Hi Ho, Hi Ho, it’s off to (We)Work We Go…

While the endgame for WeWork, following the debacle of its recent failed and withdrawn IPO, is still unfolding, and a lot of ex post facto schadenfreude has been exhibited, it is worth pointing to certain aspects of what has happened that demonstrate that reality eventually intrudes upon suspension of disbelief.

We have written before of how the need for a business to be profitable prior to a public listing seems to have become a rather quaint notion. The WeWork saga demonstrates that in spades.

However, there is more to it than that.

Consider the widely used financial metric of “EBITDA”, often as a proxy for cash available for debt service and capex. As anyone who has read a syndicated bank loan document knows, the definition of and adjustments to “EBITDA” show that its natural meaning can be tortured within an inch of its life. In addition, “Adjusted EBITDA” is a favourite of companies in corporate presentations to demonstrate that their prospects are somewhat better than the numbers produced by statutory accounting may suggest. Yet, WeWork, with its now much-mocked concept of “Community-Adjusted EBITDA”, took the distortion of reality to a new level. Nevertheless, that appears not to have prevented sundry investment and commercial banks, who should have known better, from reportedly promising the earth in terms of what WeWork should be valued at upon a public listing. USD 47BN was “conservative”. As an aside, according to the Financial Times, the SEC has recently issued fresh “guidance” to company CFOs on the topic of EBITDA, while the IASB is considering standardizing the definition of what operating profit is, presumably in an attempt to prevent what is a useful concept becoming discredited.

Secondly, robust governance matters. The S-1 which WeWork issued ahead of its proposed IPO disclosed a catalogue of circumstances in which there were clear conflicts of interest between the company and its CEO/Co-Founder, but which WeWork’s Board had seemingly chosen to overlook, or even approved. Of course, in any organization, particularly one growing so fast and with a dominant and controlling founder, there is always the potential for the agency issue and misaligned incentives to lead to outcomes that, when scrutinized, do not pass a reasonable test of propriety. In the case of WeWork, these seem to have become inextricably entangled with personal interests. Sadly, as the case of Theranos amply demonstrated, Boards often struggle to act as a check on a dominant CEO. WeWork is hardly alone on that score.

Thirdly, if a key investor pours in so much money that it removes any real incentive for the founders and managers of a start-up to exercise discipline in terms of how they allocate capital and spend cash, it makes a mockery of the paradigm that a start-up should be “lean and hungry”; not because, at the other extreme, operating on “starvation rations” is somehow a virtue, but because a surfeit of capital, and no real controls on how it is spent, create inflated expectations in terms of the value supposedly being created, leading to “magical thinking”.

Fourthly, WeWork was treated and ostensibly valued as if it had somehow created a technology platform, when its core business model was, in fact, that of an entity that leased-long and sub-let short. The mis-match between (un)predictable cash inflows and demonstrable lease obligations was breathtaking, even if an increasing proportion of its available space was leased to large corporations, less likely to be vulnerable to economic cycles.

And, finally, if there is no clear trajectory to real “cash” profitability or generating any return on capital invested, how is it possible to create a valuation model that has any credibility? If a valuation is based upon the expected Net Present Value of future cashflows and/or dividends, and no-one can explain how that number will ever become a positive one, valuing “potential” crosses over into the realm of fantasy.

Of course, it is easy to mock. Clearly the spaces which WeWork created were attractive and showed the potential for improving the concept of an office or workspace. What was, and remains troubling is the fact that somehow its business model was treated as if it was revolutionary, when it was nothing of the sort; and that a wide range of parties became invested in maintaining that fiction, because the alternative probably became too awful to contemplate.

At Awbury, we take the view that, while clearly there are and will be paradigm-shifting businesses created by those who have a vision of the new, because that is evidenced by long experience, the constraints which surround such entities remain the same- a path to profitability and positive cashflow, good governance, management accountability and robust accounting, to name a few. One can create a transformative business, but breaking free from reality is a lot harder.

The Awbury Team

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