The strangest and most alarming issues in WeWork's IPO submitting

CEO of WeWork Adam Neumann

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WeWork’s dad or mum firm, the We Firm, made a splash earlier this week with the discharge of its much-anticipated IPO prospectus.

The corporate’s S-1 lays the groundwork for what’s broadly anticipated to be one of many largest preliminary public choices of the 12 months, second solely to Uber’s IPO in Could.

It is also crammed with uncommon objects that ought to scare off all however the hardiest traders with a wholesome urge for food for threat. This is a rundown.

Mounting losses

WeWork’s income for the primary half of 2019 might have been greater than double that of a 12 months earlier, however its losses are accelerating simply as quickly. The corporate indicated in its IPO submitting that losses ballooned to greater than $900 million within the first six months of the 12 months, which follows full-year web losses of $1.9 billion in 2018.

Large losses have grow to be half and parcel of unicorn IPOs, as demonstrated by the debut of fellow high-flying tech firms Uber and Lyft earlier this 12 months, amongst many others. However WeWork continues to face robust questions across the sustainability of its enterprise and few of them have been answered in its S-1.

“You may say I am rising quicker, however you’ll be able to’t say that if for each greenback you are getting, you are dropping a greenback,” stated Renaissance Capital principal Kathleen Smith.

Equally, MKM Companions’ Rohit Kulkarni stated in a be aware Friday that traders would “must take an enormous leap of religion with the intention to consider that WeWork would present indicators of a sustainable financial mannequin” given the rising prices throughout its 528 areas. He stated WeWork might quickly discover itself strapped for money.

“At an estimated $1500-200mn in money burn monthly, we consider the corporate has about six months in execution runway forward earlier than going through a money crunch,” Kulkarni wrote in analysis be aware.

Costly lease agreements

WeWork’s lease obligations bear some consideration.

The corporate indicators long-term leases with landlords that last as long as 15 years, which requires it to pay a whole lot of hundreds of thousands of dollars in future lease, based on information supplier CB Insights. Within the S-1 submitting, WeWork stated future lease fee obligations have been $47.2 billion as of June 30, up from roughly $34 billion on the finish of 2018.

On the similar time, WeWork presents short-term rental contracts to members, in an effort to supply flexibility, gathering lease at a mean of a two-year timeframe, Smith stated.

It is a boon for its members, however might current a threat to WeWork’s enterprise, as these short-term renters might up and depart at any time, leaving the corporate on the hook for long-term leases.

“That mismatch might be lethal in a recession,” Smith stated. “It means the corporate has bought to have the ability to pay the lease prices. If for some motive there’s worth stress, lack of renewals, cancellations and so they have a time the place they don’t seem to be leasing out their house, that might be a really big threat in a recession.”

The corporate’s declining income per membership additionally raises some considerations.

WeWork estimates a complete addressable market alternative of $945 billion, when making use of its common income per WeWork membership to its potential member inhabitants, the submitting states. Nonetheless, WeWork additionally warned that revenues per member will decline sooner or later because it expands internationally into “lower-priced markets.”

“Buyers need to see [average revenue per member] improve, as a result of that may show this concept of ancillary companies,” Smith stated.

Companies are anticipated to be a long-term driver of the corporate’s income. CEO Adam Neumann has said beforehand that he sees WeWork as a “international platform” for issues like “space-as-a-service,” a play on the phrase software-as-a-service.

If WeWork is already having bother rising its common income per member, it might be difficult to get members to shell out a pair additional dollars on issues like software program or different companies.

Puzzling company construction and unpredictable China enterprise

After WeWork rebranded to grow to be The We Firm in April, it adopted a sophisticated company construction, known as an umbrella partnership company, or Up-C. In impact, this turned WeWork right into a restricted legal responsibility firm, with The We Firm overseeing it and joint ventures in Asia, in addition to different associated entities, resembling its fund ARK Capital Advisors, which oversees international actual property administration and acquisitions. (The acronym stands for Adam, Rebekah and Children, in reference to his spouse — who’s listed as a co-founder and wields important affect on the firm — and their 5 youngsters.)

