WeWork is in a bizarrely weird spot.
Building cap rates eg trading multiples are at all time, insane highs.
This inflation has been driven by institutional investors desperate for yield, with a lack of viable options.
And huge tech cos that are learning that amortizing property is a better use for their hoards of cash than seeing it rot in the basement.
So for WeWork buying into this hugely competitive market doesn't really make sense.
But conversely WeWork needs real estate to grow, and they like to grow in premium markets.
In these premium markets they are competing with dozens of other fast growing enterprises in the current economy.
Which means they are having to sign INSANELY big / long leases - they have $5B in LEASE CONTRACTS aka debt on the books through 2022.
So they are signing leases that are in the record price per square foot range to deliver their core product.
And meanwhile, as best I can find 85% of their business is still driven by "Small businesses, fast-growing startups and sole proprietors". (1)
And these segments, as known to anybody who plays in the "flex space" world, are the first tenants off the boat in a recession.
It is easy to critique and hard to create, as they say, but I don't follow WeWork's valuations or strategy.
This means that when the cyclical tenants leave, WeWork is not left with the whole bag; instead, its landlords are.
When the tenants of a building stop paying, WeWork would default on that subsidiary, but WeWork corporate would not default.
This was hugely surprising to me when I first heard it.
Plus, maybe there's a large deposit.
The bulk of executive compensation is in either outright equity ownership, or increasing bonuses based on equity price increases. Equity can be viewed as a call option on the enterprise value of the firm .
If you own a call option, you can increase its value by either making it 1) more in the money (by directly increasing the enterprise value, i.e. by generating value 'the honest way') or 2) increasing volatility directly, either by taking real economic risks (investing in more assets) or utilizing leverage (debt). Here we see both.
Note that financial investors in a company can be perfectly OK with results that boost the bottom line today, but lead to disaster down the road, so long as they're convinced there will be a short-term boost in the share price (at which point they exit and sell to the next sucker).
Just like companies have moved their computing to the cloud, the bet by WeWorks is that office space itself can be thought of in the same way. Sure, companies having their own office space will never go away just like on-prem will never go away, but for a specific type of company, WeWorks is betting that it's a niche that's still big enough to justify their $20 billion valuation.
They do add some value; basically, having an office manager, and for a sole proprietorship who may be big on plans but short on time, it may be better to exchange money for WeWork amenities, rather than spending time dealing with office stuff, eg going to supermarket to stock the office with snacks.
WeWorks isn't selling office space by the sq foot, but similarly, Apple doesn't sell computers by the gigabyte of RAM either. They sell being a part of a sexy glamorous office full of other people seizing life by the horns and living life to the fullest, including meetups, and happy hours, and an app. Gotta have an app. People don't do the boring office job that your parent's did, at a WeWorks space. (Whether or not people are doing the same boring office job is besides the point, that's what they're selling.) By building their brand, and offering convenience and consistency, the goal is to just be where sole proprietorships and tiny companies work, during this fad, and the next.
It's really just a matter of sorting out where the notes one is considering are in the pecking order and estimating the probability of the issuer going bankrupt to put reasonable bounds on expected return of principle if they fail.
A similar estimate can then be made on the probability of default or restructuring for the notes under consideration.
Given that information and a big enough coupon, a quarter-Kelly or half-Kelly bet may not be unreasonable.
At this point there are too many unknowns to make that case however.
We'll have to see what coupon they decide on and enumerate the things that could knock them out or severely limit their free cash flow.
To your quote from the CEO, it's not a great way to market debt issues tbh. WeWork really isn't any different from any other REIT and one does not lend a REIT money because they are great people.
I did succeed because it had a lot of customers with a lot of money to burn (startups) and it offered very good networking opportunities, later on it offered top of the line real estate and services but they were never the economic option.
In a recession when there won’t be VC money to burn and an infinite amount of rounds to raise it I don’t think they’ll do very well.
Traditional businesses won’t get much value from most of their offerings and if they would be cutting back then cheap lease in industrial parks and sub prime locations would be what they’ll be after.
WeWork isn't cost effective vs renting your own office space, it just removes the friction (and yes, some of the related costs) involved with getting a "trendy" SV-style office.
During a crunch, I think we'll see alot of these businesses retreat to sparser accomodations in run of the mill office buildings removed from downtown. WeWork will be constrained in this environment, since the record leases they are signing will place a pretty high floor on how much they can lower prices to compete...
If the market rages for another 5 years, WeWork is gonna hit it out of the park. If we recession before that, it'll implode spectacularly.
Why would a company do that? Well, the same reason companies pay by the minute for cloud servers - to more accurately match their demand for office space/server resources.
When the economy tanks or other uncertainties face a company, the first thing to get the chop are big long leases for new office space with upfront capital investment on fitouts. So, a prudent CFO is LESS likely to sign a traditional lease and instead go to wework for a year-to-year commitment while they ride out the economic turmoil.
In addition, if the CFO or management see potential layoffs coming, they are even more likely to take up flexible space so when layoffs happen, they can also shed the office space.
I think during a downturn in the economy is when flexible office shines as a prudent option for businesses.
The press seems to focus on the free coffee/beer to position flexible office as a premium or luxury product and use the flawed logic that when the economy falters, a “luxury” coworking space will be the first thing that gets cut from a company’s budget.
And speaking of cap rates vs. multiples (valuation per sq foot), wsj had a great article on the Wework business model on how artifical it's valuation seems versus traditional office-leasing:
We just launched RealCrowd University - http://www.realcrowduniversity.com - which is our crash course on real estate education.
