obligation of the managers towards not just shareholders but other stakeholders of society. So, consider what Scott Galloway of NYU says: “the last round $47 billion “valuation” is an illusion. SoftBank invested at this valuation with a “pref,” meaning their money is the first money out, limiting the downside. The suckers, idiots, CNBC viewers, great Americans, and people trying to feel young again who buy on the first trade — or after — don’t have this downside protection. Similar to the DJIA, last-round private valuations are harmful metrics that create the illusion of prosperity. The bankers (JPM and Goldman) stand to register $122 million in fees flinging feces at retail investors visiting the unicorn zoo”.
If WeWork goes bankrupt, Neumann will already have cashed out to the tune of hundreds of millions and the banks that underwrote the IPO will have collected hefty fees.
The only losers will be the public investors that allow themselves to buy this overpriced and extremely dangerous stock, says Forbes. Smells like a Ponzi scheme? Perhaps Adam Neuman feels that he has the moral credentials to do so since he is on a mission to “elevate the world’s consciousness”. Stop drinking your own Kool-Aid, Adam.
Organization Design strategy taught me the importance of Routines and Culture to help the company achieve its mission. If the critical task of the company is to reduce the cost of office space for its members by providing “space as a service”, then how does the CEO justify spending $60M on a jet for his personal travel or drawing $700M out while the company needs significant investments to survive? In fact, Neumann seems to have other conflicts of interest and profits from his company such as having a personal line of credit of up to $500 million from UBS (UBS), JPMorgan (JPM), and Credit Suisse (CS), all of whom are also underwriters in WeWork’s IPO.
The culture seems to be toxic as well, where off-the-cuff firing is common, there is discrimination in the buy-back prices that employees get vs. what the founder gets, and free-flowing tequila is served to celebrate the day 7% of the workforce is let go to save costs. Really?
In Economics and Negotiations, we discussed a lot about reputation and how it can influence your success and ability to create value for yourself and the business. We have to question the judgment of the investors who ignored Adam’s reputation for being irresponsible, eccentric, and self-serving and poured billions of dollars into the business. There are several examples of this, covered in this story by WSJ, which allude to an utter failure of governance at this company.
WeWork has a great product-market fit and is fundamentally changing where we work, so it would be a shame to see the company implode. And I think the investors are finally waking up to this reality and are looking to oust Adam to ensure a healthy future. Like they say, never waste a good crisis and it’s time to use this crisis to make some drastic changes. While a change in leadership and some adult supervision by the board will definitely help the cause, WeWork has some bigger and more fundamental executional and cultural challenges to address if it has to survive and thrive in the future.
As for me, I’m heading back to another quarter of school where I will learn theories and lessons that someone like Adam is probably trashing while making millions at this very moment.