WeWork arrived on a hype train en route to its scheduled initial public offering last summer. The well-known unicorn company capitalized on a palpable trend among millennials to seek “co-working” environments, where freelancers and others engaging in the gig economy could rent office space on an as-needed basis and companies could use offices in the near term, rather than commit to long-term leases or real estate purchases. Supported by marquee corporate clients and top-tier capital sources, WeWork was estimated to be worth $47 billion, while IPO valuation projections ranged from $60 billion to $100 billion.
However, when the company’s S-1 offering document was released, it set off alarm bells for many of those who read it.
The first issue was purely fundamental: As company revenues had grown, so had losses. You usually hope for some benefits of scale that slow the bleeding, but from the S-1 and discussions with management, we perceived a lot of confidence but no clear path to profitability. Interestingly, the company actually invented a new profitability measure called “community-aided income,” which excluded various expenses that reduce traditional cash flows.
This might have been less disconcerting with a lower-valued company. But investors were skeptical that geography-driven office space market was really like the cloud (a comparison some had made), which can be accessed and scaled globally. We also noted that an existing European player with a similar business carried a much lower valuation than the one being proposed for WeWork.
A second crucial issue related to corporate culture and governance. In the manner of many young companies, WeWork was closely associated with its founder, Adam Neumann, who articulated, and was seen as central to achieving, its world-changing vision. However, the arrangements in place went beyond the norm. He controlled the board, and via a dual share class structure, received 20 votes for every single share he owned. In the event of his disability, his wife, who had co-founded the company, would be empowered to create a committee to designate his replacement.
In addition, Neumann had engaged in a number of individual transactions with the company, including selling it naming rights to the word “We” for $5.8 million and taking loans to fund personal real estate purchases and what news reports portrayed as a lavish lifestyle.
The net result was blowback against WeWork by potential investors. To the company’s credit, it took corrective actions, including the return of the naming rights fee, a reduction in Neumann’s voting power and changes to the succession process. But that was not enough, and Neumann resigned as CEO, taking a payout in light of his past work for the company while remaining on the board as non-executive chairman. Shortly thereafter, the IPO was withdrawn, and WeWork’s chief corporate backer, Softbank, invested another $750 million for an increased ownership stake; WeWork has since been working to trim costs and selling non-core assets, with prospects for a future public offering in question.
Could Governance Have Helped?
Perhaps at a different time, the IPO would have made it through. The poor post-IPO performance of Uber and Lyft shares last year made investors more cautious, and led them to demand more evidence of profitability from new offerings. The WeWork situation might also have been improved with more adult supervision. An empowered board might have reined in interested transactions, and suggested a more conservative pre-offering expansion plan—perhaps working on profitability in select markets before scaling the system globally. And it could have sought a less-speculative IPO price to engender the trust of long-term investors.
Of course, it’s easier to play Monday-morning quarterback than it is to proactively identify meaningful risks. That, to me, is why it is so important to look at companies—especially within the smaller-capitalization universe—based on deep research and fundamental analysis, and to assess whether their business model is sustainable in light of cash flows, cost structure, competitive advantages, operating environment and, importantly, governance. An effective board, attention to stakeholder views/interests, appropriate compensation—all of these factors may provide clues as to what the future holds for a given company, no matter what the level of hype and enthusiasm that greets it on Wall Street.