Shellacking the retail investor
I am glad WeWork is in the headlines these days, since I told you in May that I see it going to zero eventually. Now, I’ve been sanguine about a so-called bubble in these unicorns for a number of years. And in that vein, back in 2014, I wrote “Some thoughts on the new Internet bubble“. My view then was that “we are in a land grab in the technology sector as the industry moves away from the PC to a more mobile and cloud-centric universe. The dynamics of that kind of paradigm shift make manias likely, even inevitable because an investment in companies coming to prominence in this space right now is like buying a call option with huge amounts of implied volatility. That optionality is worth a lot of money – so much that it creates the kind of price movements that naturally lead to bubbles or manias.”
But, now that these companies have matured somewhat, but are still loss-making and are being shopped to retail investors, I am singing a different tune. Josh Brown’s recent video and comments on Twitter sum up where I’m coming from. Click the link for the video.
This is the part I never want you to forget.
Wall Street was THISCLOSE to selling you #WeWork at $50 billion.
Stop quacking like a duck and they’ll stop throwing breadcrumbs at you. pic.twitter.com/phV9Ubyn53
— Downtown Josh Brown (@ReformedBroker) September 24, 2019
It’s unconscionable really. As I said earlier, these companies have high optionality embedded in their share prices. Many of them are going to zero. And the survivors might just become the next Google, eBay, or Amazon. But retail investors are not well-positioned to make that determination. And the process whereby a company like WeWork comes to market at an extreme valuation is rife with conflicts of interest that end up hurting retail investors more than anyone else. That’s what Josh was getting at.
The Collapse of the Private Market
Josh also noted that the poor trading environment for (Lyft and) Uber contributed to investor scepticism of WeWork.
One last thing – if $UBER were at 70 now instead of 30, $WE IPO would’ve been fine and Adam would’ve had complete control. No one is ever in complete control of their own destiny.
— Downtown Josh Brown (@ReformedBroker) September 24, 2019
I think that’s right. When I talked about WeWork in May, I wrote that “[i]n one sense, it is a bubble. 100%. Most of these companies are overvalued. Look at WeWork as a prime example… But I have no doubt they can conduct a successful IPO that values them in excess of $40 billion in the public market.” But that was then. The market conditions now have completely changed. And the poor trading of Uber and Lyft are major reasons why.
As I wrote last week, I think we are going to see a sea change in the way these unicorns are valued in the private market too. “If private market investors are exposed to deep losses, their behavior might change. And to the degree they realize that an IPO is not the endgame. But instead, large losses may well be, this could impair the ability of loss-making companies to get additional funding rounds. Once that happens, we will see these companies cut back on investment, lay off workers and husband cash.”
The test of this theory is Peloton, another overvalued Unicorn looking to come to market. I know a few people who have these bikes. And I am a bike rider myself, having put in over 4000 kilometers cycling on the road and gravel this year already after nearly 7000 last year. But I would never buy a Peloton bike.
See, as a serious cyclist, I would rather use my own road bike with an indoor trainer and a social cycling app like Zwift than buy a Peloton bike. And my wife, who doesn’t cycle, would never buy a Peloton either. We have enough excess cash flow to afford it. But, it’s a huge luxury. And she already has an elliptical she hardly uses. There’s zero chance she would shell out thousands of dollars for a Peloton bike or treadmill and pay thousands more per year in subscription costs. It won’t happen.
So, what’s Peloton’s addressable market? It’s not very big, realistically. What I just told you about me and my wife gets at why. But can Peloton scale enough to realize a margin that eventually justifies a $7.6 billion market valuation? The short answer is no. That’s going to leave them reducing their IPO implied market cap, tanking in the aftermarket after an IPO, or pulling the initial public offering altogether.
However you look at it, private market investors who funded the last round of investment are going to take a bath. And then they’ll have to start questioning whether they want to continue funding these unicorns at ridiculous valuations.
This is where we are.
WeWork has tentacles
WeWork’s business model is horrible because they are ‘lending’ long and ‘borrowing’ short by locking in long-term leases and backstoping that with short-term contracts. And they are doing so at fantastically high, top-of-the-market lease rates. This is a disaster waiting to happen.
But what happens to the commercial real estate market if WeWork runs into trouble? Dan Alpert wrote a piece I recommend on this. Here are the key bits:
For what WeWork has undertaken, as disclosed in the prospectus for its erstwhile IPO, is – in fact — $34 billion (yes, that’s billions) of rent obligations to landlords around the world over the next 15 year, highly concentrated in centers of commerce such as New York and London.
[…]
…This for a company that grossed less than $2.6 billion in sales for the 12 months through June 2019, and in that period had only $232 million – after other cash operating expenses – before paying its rent bills of $2.1 billion.
[…]
…In New York and London, WeWork is the largest private sector office tenant – something they actually crow about. In Manhattan, the company has over 5.3 million square feet of office space – more than the entire enclosed space of the Mall of America, the largest mall in the US.
[…]
But, in terms of net absorption, according to data from industry sources and my calculations, if WeWork were removed from the equation, the Manhattan market would have experienced negative absorption of roughly -700,000 square feet of leased space, as opposed to the just over 2.3 million square feet of net absorption that it experienced over the 24 months ended June. This, folks, means that at the margin WeWork is moving markets – bigly.
If WeWork runs into trouble, New York CRE and London CRE run into trouble. And that will reverberate far and wide via the debt allocated to that market and the derivatives built on top of that debt. So a WeWork meltdown could be potentially worse than one might think it would be given it only has a market cap in the tens of billions of dollars.
My view: when this latest Internet bubble crashes, there will be collateral damage because a lot of jobs and capital investment depend on these companies. But, for me, it’s the connection to property markets and the debt and leverage associated with them that has me concerned about WeWork specifically.
Let’s see how this plays out.