The troubled IPO of WeWork parent We Co. can still be completed but the company needs to make more significant progress allaying investors concerns. That’s according to Nick Mazing, Director of Research at Sentieo, a leading AI-enabled financial research and workflow platform. In an interview with IPO Edge, he also draws a comparison between WeWork and banks, which have a similar strategy of “borrowing” long term and “lending” short term – a model that requires very close risk management. He also stresses that the removal of references to cash flow and profitability in the company’s latest filing is a red flag. The good news, he says, is that the company has the ability to make swift changes to improve issues such as governance if it chooses. The full interview is below:
Mr. Mazing is the Head of Research at Sentieo. Previously, he was a consumer-focused long/short analyst and portfolio manager, and worked in investment banking at Lehman Brothers.
IPO Edge: Very broadly, do you think that the We Work IPO will happen?
Mr. Mazing: This was a big question even before the IPO filing a few weeks ago because most private investors do look for an exit, eventually. There were two key questions around We Work, one, the sustainability of the business model, and, two, the governance issues that kept popping up. Their bonds traded under 90. The detailed disclosures in the IPO filing probably strengthened the concerns. A well-followed pseudonymous finance twitter account ran a poll in August, with almost 350 responses, and over 60% of respondents did not see the IPO happening in the next three months. And just as a reminder, the US equity market is very close to all-time highs, and we have seen a good number of marquee IPOs across industries happening this year, like the offerings by Uber, Lyft, Slack, Chewy and Pinterest. The IPO conditions are about as good as they get. I think that we will see something before year-end because the company appears to be addressing the concerns of the skeptics.
IPO Edge: Let’s break these down the skepticism in three buckets: the business model, the valuation, and the governance. What do you have to say about the business model?
Mr. Mazing: The framework for understanding the business model risk is similar to that of a bank: there is a fundamental asset-liability mismatch. WeWork “borrows” wholesale and “lends” retail, and, theoretically, earns a spread. However, to earn that spread, it takes the duration risk: tenants rent mostly on a short-term basis while the company’s obligations are long-term in nature. Nothing here is new, neither the business model nor the fundamental risk. Three out of the four oldest businesses in the world are hotels, in operation in Japan since the 8th century. This kind of longevity means the business model, the short-term rental, is extremely durable but I would also guess that they have been funded with equity, not with debt. To add, the company’s removing a lot of references to cash flow in the S-1/A, as you covered, doesn’t help their case here.
IPO Edge: How about the valuation? Isn’t WeWork a “Strong Buy” at some price?
Mr. Mazing: The valuation situation here is really feeding the deep skepticism that I see by public market investors about private market valuations. This is just the nature of the game: VC is very clubby and collaborative. Everyone is in everyone’s next round. There is no shorting. This is not a bad model: we have seen incredible companies come through this ecosystem. The public markets are competitive and ruthless: I might be shorting your largest long, and you might hate me viscerally for that. There is endless price discovery, there are many competing entities and styles of investing. WeWork’s private market valuation looks high when compared to its large public comp, IWG, as Renaissance Capital did in this side-by-side table. WeWork was valued privately at $47 billion, IWG is at under $4 billion; IWG is profitable, and both have 600k workstations. Now, obviously, WeWork has been growing much faster but this WSJ report indicates that WeWork is discussing cutting its private market valuation in half for the IPO. The headline obviously looks bad but I see it as a positive for the offering: the company is responding to investor concerns about its valuation.
IPO Edge: The final bucket is governance: what do you see going on there?
Mr. Mazing: The company is improving! Just like with the valuation, there are serious indications that they are listening to investor feedback. We saw two notable changes in the S-1/A vs. the S-1: the company appointed the first woman to its Board of Directors, as you covered on Cheddar TV, and the founder returned the $5-$6 million he got for the We name. There is plenty more that can be questioned by public market investors. My rule of thumb is that if one needs to be a lawyer to understand a filing, chances are, there is “something” going on. WeWork has more related party transactions compared to other recent IPOs, as we wrote in Forbes, then there are the unusual compensation and legal structures, the VC converts, and the dual class shares. Now, none of these are unusual individually but we see a higher concentration here, and potential investors are right to frown, especially with a dual class share structure that would prevent an investor from pushing for changes. These have been more popular recently but as you know, the S&P made these companies ineligible for inclusion in the S&P 500/400/600 indices. This is a big deal as there are many index- or index-benchmarked investors who will not be interested.
IPO Edge: What do you think can be done to improve the odds of a successful offering?
Mr. Mazing: The good news here is that most of what can be done is completely under the control of the company. They can address the governance issues relatively quickly, just like they did with the We trademark payment and the BOD appointment. They don’t have to have unreadable disclosures around incentive compensation. They don’t have to have dual class shares. You get the idea. While founder-led companies are all the rage, in this specific case, institutional investors might feel more comfortable with a “suit” and the founder being in a chairman role. The valuation is clearly something that is being addressed. There might be other things around Softbank participation, “best efforts”, lock-up terms, and other things that the underwriters can arrange for. Besides valuation and governance, the company could provide more detailed disclosures, maybe even down to the property level, to assuage the questions around the long-term economics. There is an angle here that maybe WeWork is, in fact, the best overall provider of office space in terms of cost and flexibility, and it has gathered up enough scale where it does matter, where it is systematically important to the office real estate sector. It is already the largest office tenant in New York City, Chicago, central London, Denver, and the largest private tenant in DC. It appears that WeWork will continue to need cash for the foreseeable future, and the public markets might be the place for that, but this funding will come on terms that make the large institutional investors comfortable.