Coyote Blog

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.