Imagine investing in a company that made a US$1.6bn loss in 2018, has already lost US$690m in 2019, has no idea when – or if – it will deliver a profit, has no intention of paying cash dividends and admits that its growth strategy may be unsustainable.

That is precisely what co-working space provider WeWork is offering. Counter-intuitive as it may seem, banks like JP Morgan and Goldman Sachs are betting that investors will take the bait.

But how? WeWork was founded in 2010 in New York, ostensibly to provide flexible working spaces for freelancers and startups. In the nine years since its founding, the company has grown rapidly and has a presence in 111 cities and 29 countries.

However, the service it offers is not new. Office space leasing has been around for decades – even on the micro co-working scale WeWork and its ilk offers. Essentially, what WeWork has done is drag the office leasing sector into the age of Uberisation: by slapping on faux-tech lingo of “space-as-a-service” and its mission as “elevating the world’s consciousness.”

That still doesn’t show the whole picture. WeWork’s revenues have more than tripled in three years, from US$436m in 2016 to US$1.8bn in 2018, and it is on target to exceed its 2018 income by a good US$1bn in 2019. But its costs are rising even faster than its revenues. In the first 6 months of 2019 alone, it expended US$255m on readying new WeWork spaces for opening, US$320m on sales and marketing and US$370m on other “growth and development” expenses.

Spending on “growth and development” is par for the course for any startup that accepts venture capital. After all, VCs expect their money to be used for productive activity – the old adage that you need to spend money to make money. But stripping out the growth-related costs reveals a different picture. In the first 6 months of 2019, WeWork’s revenues were US$1.535bn. The cost of operating its existing locations was US$1.233m, and it had “general and administrative” expenses of US$390m (including stock-related employee compensation), plus US$81m of “other operating expenses.” Even without the growth-related costs, therefore, it made an operating loss of US$169m.

So what’s going on?

WeWork’s business, essentially, aims to capture the spread between long-term and short-term rental costs. Landlords want stability and guaranteed cash flows, so they’re willing to lease office space at lower rates if a tenant is willing to make a long-term commitment, as WeWork does. Companies, on the other hand, want the flexibility of short-term leases that allow them to quickly grow, shrink, or move their office space in response to personnel needs. As a result, they’re willing to pay higher rents for this flexibility.

However, this model only works during times of economic expansion. When the economy enters a recession, companies lay off workers and reduce their office space. In this situation, short-term rents can decline to the point where they no longer cover the long-term rental expense.

The results?

WeWork was scheduled to launch its IPO in mid-September – it has been pulled indefinitely. WeWork’s largest investor, SoftBank has also ousted controversial founder and CEO Adam Neumann from the board, along with 20 other executives. The IPO withdrawal has also rattled Wall Street, which is signalling that it will no longer tolerate high-flying, money-bleeding tech IPOs.

WeWork’s implosion is especially galling for Jamie Dimon’s JPMorgan Chase and David Solomon’s Goldman Sachs, which stood to profit off these mega deals. While it likely won’t impact the banks’ third-quarter earnings, it is estimated that it could damper investment banking profits for the next six months or so.

WeWork is only the latest in a string of high-profile tech IPOs that failed to get off the ground this year. At the start of 2019, investors had been eager to buy up shares of tech darlings like Uber and Lyft while overlooking their massive debt and unclear path to profits – with the hope that each would be the next Amazon of their industry.

That hasn’t panned out. Uber closed at its all-time low on Monday, at US$30.47, well below its US$45 IPO price. Lyft, too, fell to a low of US$40.84 on Monday, about half of its value on its first day of public trading. In recent weeks, Hollywood talent agency Endeavor Group pulled its IPO, while shares of Peloton Interactive Inc., the fitness startup known for on-demand workout programs on its exercise bikes, slid as much as 7 per cent in their market debut.

The IPO market is likely to slow even further, with economic slowdown warning signs blaring across the world’s markets. Stocks are among the riskiest assets to hold in a downturn, and newly public companies typically see more price swings than average as investors pile in to make their first bets.

Lessons Learned?

In the past, tech companies wore their losses as a perverse badge of pride – signifying ambition, scale, and growth. Now, as the market is seeing through the smokescreen, investors are increasingly exercising market discipline and doing their due diligence. The stock market used to be a staid but safe bet before the dotcom boom ushered in flashy entrants with huge marketing budgets. Now, it appears that we are heading back to IPO sanity – a sign that the stock market is maturing.



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