We(Not)Work? Three Indispensable Reminders for All Business Leaders

By David Gross

The Startup Muse's recent articles on WeWork Founder Adam Neumann and WeWork's accelerated IPO got me thinking. In the WeWork story, are there indispensable reminders — i.e., reminders that apply regardless of industry, revenue, or stage of maturity — for all business leaders? I found five and cover three in this article, the first in a two-part series. 

1) Business Definition & Focus: Where Will We Play?

This question is one of the most frequently asked questions in business. It's also one of the easiest one to get wrong. When a company loses focus on its core business, the operational and financial impacts are devastating.

At its inception, WeWork took Class-B and -C office space, made it hip, and then subleased space at unreserved "hot desks" and in dedicated offices to freelancers and startups. By providing a hip and affordable alternative to working at home, residing at Starbucks, or renting the dreaded single office suite, WeWork quickly developed a cult following. What business is WeWork in today? As the partial list of WeWork milestones below illustrates, it's hard to tell.

2) Scalability: As Revenue Increases, What Happens to Costs & Margins?

As a company increases revenue, cost efficiencies should materialize, and margins should improve.

In December 2018, WeWork set up business in its 100th city, up from 65 cities a little over a year earlier. Just as impressively, WeWork expanded from 207 to 425 locations and doubled revenue over approximately the same period. With its status as the largest private tenant in New York, London, and other cities, and its global scale, WeWork should benefit from economies of scale. The reality? As revenue doubled, WeWork's losses doubled, and its negative net margin remained flat at approximately -100 percent.

While there is currently limited data on WeWork's costs, work by The Financial TimesAxios and others provide vital clues. Let's focus on three costs: broker commissions, leases, and interest costs.

  • Broker Commissions: In 2018, WeWork sweetened incentives for third party brokers. According to Bloomberg, commissions doubled for brokers at the largest firms and rose to 100 percent on the first year of rent paid by tenants who switched from one of WeWork's top competitors. As a result, on the typical 3- to 5-year lease for enterprise tenants, WeWork spent 20 to 33 percent of rent on broker commissions. Worse yet, after adding in the 50 percent rent concession that tenants receive during the first year of their contracts, WeWork found itself giving away 30 to 50 percent of potential rents to land a new tenant. Ouch. For this acquisition math to generate shareholder returns over time, WeWork will have to excel at renewals. Today, it doesn't.

  • Leases: In its 2018 bond prospectus, WeWork disclosed $18 billion in future lease obligations. In the past year, future lease obligations have skyrocketed to $34 billion, in line with the doubling of locations and revenue, according to The Wall Street Journal.The good news for WeWork (and bad news for its landlords)? WeWork executes lease agreements through special-purpose vehicles and only guarantees approximately 11 percent of its future lease payments. In theory, WeWork can walk away from most of its lease obligations/costs should the economy spiral downward.

  • Interests Costs: With WeWork seeking to raise $3 to $4 billion in debt before its IPO, WeWork's interest expense will increase dramatically in 2020. Assuming WeWork raises $4 billion at 6 to 8% interest per annum, WeWork's annual interest payments should rise by $240 to $320 million.

3) Cash is King! Do We Have Enough?

Without sufficient cash reserves and credit, companies go out of business. Remaining focused on the core business, generating tangible cash-on-cash returns from investments (broadly defined), and understanding the steps required to weather an economic downturn are critical. So too, is cash forecasting and scenario planning.

Today, WeWork faces two significant threats that could dramatically alter its cash reserves and access to credit.

  • Investor Sentiment: Under any scenario, WeWork will require billions in additional funding over the next several years. For this reason, near-term investor sentiment poses a risk to WeWork's viability. To address this risk, WeWork must demonstrate that it has the discipline to focus on a specific market. It must also show that it has the discipline to generate healthy returns on its operating investments, burgeoning real estate portfolio, and acquisitions. If it can't, investors will balk at WeWork's debt offering or the subsequent IPO, and WeWork's prospects will dim considerably.

  • The Economy: During the 1992 US presidential election, President Bill Clinton's chief strategist, James Carville, popularized the saying, "It's the economy, stupid." The same is true for WeWork. When the economy falters, reduced demand will lead to higher discounts, lower membership growth rates (or losses), and lower renewal rates. Or will it? In the next downturn, freelancers and startups may leave in droves, but companies with 1,000+ employees can reasonably be expected to seek real estate cost savings and flexibility. Compared with traditional commercial real estate options, WeWork utilizes space more efficiently — i.e., less square feet per employee — and requires shorter commitments. In doing so, WeWork enables large companies to lower their real estate costs and strengthen their balance sheets. Sound far-fetched? It's not. WeWork's client base already includes 30% of the Fortune 500, and the typical enterprise tenant saves 25 to 50 percent on operating costs.

Business definition and focus. Scalability. Cash is king. These three indispensable reminders apply to WeWork and every other business. How does your organization stack up?

David Gross is a Founder & Managing Director at Strategic Value Partners (SVP). SVP delivers tangible results through strategic planning, team building and development, and intensive change management. SVP serves aerospace and defense, automotive, healthcare, natural resource, retail, and TMT companies. SVP also collaborates with alternative investment managers. In every case, SVP's goal is to create exponential returns while proactively managing strategic, operating, and financial risks. For additional information, please visit www.consultsvp.com or email connectwithus@consultsvp.com.