Archive for September 2019

WeWork Looks To Be The New Pets.com

The spectacular flame-out of Pets.com is the event that many folks of my era use to mark the end of the late 90's internet bubble.  In turn, it looks like WeWork is vying to mark the end of the current Silicon Valley unicorn bubble.  I won't go into all the problems of its IPO, but suffice it to say that they can't get retail investors to bite anywhere near their last private funding round valuation, and in fact are scrambling to maybe go public at half the value that companies like Softbank invested at.

The incredible thing about WeWork is that it is really a minor repackaging of a quite mature real estate model.  Companies like Regus have for decades leased large blocks of space and then released it in small blocks to individuals and small businesses, sometimes packaged with additional services.  WeWork just took that model, then added some new age language and some espresso machines.

While WeWork is growing rapidly, the service it offers is not new. The Belgian company IWG, which operates under the brand name Regus and a variety of other, smaller brands, utilizes the same business model of leasing office space, refurbishing it, and sub-leasing it under shorter terms to tenants.

IWG has more square feet of office space than WeWork, earns more revenue, and actually earns a profit. However, IWG has a market cap of just $3.7 billion, less than 10% of WeWork’s most recent valuation. The primary difference between the two is that WeWork describes its business model in the faux-tech lingo of “space-as-a-service” and its mission as “elevating the world’s consciousness.”...

Another difference is that WeWork operates with a much higher degree of risk by taking on significantly more operating lease commitments with longer terms and more geographic concentration.

I compared this to Pets.com but actually I think a better analogy is to the late 70s/early 80s Texas real estate and S&L bubble.  In the runup to the S&L crash, land investors played a game wherein they flipped a piece of real estate back and forth between related parties, raising the price with each sale.  Having pumped up the value on paper, they then got some S&L to lend at 100% or even 105% LTV and when the land values all crashed, S&L's were left holding the bag.

This process of pyramiding the value of an illiquid asset in private sales is very similar to what is going on in the Silicon Valley unicorn world.  Companies like Lyft and Uber and WeWork have seen private funding rounds at ever-increasing valuations.  These are done outside the accountability of the broader market and untethered to any sort of normal valuation metrics like earnings or even revenues.

These unicorns often promote custom metrics like engagements or users rather than any traditional financial metrics, because their financials generally are awful.  WeWork, for example, consistently spends $2 for every $1 of revenue it brings in.   All you have to know about the complete corruption of valuation metrics can be gained by looking at WeWork's preferred metrics:

More than its cash-burning ways, WeWork’s IPO will test investor tolerance for made-up accounting metrics. You might recall “Community Adjusted EBITDA,” the gauge WeWork devised to measure net income before not only interest, taxes, depreciation, and amortization, but also “building- and community-level operating expenses,” a category that includes rent and tenancy expenses, utilities, internet, the salaries of building staff, and the cost of building amenities (which WeWork has described as “our largest category of expenses”).

  • ARPPM (annual average membership and service revenue per physical member). “[R]epresents our membership and service revenue (other than membership and service revenue generated from the sale of WeLive Memberships and related services) divided by the average of the number of WeWork Memberships as of the first day of each month in the period.” (Note: this is not just creative accounting, but also creative acronym construction.)
  • Adjusted EBITDA before Growth Investments. “[A]n additional supplemental measure of our operating performance, which represents our Adjusted EBITDA further adjusted to remove other revenue and expenses (other than revenue that relates to management fee income from advisory services provided to Branded Locations) and what we define as ‘Growth Investments,’ which are sales and marketing expenses, growth and new market development expenses and pre-opening community expenses.”
  • Location Contribution. “[R]epresents our membership and service revenue less total lease costs included in community operating expenses, both calculated in accordance with GAAP, excluding the impact of Adjustments for Impact of Straight-lining of Rent included in community operating expenses.”

Or, you could just throw your money on the street.

This has been a pyramid scheme, pure and simple (with more than a touch of founder self-dealing at WeWork).  There is no way Softbank could have imagined that WeWork was actually worth $47 billion if they were to hold it and manage it for 30 years.  The only way they thought $47 billion made sense was that they were sure they could unload it on the next group, probably retail investors, for a higher number.  This is greater fool investing, and works right up until there is not another fool available.

Postscript:  WeWork founder Adam Neumann reminds me a lot of Donald Trump in his business life.  All the investors will lose money. The company will likely go bankrupt.  Building owners will have leases broken and banks will lose money on defaulted loans.  But Adam Neumann will walk away from it all with hundreds of millions of dollars.  That is the typical Trump deal in a nutshell.

Trump Argues Any Current Business Problems are "Bad Management"

From an interview the other day

Q I can read you the tweet, Mr. President. You said that, “Badly run and weak companies are smartly blaming these small tariffs instead of themselves…”

THE PRESIDENT: Yeah. A lot of badly run companies are trying to blame tariffs. In other words, if they’re running badly and they’re having a bad quarter, or if they’re just unlucky in some way, they’re likely to blame the tariffs. It’s not the tariffs. It’s called “bad management.”

