In September, parent company WeCo pulled its IPO and announced that Adam Neumann would step down as CEO, as the conflict of interest between Adam Neumann’s funding requirements and Softbank’s valuation concerns came to an end. Here, we look at what may lie ahead for WeWork in the short, medium and long term.
The immediate short-term implication is that WeCo will need a refinancing to replace the missed IPO proceeds. Softbank has already invested approx. $10bn, hence this seems likely. However, this comes at a cost of substantially cutting growth plans and further rightsizing of the cost base. In order to secure the new funds, we may also see Softbank installing a new veteran CEO to spearhead the operation. Already rumours emerged that Marcelo Claure, CEO of Sprint (another Softbank investment) may take over after Sprint was sold to T-Mobile.
Another short-term effect is that the withdrawal of WeWork will soften demand for office space in gateway cities such as London and this will adversely affect rental levels and ultimately office values. However, this can be partly offset by other competitors stepping up. For example, IWG CEO Mark Dixon reacted to the WeWork news expressing the aim to double its growth rate to closer to 25%.
These short-term effects however seem mere adjustments, and we believe the medium-term implications are more long-lasting. In order to understand those, we need to identify the questions that WeWork needs to answer in order to come out of this transformation successfully. In our view, a good illustration is to look at what Amazon achieved in the aftermath of the Tech Bubble bursting.
In 2000, amazon.com shares dropped a whopping 80% and many believed it would follow other dot.coms into bankruptcy. Amazon however embarked on a drastic cost cutting drive to survive. Even though sales still rose 68% to $2.76bn from $1.64bn and it made a loss, two important measures struck: (1) Amazon’s customer satisfaction grade rose to 84, the highest in its existence and (2) operating loss declined to 6% of sales from 26%!
The 2001 annual report revealed the full extent of the transformation. Sales only rose by 13%, but cost-to-sales dropped even further which allowed Amazon to add “lower prices” to its hallmark customer promises of (1) convenience and (2) choice. Jeff Bezos described it as follows: for the last two years amazon.com has focused on its cost structure after chasing unbridled top line growth. We now have a better more efficient organisation which sets us up for our third phase: balanced growth. After 2001, Amazon’s sales growth never dropped below 20% again and the rest is history.
With that in mind, what next for WeWork? In our view, WeWork will have to sacrifice short term growth and invest in its platform and its technology. In addition, it will have to rely more on internally funded growth. Hence the key questions WeWork will have to answer before they can try another IPO: (1) can they demonstrate its mature operations are cashflow positive, (2) does it have the strong customer relations that allowed Amazon to pull through and (3) can they develop the workspace technology platform which will make it a low-cost provider.
As a result, in the medium-term a transforming WeWork will be even more assertive towards its landlords. Ask anyone in the logistics market and they’ll say Amazon is tough on pricing, but also keen on long term relations with its landlords. One can expect WeWork to act likewise. Furthermore, WeWork is likely to be less patient with underperforming locations.
Finally, as WeWork transforms, we may see more aggressive competition in the flex space market which even in gateway cities is currently only 5% of the total market. As a result, we think that like in the hotel sector, flex operators will increasingly differentiate formats to service different market segments. This would lead to a more diverse offering for tenants, which would be a good thing.
If we assume WeWork successfully transforms, then the “lower price” promise Jeff Bezos becomes very interesting: can WeWork do the same? Before we get into this, we need to tackle a myth. When talking about lower costs for occupiers, real estate people assume lower rents, but we think this is wrong. For a business lower prices for accommodation mean lower production cost per unit of which occupancy forms only part. Furthermore, if more efficient use of space can increase the units produced per square meter, the cost can rise and still decrease the cost per unit sold. Hence WeWork sells workstations not square meters.
And then for a corporate user, if you can fluctuate the number of stations within a contract and buy them in bulk across a large varied portfolio of locations, then it can offer economies of scale, which lower the cost per unit sold even further. Finally, if this can be accompanied by a workspace technology platform in your global office network, the overall productivity gains are very clear. WeWork’s assumption is that corporates are willing to pay for that.
Hence, the long-term effect of a successful WeWork transformation on the real estate market will be a more client focused more segmented market where (maybe for the first time) the customer comes first. But we are not yet there. And maybe the 4pm Friday WeWork app-message “Help, we have run out of prosecco” going around a London location may indicate that for WeWork things may get worse before they get better.
