No IPO in recent memory has received as much negative pre-public publicity as WeWork, which provides shared workspaces and services for startups and other enterprises. The outpouring of criticism has focused on a number of items including a record of past and probable continuing losses, its original proposed stratospheric valuation, its byzantine corporate structure, its woeful (or nonexistent) corporate governance, and most of all its flamboyant founder, Adam Neumann.
So perhaps it was not a surprise when WeWork, given the continuing criticism, announced recently it would delay the IPO for at least for a few months.
Why the seeming vitriol around WeWork and Neumann? [Editor's note: Neumann resigned as CEO on September 24.) After all, the company has posted stellar top-line growth. And this is not the first company to go public with these very same attributes. Neumann is not the first corporate leader with a bit of what some call a messiah complex. Facebook, Alphabet, Snap, UBER, Lyft and even Amazon shared one or more of these features, yet none experienced the negative uproar generated by WeWork.
The lessons are classic examples (and warnings to other IPO companies) of how not to frame a public offering.
To ameliorate some of the criticism, and to salvage its IPO, WeWork recently pivoted. It proposed its IPO valuation of $47 billion be slashed, added a woman to its board of directors, and, this past week, indicated it would modify its corporate governance structure. Whether these actions will be sufficient remains to be seen. WeWork clearly is not advancing its case from a position of strength.
What is the difference and is it warranted?
A dive into the numbers
Are the reasons cited above the reason to cause WeWork’s IPO to collapse? No. The reason for pulling support should be based on the numbers in its prospectus, not on emotional reactions to Adam Neumann. There has been a paucity of this analysis.
With co-author Sean Bracken, I’ve analyzed the company, minus the surrounding drama, by focusing on the financials and other operational details published in the company’s prospectus. The lessons to be found there are classic examples (and warnings to other IPO companies) of how not to frame a public offering. WeWork took advantage of being deemed an “emerging company” under the Jumpstart Our Business Startups Act of 2012. The JOBS Act permits these companies to apply differing, i.e., lower, standards in terms of disclosure in an IPO. In my opinion, WeWork should be pilloried for exploiting these standards.
There are numerous examples provided in our analysis, entitled Why WeWork Won’t, but some of the major examples of how they could have made a better case for the company by not obfuscating their financials are highlighted below.
In short, WeWork took advantage of the JOBS Act to present their financials in such a way that, in aggregate, could be considered misleading. In general, they presented the most favorable outcomes, without providing counterbalancing offsets to revenues and expenses.
For example, WeWork never presented a GAAP-compliant EBIDTA line anywhere in the prospectus, which is a very basic metric. Instead, they proposed a new metric, “contribution margin”, as the basis of how to analyze their unit economics. This metric incorporates the benefit of free rent and other concessions they receive from landlords on the front-end without disclosing the future costs the company will incur when these concessions burn off.
Among several items detailed in my analysis, WeWork failed to include major expenses in their current operations that could materially impact their contribution margin, such as the failure to record any reserves for their furniture, fixtures, and equipment that are very real current costs. They fail to allocate any of their corporate G&A to their open, operating facilities. GAAP would require them to allocate all of it in an EBIDTA calculation. If these items are included, WeWork’s contribution margin becomes substantially negative. Ultimately, the metric WeWork proposes to use is of marginal utility in analyzing the company’s results.
Missing information
The prospectus fails to give guidance to potential investors in other areas. WeWork fails to discuss the impact of the free rent and other concessions it has to give to its enterprise tenants as an offset to the concessions they have received from landlords. Further, there is no discussion of the potential impact of the revenue sharing arrangements WeWork provides landlords in exchange for the latter’s willingness to provide the capital for the buildout and tenant improvements at their facilities. Both factors will have an impact on their top line revenues. WeWork also fails to address how they will get their G&A growth under control to some reasonable level. G&A is growing at a rate that exceeds their topline revenue growth.
Lastly, and perhaps most importantly, in light of the recent developments, WeWork failed to address what will happen in terms of shareholder dilution, if the IPO is at the value more recently floated, as low as potentially $15 billion. This would constitute a “down round,” and typically prior venture investors receive extra shares to protect their ownership percentage in a down round. There is only a cryptic reference in the footnotes as to how SoftBank, the company’s largest backer, is protected in the event of a down round. Who will bear the dilution? SoftBank? Neumann, or the new public shareholders?
This leads to the question of how WeWork should be valued. For reasons discussed in the article, WeWork is not a tech company. On the basis of what it does as opposed to what it says, it is a real estate service company and should be valued as such. The value will wind up far closer to its major competitor, Regus, than as a tech company.
The unspoken gorilla in the room is SoftBank’s role in all of this. Will SoftBank exercise control over the company? Will they always be there to bail out WeWork? Is Chairman and CEO Masayoshi Son’s mutual admiration with Neumann part of the unspoken issue? It has been suggested that SoftBank may backstop the IPO in some respect by buying a major portion of the IPO when it goes effective. There is a major issue in terms of how SoftBank will be treated in the IPO and whether they will support WeWork by committing even more money.
What’s to be learned?
In sum, what can we learn from possibly the worst pre-IPO marketing example ever?
No doubt Neumann has brought much of it on himself, starting with his New Age corporate mission “to elevate the world’s consciousness” and his personal objective of “We are here to change the world; nothing less interests me.” Indeed, WeWork’s prospectus reads like a Marianne Williamson self-help book.
The market should acknowledge that Neumann and WeWork recognized an unmet demand, especially for smaller tenants. Co-working space is here to stay and this is largely attributable to Neumann. Can the company ultimately be profitable? Probably, as there are other companies engaged in similar models that do make money. But the values of those successful companies are not at the level at which Softbank previously invested in WeWork.
The ultimate lesson: Any corporate leader with the intent of going public must let the company, not the individual, be the focus of attention. One needs to establish the corporate mission, lead by example, and let the company’s actions, not the founder’s verbiage, speak for itself.
About the Author
Nori Gerardo Lietz is a Senior Lecturer of Business Administration in the Finance and Entrepreneurial Management Units at Harvard Business School. She presently teaches Real Estate Private Equity and Venture Capital and Private Equity.
[Image: iStock]