The first answer to this is, LOL.  This is the man with a string of failed businesses (steaks, college) and multiple bankruptcies in his core business.  In fact, I would list one of Trump's most useful business skills is his ability to get other players in the capital structure to take the losses for his bad business decisions and management.

But as far as trade is concerned, if one is worried about bad management in US businesses, then the right thing is certainly not to protect those businesses from competition.  The US auto business in the 60's and 70's as well as almost the entirety of the British industrial base in the 20th century are good examples of the problem.  Protecting businesses from international competition, as is Trump's objective, only shelters those businesses from accountability and reduces the pressure to fix whatever bad management may exist.

As a special bonus, I would argue that many of the bad habits of large US companies today are directly attributable to the stimulative Federal Reserve policy which Trump wants to increase.  Returning profits to shareholders in the form of share buybacks rather than dividends is a perfectly valid strategy, particularly when the tax code favors capital gains over dividends.  But when companies borrow billions just to buy back more of their own stock, rather than reinvest it in new opportunities, something is broken.  A large part of the blame are twin Federal Reserve policies of low interest rates and a QE-created equity and asset price bubble.

Why California Forcing Uber Drivers to Become Employees May Hurt Many Drivers

Apparently California is close to a new law mandating that Uber drivers (and other "gig" economy workers) be treated as employees rather than independent contractors.  Progressives are cheering this as a victory for the drivers:

I have explained before why this will likely kill Uber (e.g. here) but let me summarize quickly the argument of why this is bad for most drivers (self-plagiarized from a Twitter thread).  The key issues are driver productivity and driver agency.

Let's define worker productivity as far as Uber is concerned as the amount of customer revenue a driver brings in per paid hour. In the current model, this is not a real concern for Uber as they are only paying Uber drivers when they are actually driving customers.  Essentially, Uber drivers and Uber have a revenue share agreement to split customer revenue. Uber has set the share low enough to maximize its revenue (of course) but high enough to still attract drivers. It tweaks this formula fairly frequently.  Uber driver productivity as we have defined it is essentially locked in by the formulas in this revenue share agreement.

Given this arrangement, note what Uber does NOT have to worry about. It does not have to worry that drivers are working hard enough or are positioning themselves in productive locations and productive times of day.  Uber drivers can drive anywhere they want at any time they want.  An Uber driver currently can turn on the app at 4am in the suburbs of Peoria and Uber does not care, even if this positioning is unlikely to get many rides. Why? Because Uber only pays if there is a ride.  It doesn't care if the driver is sitting around unproductively, because it is not paying the driver for that time.

So today, it is left up to the driver to make trade-offs between the most productive time & positioning and the demands of their own personal schedule & life choices. This sort of flexibility has real value to many drivers. It is agency that many hourly workers don't have, and that has attracted many people to become Uber drivers.  My neighbor, for example, sits in his living room all day with the app on and runs out to the car whenever he accepts a ride (and then turns the app off so he can come back home).  He gets few rides in our area but he is happy with the lifestyle and the little bit of extra money he makes from Uber.

But this all changes if drivers must be Uber employees and subject to wage and hour laws.  The key difference under such wage and hour laws is that Uber would have to pay drivers whether they have a passenger or not, as long as the app is turned on.  Suddenly, forced to pay for labor whether the labor is working or not, Uber is going to get real interested in driver productivity.

If Uber pays by the hour, my neighbor's preferred way to drive is a dead loser for the company. In fact, if I am a driver and paid by the hour, I could go find a library in an out of the way place at an odd time of day and sit and read and collect hourly paychecks -- All without having to drive much. Now, instead of productivity choices being in the driver's hands because it's the driver that makes more or less money with greater or lesser productivity, these choices now land in Uber's lap. Uber can no longer allow so much driver agency.

If making Uber drivers hourly workers does not kill Uber altogether, then Uber is going to be forced to monitor driver productivity and do one or both of two things:

  1. Establish productivity rules, such as driving time windows and allowed geographic ranges and/or
  2. Set a minimum productivity threshold below which Uber will have to let those drivers go

Interestingly, like a lot of labor regulation, this one will benefit the middle while hurting the lower-paid drivers.

  1. Top drivers will be unaffected, because they already make the minimum
  2. Middle drivers may get a small boost
  3. Lower-earning drivers will lose their driving jobs entirely

A better way to characterize this law is that it will greatly reduce the flexibility many Uber drivers love, while causing the lowest paid drivers not to make more, but to lose their driving gig altogether.

I wrote a great deal more about how much of labor regulation actually hurts the lowest rungs of unskilled workers in an article here for Regulation Magazine.