By: Michele Wood

In August, co-working giant WeWork, now known as “The We Company,” or just “We” for short, released its S1 document in advance of its highly anticipated IPO. Claiming a $47bn private valuation, the company soon met with investor scrutiny, reduced its targeted valuation to $20bn, and then again last week to $15bn. As Bloomberg reported, the reaction wasn’t “quite the celebration the office-rental unicorn once foresaw.”

Why was there such a disconnect between the initial valuation and market response? To answer, we need to explore WeWork’s history and fundamentals. WeWork is the original name and concept of the We Company. WeWork offers co-working, a product and service wherein office users can rent office space as small as a single work surface for short terms. Many flexible options are available to users including a dedicated desk, furnished private office, conference rooms, full floor leases, plus amenities such as gourmet coffee, Foosball tables and wine and cheese events. At the time of this writing, the numbers were as follows:

• 528 locations as of Q2 2019 (up from 485 in Q1)
• 27 million square feet total
• $47bn in committed lease obligations
• 169 locations in the pipeline
• 50% of company memberships are outside the US
• Raised more than $12bn since its founding in 2010, but has never turned a profit
• 20,000 companies are WeWork customers
• 40% of memberships are enterprise customers
• Companies with 1,000 employees or more comprise 20% of the customer base and include Microsoft, Samsung, Starbucks and Facebook

Co-working has become a big business for modern workers. Professionals in the “gig economy,” contract workers, employees traveling on assignments, people wanting flexibility in their workdays or lease contracts or sole practitioners simply wanting human contact during the day are all finding co-working spaces a great solution. Perhaps even more than the flexibility or convenience, the “co” part of co-working is critical.

WeWork was founded by Adam Neumann and Miguel McKelvey, and both men were raised in communal environments. Neumann is Israeli and spent much of his childhood in a kibbutz. McKelvey was raised in a commune in Oregon, exclusive to single mothers. They met by chance in New York and opened the company in 2010. Community is how co-working distinguishes itself from its close cousin, executive suites. Co-working spaces, especially for WeWork and its top competitors, offer “amenity bases” in their offices, which facilitate interaction around common areas like printers, food stations or game tables. In fact, WeWork studies the ways in which spatial design determines interaction and behavior. McKelvey comes from an architecture background and did all the company’s initial interiors.

Since launching in 2010, into a world that did not yet see co-working as an everyday word, WeWork has become the juggernaut of the industry, successfully defining and designing a market for micro, flex office. Their stated goal to “elevate the world’s consciousness” may cause outsiders’ eyes to roll, but their implied goal of making space more efficient makes sense to users, landlords and investors. Instead of one office per one worker, occupied for maybe 40 hours per week, co-working operates more like a gym membership model. You may have space for 50 people at any given time, but you can sell 100 memberships because not all members are there at the same time.

WeWork now accounts for half of co-working’s market share. Scale, know-how and brand awareness are all required to operate a co-working space profitably, and providers like WeWork have an advantage over newcomers. They have been able, primarily through their blitz-growth, to bring “co-working” into the common lexicon and make it easier for some boutique co-working and flexible office companies to thrive. Some of these smaller competitors are now providing distinct options from WeWork to help diversify the market and cater to ever-evolving user needs and wants. For example, The Riveter has co-working spaces in Los Angeles and Seattle and while they offer memberships to all, the spaces and event planning are women-focused. The offices are designed with access, security and privacy needs (for demands such as breast pumping) that may be lacking in more generic space.

One advantage of having such a large market share is the amount of data WeWork can harvest from its own operations. They have claimed that they can study how businesses use space and respond to those needs faster than traditional office. For enterprise customers taking larger spaces for longer terms, the company can offer full office design, customized using analytics to determine size needed and which suite of services would best fit the company’s needs. Companies can then lease just the space they need, reducing waste while adding amenities to attract talent, just by optimizing design. Traditionally, companies have had to budget roughly 225 SF per worker. Though that size has shrunk in recent years, users of desk space in co-working need only about 25 SF—a reduction of 90%.

One of the odd things about WeWork’s self-advertising of late is its insistence on identifying as a technology company rather than a real estate company. Though most analysts and potential investors have balked at this claim, the company has invested heavily in tech platforms to serve their co-working operations. For years they have been data collection feedback to make and improve space design. If rooms score high, they replicate it in other locations. If it scores low, they fix the problem. Over time, they have developed algorithms to optimize desk placement for maximum fit without impeding flow. Interiors have sensors and beacons that track user locations, identifying areas of high traffic and low use. Along these lines, the company has announced plans to acquire Space IQ, a company focused on analytics software that optimizes office space efficiency. This is in addition to the purchase of 9 other tech specialization companies since 2018, including Managed by Q, software that facilitates hiring services, and Waltz, a building access and security management startup.

All of these strengths and combined resources gave We leadership great confidence in going forward with an IPO. But, as soon as investors got a look at the S1 last month, many red flags were apparent.

