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Will Critics Derail WeWork's IPO?

WeWork’s competitors may view the company’s IPO as a lesson in how not to raise capital, says one source.

WeWork appears to still be pushing forward with its planned IPO, despite a backlash of criticism that highlights concerns related to lack of profitability and business model risks that could weigh on the company’s reception on Wall Street.

WeWork, which renamed itself as The We Company in January, has emerged as a global leader in the co-working and flexible office space. The question is whether it can parlay its brand strength and market position to pull off a successful IPO that could fuel even more growth for the company. Since the company was founded in 2010, its network of co-working facilities has grown to 528 locations in 111 cities in 29 countries as of June, according to data included in the company’s S-1 filing released in August. In addition, WeWork said it had identified a total target market that includes 280 cities.

To its credit, WeWork has been a fantastic innovator in an industry that had seen very little innovation for a long time, notes Edward J. “Ted” Hunter, a partner and chair of the real estate practice at the law firm of Lowenstein Sandler. “Investors, particularly institutional investors, are quite enamored with innovators, and tenants seem to like the product that WeWork is selling, which is a compelling combination for an IPO,” he says.

Although WeWork officially filed its IPO paperwork in April, the company has not disclosed its offering price or exactly when it plans to go public. Reuters has reported that the company is preparing to kick-off its road show with investors as early as this week. Reuters also reported that the company is moving forward with its planned IPO even amid a sharp drop in estimates of the company’s value—from a valuation of nearly $47 billion in January to what some believe is now a little over $20 billion.

Expansion comes at a cost

It’s no surprise that the company is looking to tap into public market capital to finance what has been aggressive global growth. The company website currently boasts 831 open and pending locations in 125 cities.

Although The We Company includes other operating divisions and partnerships, such as its WeLive urban housing, the core of the business is its WeWork-branded co-working facilities that provide space-as-a-service to office space users. WeWork typically commits to 15- to 20-year leases, and then repackages that space to occupiers who commit to a short-term membership fee. WeWork is able to charge a premium over the rent they pay in exchange for the flexibility and added services they provide to members.

One of the glaring issues for the looming IPO is lack of profitability. In its S-1, the company showed net losses every year for the past five years of data included in the filing. Recent losses attributable to the previously named WeWork Companies Inc. reached $1.6 billion in 2018 and $689.7 million in the first half of 2019.

The lack of profitability was a factor in Fitch Ratings recent move to downgrade the company’s Long-Term Issuer Default Rating (IDR) from BB- to B and also downgrade the senior unsecured notes from BB-/RR4 to B-/RR5. “WeWork is simultaneously expanding aggressively while investing in personnel and technology to achieve its growth ambitions. This translates to a farther out inflection point of normalized profitability and free cash flow than we anticipated in 2018,” says McNeil.

Landlords also have struggled with WeWork’s credit that is “nearly impossible” to underwrite, adds Hunter. Many lenders and appraisers have discounted the value of WeWork leases tremendously over the past few years, which puts a damper on the enthusiasm of landlords to lease large portions of their space to WeWork. Additionally, landlords are increasingly wary of having WeWork in their buildings, in part because WeWork's business model is inherently in direct competition with the landlord's core business, as well as the fact that WeWork has pushed for lease terms that aim to restrict what amenities landlords can provide to tenants, he says.

Risks mount in a downturn

Critics also have been quick to point to a business model that has not been tested by an economic downturn. WeWork’s success has come during a strong office market with a rising or cresting real estate cycle, says Walter Johnston, vice president, CMBS ratings, at Morningstar Credit Ratings LLC. “The challenge is that if rents don’t continue to rise, and if rents actually begin to fall, WeWork isn’t going to be able to re-lease its space at higher rents,” says Johnson.

“WeWork's business model faces the same downside issue as many companies across multiple industries—namely, when you obligate yourself to longer-term liabilities, mark them up, and resell them on a short-term basis, you can be exposed if your demand dries up,” says Ian Formigle, vice president of investments at CrowdStreet, a Portland-based crowdfunding platform. In WeWork's case, they are even more exposed as office rents are cyclical and competitors could pop up everywhere, he adds.

Portland was an early adopter of co-working space. In addition to four WeWork facilities, the city has several other options that include the likes of Regus, Centrl Office, Industrious and Urban Office, among others.

On the positive side, the S-1 highlights the continued shift away from a core user base that consists of start-ups and small businesses to more “enterprise” level clients, or those firms with more than 500 employees. “We continue to see viability in WeWork’s model because flexible workspace is an attractive option for enterprises,” says Kevin McNeil, director, U.S. corporates, technology, media & telecommunications, at Fitch Ratings. “The company’s market potential is sizable, and it has developed a compelling brand and network,” he adds.

Competitors watch and wait

Competitors will be watching this IPO carefully to see how receptive the public equity market is to the WeWork model. “At this point, I think competitors may view the WeWork IPO as a lesson in how not to raise capital,” says Formigle. “Had WeWork's IPO process pegged a new high (valuation) for the company, then I would have expected to see its competitors seek to cash in on the liquidity that the market was offering via their own IPOs, but that is clearly not how the market is reacting.” If anything, WeWork's competitors may view the situation as an opportunity to remain in the shadows and quietly gain market share as the WeWork veneer rubs off, he adds.

If the IPO does go forward, it could create greater transparency for WeWork’s financials and growth strategy. For example, WeWork has been gobbling up office space. According to its S-1, the firm’s location pipeline included about 40 million sq. ft. as of June. The firm leased 12.7 million sq. ft. in 2018 and another 16.3 million sq. ft. in the first half of 2019.

“As rating agencies are able to get more access to the financials of WeWork and make more informed credit decisions on the strength of the company, investors are going to be able to make better decisions about the strength of WeWork,” says Johnston.

WeWork would be subject to greater financial reporting requirements and more pressure to meet analyst and investor expectations on performance. The primary challenge for WeWork and its competitors in going public may be the culture shock that goes along with becoming a public company, adds Hunter.

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