This chart from the S-1 reveals how sophisticated all of it is:

The Up-C construction has tax advantages for Neumann and different executives, as they will be capable of pay tax on any income at a person income-tax charge, based on the Monetary Instances. In the meantime, public shareholders can be topic to double taxation, because the holding firm can be taxed on earnings and traders pays anoter tax on dividends.

In its S-1, WeWork stated the Up-C construction would give it extra flexibility to pursue acquisitions, whereas preserving money owed and obligations of its different companies separate.

“Such a construction permits us to separate our WeWork space-as-a-service providing from the remainder of our current companies, and also will enable us to carry individually any future enterprise areas into which we might increase,” the submitting states.

Kulkarni stated in an interview with CNBC that WeWork’s enterprise in Asia remains to be within the early phases of growth, so the construction permits them to “isolate the losses” related to it.

Within the firm’s S-1, WeWork famous that its contribution margin, which is the income left from membership and companies after subtracting working bills of these areas, would have been three proportion factors greater if it had excluded the China enterprise.

WeWork faces distinctive dangers with its operations in China. Enterprise within the area is run by teams it may possibly’t management, native legal guidelines are totally different when it comes to the size of leases and it falls beneath the 2017 China Cybersecurity Regulation, which supplies the Chinese language authorities entry to enterprise information.

Kulkarni stated he believes WeWork hasn’t supplied “ample disclosures round how the China and Asia property are held” and that its complicated company construction might probably current important dangers.

“It is a puzzle that must be solved,” Kulkarni stated.

An all-male board of administrators

The We Firm disclosed who will serve on its board of administrators in its IPO prospectus. Not a single lady will serve on the corporate’s seven-member board, which might probably open it as much as criticism afterward down the road.

Neumann is chairman of the board and is joined by Bruce Dunlevie, a founding associate of Benchmark Capital, Ronald Fish, a vice chairman of WeWork’s largest backer, SoftBank. Lewis Frankfort, Steven Langman, Mark Schwartz and John Zhao additionally function administrators.

By appointing solely male administrators, WeWork is bucking the bigger pattern towards gender inclusive boards. As of final month, each S&P 500 firm had no less than one feminine director on its board. Having a more-diverse board is broadly considered as an avenue towards higher shareholder returns.

CEO Adam Neumann’s management and potential conflicts of curiosity

For those who’re betting on WeWork, you are betting on Neumann.

He controls the vast majority of the voting rights via the corporate’s class B and C shares, with each lessons carrying 20 votes per share in comparison with class A shares, which have one vote per share. Neumann’s holdings might additional improve because of a pre-IPO award choice of up about 42.5 million shares, which can vest over the following 10 years.

Complicating issues, WeWork leases and pays lease on buildings owned partly by Neumann. He has possession stakes in 4 business properties leased to WeWork, the S-1 states. Between 2016 and June 2019, the corporate had paid $20.9 million to the landlords overseeing these leases, which in impact consists of Neumann.

Moreover, when WeWork rebranded to grow to be The We Firm in April, it acquired the trademark to “We” from We Holdings LLC, an funding car with Neumann and co-founder Miguel McKelvey. As a part of the deal, We Holdings LLC bought an extra stake in We value $5.9 billion. 

These sorts of transactions are issues traders usually do not prefer to see, Smith stated.

A lot of the corporate is driving on Neumann that he was included among the many dangers listed in WeWork’s S-1. The corporate famous that Neumann is “important” to its operations, but it has “no employment settlement in place.”

“If Adam doesn’t proceed to function our Chief Government Officer, it might have a fabric hostile impact on our enterprise,” the submitting states.

Moreover, ought to Neumann ever grow to be completely disabled or deceased, his spouse Rebekah, who serves as the corporate’s chief model and affect officer, is considered one of two different individuals who will select his successor. If two preselected administrators are not serving on the board, Rebekah can even choose which board members will help her within the choice course of.

WeWork acknowledges within the S-1 that Neumann has “deep involvement in all points of the expansion” of the corporate, including that he has “confirmed he can concurrently put on the hats of visionary, operator and innovator, whereas thriving as a neighborhood and tradition creator.”