Lots of unicorn companies are led by charismatic, idiosyncratic founders. WeWork is no different in Adam Neumann. Since its founding, Neumann has partners in McKelvey and his wife Rebekah Neumann, but he has remained the face and in most cases, the voice of the company. By many accounts, he has driven company direction and culture. The S1 revealed that Neumann had granted many leadership roles in the company to family members and close friends. The term “related parties” appear more than 100 times in the filing. Many readers of the S1 criticized non-arm’s length leases wherein Neumann owned buildings that WeWork leased. In addition to helping his friends and family, he granted himself full voting control with his Class C shares that carried 20 votes per share. This was both outrageous and twice the number he had listed as having in a 2018 bond disclosure. Also suspicious was an untimely selling of much of his own equity (around $700 million) ahead of the stock offering, and selling the “We” trademark to the company for a personal gain of $5.9 million.

A risk threat for a company like WeWork in a period of hyper growth is quantity taking precedence over quality. Co-working is part of the modern “space as service” landscape, which means that the service is more important than many aspects of the space. In this way it is like hospitality. A gorgeous, modern hotel will suffer if the service is poor and customers have a bad experience. This is especially true for We as more and more competitors enter the market every day. WeWork’s largest competitor is International Workplace Group (IWG) which also announced plans for an IPO in August. The company, formerly known as Regus, has been in flexible work space for decades, popularizing the executive suite product, but recently updating to more co-working type models and launching a hip, well-designed line called Spaces.

Co-working company Industrious brought in $80 million in funding from Brookfield and Equinox in late August, and commercial real estate behemoth CBRE just opened their first co-working space called Hana this summer. While not all co-working operators will be successful, some of the better and larger companies with good resources backing them will be able to offer WeWork customers good alternatives if they become unhappy with bad service.

Investors have pointed out that in an economic down turn, flex space is the first to get cut by companies looking to control expenses. Regus, before becoming IWG, filed for bankruptcy in 2003 following the dot com bubble. Though they survived the downturn, it’s a cautionary tale of how other flex office models weathered the business cycle. Sam Zell of Equity International has been critical of the company, citing their byzantine corporate governance and the fact that they are covering long-term liabilities (their long master leases) with short-term assets (their short sub-leases to users.) He characterizes WeWork as operating on the margins, and that doesn’t make for strong corporate foundations.

WeWork’s insistence that it is a tech company is also a danger. Technology companies can operate on no profit for longer than real estate companies because their profit models often show a hockey-stick growth once market share and brand loyalty are established. Large sums of capital are needed to develop software and get it into users hands, but once its there, updates and maintenance are low cost and profit margins go up exponentially. Real estate is very different as operation costs are constant and upgrades or renovations to space and FF&E are expensive and disruptive to users.

An interesting comparison can be made to Peloton, a company that makes high-tech exercise bikes. Peloton filed for an IPO in August as well. The September 7^th issue of The Economist reported, with classic British wit, “Like many of the current crop of tech ‘unicorns’—private companies with a valuation of $1bn or more—Peloton does not do anything so unfashionable as making money.” But they are growing market share and transforming the business model. While bike makers used to be in the manufacturing business, Peloton now makes 20% of their revenues from subscriptions. Software updates to aging but still functional bikes is a good way to grow sales to existing customers. This is how WeWork differs from other self-proclaimed tech-hybrid companies. Unlike an exercise program, We cannot simply open a space and install software updates periodically to keep it running and fresh. It’s a hospitality hybrid, with capital expenses for physical space, FF&E, management and staff all running high and constant. This is new, and has greater risk than tech or quasi-tech.

In the post-S1 fallout, WeWork has wisely rethought some of their choices and has issued some changes in response. The company brought in their first female board member, Frances Frei from Uber. Neumann gave back the $5.9 million trademark payment, and he has said he will return any profits he receives from real estate transactions with the company. Some of the non-arm’s length power positions have been modified, including removing Neumann’s wife from the succession committee should he become incapacitated. Neumann has also changed the high-vote Class C stocks from 20 votes per share to 10, more in line with other companies.

WeWork’s largest investor, the Japanese firm SoftBank, has reportedly encouraged the company to delay and potentially shelve the IPO. The company originally declined the delay, going forward with the road show while reducing their projected valuation to $20bn. Reports are now coming that the IPO has been delayed to at least October, and possibly later, and a projected valuation is closer to $12bn.

Market disruptors are always interesting to watch, especially from the sidelines. For investors looking at WeWork as a tenant, there is still indication of strong fundamentals. A study done by Eastdil Secured reported that, “Leasing to WeWork has little to no cap rate impact for the landlord, provided WeWork leases less than 25% of the total building. When WeWork leases 50 to 100% of the building, a cap rate premium of 50 to 75 basis points or more is common if WeWork does not offer a parent guarantee, as it often does not.” This is a shift, especially for lenders who a year ago may have financed a project with 70% co-working without hesitation. Now, some may insist on 10% or less, particularly if the tenant is WeWork.

Co-working is not a failing concept, and will continue to expand as traditional office becomes outdated to many users. As Coworking Resources’ recent guide, “An Insider’s Guide to WeWork” states, “demand for flexible leases and professional community is not just a trend, but a necessity in this age.”

Editor’s Note: Since the publication of this article, Adam Neumann has stepped down as CEO of We Company. He has been replaced by Artie Minson and Sebastian Gunningham. Neumann will continue to serve as nonexecutive chairman of We.