We do a podcast on the fundamentals of real estate and this is the best of those episodes plus a bunch of other educational content we've put together.
Let us know your thoughts! If there's anything specific you'd want us to cover shoot me a note.
1. Lots of the people looking at WeWork space are aspirational, to the extent that they hope being at WeWork will boost the prospects of their small business (via networking etc)
2. The tenants in more than one office on our floor were involved in one form or another of cyber-currency promotion.
3. Turnover is wicked fast.
4. Marketing to WeWork tenants is a lucrative revenue stream, both online and in WeWork buildings. All these kids have money burning a hole in their pocket and service providers are paying WeWork a lot to reach them.
5. WeWork competition is very strong at the high-end (Knotel etc). Everyone else is hanging on for dear life.
Having said that, 80% utilization is great and maybe catching all the premium market will work.
I have a single private office at WeWrok in downtown LA for $650. Is that a good deal or bad deal?
Do you feel like you need to ask me what size my office is to answer? If you do then you fundamentally misunderstand what WeWork is selling.
Yes WeWork buys square footage, but that is not what they are selling. Google does not sell search (eyeballs), Amazon does not sell products (logistics), Github does not sell code storage (collaboration), and Apple does not sell computers.
This holds true for every successful company in the world until the innovators dilemma overtakes them.
It's meaningless to compare sats.
I recently looked around and there are 10 executive suites firms within 2 miles from me (a WeWork is 12 miles away). I tried two of them and they were very nice.
I wish WeWork well, I just don't get their business model.
"Better" than WeWork does not mean WeWork isn't also better than existing patterns. I put "better" in quotes because cheaper is not always better.
We have other locations in Europe, LA, NY but for a single employee or two it makes sense.
Why are these companies now using the bond market instead of hitting up VC's or listing? Considering interest rates are now creeping up it seems the least efficient time to do it.
In the case where bond holders do well, wouldn't shareholders do better? And in the bad scenario, with as many long term liabilities as WeWork has, are the bond holders going to be substantially more secured than the shareholders?
Does WeWork own anything real to secure the debt?
Because if the company goes bankrupt, bond-holders get paid before shareholders.
As such, bond-holders are always in a less-risky position. You'll always recoup some of your money during bankruptcy. (Don't estimate the value of the shelves and furniture!) While shareholders only get some $$ if the bonds are fully paid off.
> In the case where bond holders do well, wouldn't shareholders do better?
Not always. Bond holders will do well if the share-price stays steady or even negative. The company may stagnate over the next 7 years, at which point holding bonds would have been a better investment. The company is legally obligated to pay bondholders at its highest priority, until bankruptcy.
The Bonds aren't sold yet, but will likely be in the range of 4.5% to 5% (depending on market conditions during the sell-date). Over 7 years, the company needs to grow its share price by 36% for equity to beat a 4.5% bonds, or 40% to beat the 5% bond. Doable for sure, but its not too hard imagining a situation where they fail this benchmark and the bonds end up the superior choice.
For example: GNC's stock price doesn't help its shareholders, but the bond-holders would be doing fine.
Such bonds are called "convertible bonds". The bonds listed in this article are:
> WeWork is issuing seven-year, senior unsecured bonds
Which is pretty specific. I don't know the meaning of every word, but it sounds as if this is a conventional 7-year junk bond.
So I'm not 100% a financial professional. But I'm pretty sure the lingo is super-specific about these details.
But "convertible debt" is a big deal. If Bloomberg (a financial newspaper) didn't use the word "convertible" to describe the debt, its probably not convertible.
There is no new technology in WeWork and there are no legal ways to create or corner markets in real estate; people have been trying for millennia. Unless they have a highly scalable revenue stream hidden somewhere, we can expect that their valuation will, at best, grow on a similar curve to other REITs.
If I owned their equity, it would be because I got it super cheap and expected them to start paying a dividend sometime soon.
I would not own their debt except through a broad based ETF. It's really hard to make long term profits on junk bonds except by playing the law of averages.
From the article: WeWork is issuing seven-year, senior unsecured bonds
Got some Bitcoins or Pets.com to invest in instead?
>WeWork is issuing seven-year, senior unsecured bonds
This means that in case of bankruptcy the holders of these bonds will probably be the last ones to get paid back, if they ever do. This increased risk is usually compensated by a higher yield than regular bonds.
EDIT: As commenters point out, they wouldn't be the _last_: "In the event the issuer goes bankrupt, senior debt theoretically must be repaid before other creditors receive any payment."
In fact, this is one way that companies die in a recession: credit spreads blow up (i.e. risky debt is much more expensive than good debt). That makes it difficult for struggling companies to refinance maturing debt, and they go under.
There's even a class of debt called CoCo bonds (contingent convertibles) that turn into equity if the company is struggling. The idea is to avoid the maturing debt scenario I described above. In practice, they're a horrible product for investors. Equity-like risk with bond-like returns.
The term is often used in the financial press: http://lexicon.ft.com/Term?term=junk-bond
when major banks/investors refused to deal with BBB or lower they called it 'Junk'. When they realized 1) the credit risk can be safely managed with modern financial theory and instruments 2) there was money to be made ... they quickly adopted it and had to figure something out to drop the 'Junk' pejorative.
Do you know any good resources, books included, but especially sites that go beyond the theory and into the day to day lingo at a bond desk ?