Chit Chat Stocks - WeWork (Ticker: WE) Not So Deep Dive

Episode Date: August 1, 2023

WeWork (WE) provides flexible office space solutions, but it has faced significant financial and corporate governance challenges in the past, raising questions about its long-term sustainability and growth prospects. At the end of the month, we will publish an Arch Capital episode that will cover the company: Coupang. Listen closely as Brett and Ryan go through the history, financials, and future prospects of WeWork. Enjoy the show! ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (2:48) Industry | (18:33) Management & Ownership | (23:48) Earnings | (26:19) Balance Sheet | (31:14) Valuation | (35:23) Our Analysis | (39:10) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. All right, welcome in. This is the Tuesday Not So Deep Dive episode on Chachette Money. My name is Brett Schaefer, and I'm joined as always by my co-host, Ryan Henderson. Ryan, we are continuing

the Fallen Angels month? And are you excited to talk about the best business of all time, the highest TAM of all time, the best, the greatest founder of all time, Adam Newman's company, WeWork, and why it is still trading on the public markets and what's up with this company in 2023? Yes, I am excited. The stock is down 98% since it SPACed. So this, I think of all the fallen angels stocks that we've done is down the furthest from its IPO price. So I'm excited to dig into this one because, and I will preface this by saying the fallen angels is fun because you're basically digging through the trash bin but if you find something that can work the upside is significantly higher yep 100 and even if in this case little spoiler alert this

is probably the worst business we've ever covered but it's always a good case study to i think spark networks might have been worse oh all right yeah that that could be worse that be worse we'll see who files bankruptcy sooner but i i would argue that honestly we work hard to default it but whatever we'll get to that argument later the either way it's a great case study on what makes a bad business and kind of what things to look at to avoid you know because that's that's the most important thing is to to make sure you're avoiding the bad businesses and you know as buffett says not going to zero on your investments uh before we get into it anyone who wants to look at our charts graphics financials all the good stuff subscribe to the newsletter it

is free i think we're closing in on 2000 on that one so get your free show notes along with each episode we think it's a great combo and besides that let's get right into it ryan what does we work do formally i should say the wii company yeah they did they used to be named the wii company uh which is funny but i'll get into the business model because it's actually i think it's fairly attractive if done right um and i might i think we'll probably by the end of the show come to similar conclusions on what we think but i will say there's a real case where this works out so don't don't tune out yet just because we think there's also a potential for bankruptcy but let's talk about the we work model it's really pretty simple they enter into leases in commercial areas

typically for a long duration. And sometimes it's one floor, sometimes it's multiple floors in a big building, sometimes it's the whole building. And then they reconfigure the space and rent it out to individuals and organizations to work in. So I think it's a pretty simple model. This is probably pretty common for anyone who's worked in any sort of co-working environment. But the average length of WeWork's leases, so they're basically, I mean, most people know what leases are, but their average duration on stays where they are located is 15 years. And the average membership term, so how long their renters are staying, is 19 months. So you can see already that they are locked into these longer-term agreements, and there's the risk that if they're not able to get the short-term agreements, there's bills they can't pay, that kind of thing. But on the flip side, if they're able to get higher occupancy, upcharge, theoretically, it's like real estate arbitrage, I guess, if you want to call it that.

But I want to give maybe a picture on the economics or how the business income statement could work down the road right now. So if you stripped out all the costs of running the WeWork corporation, so just the pure renting out the space and then renting it out to other people, WeWork would be generating roughly a 10% profit margin. So that's literally just their revenue minus cost of revenue, essentially. But that's obviously they have other expenses. So that's not their true profit margins, but theoretically it could work if you stripped

out all the other costs. Now WeWork today has 613 locations across 33 countries and they generate revenue through three product offerings. So the first one is space as a service. Yes. That's still SaaS technically. That was great. That was great that they took that as SaaS and then made it just an entirely different thing. Really, really good at making gimmicky marketing. I got to say. Yeah. A hundred percent. But this is basically their core offering. It just allows people to rent either a dedicated desk, which typically range from $300 to $600

a month, a private office, $400 to $1,400 a month, depending on the city, or in some cases, even an entire floor that's typically more for the enterprise businesses that maybe they have like a division that they're setting up and they just want to get started without entering into anything long-term, they can rent out a floor through WeWork. But members typically pay on a monthly basis. They can also sometimes pay upfront, but they pick their rental duration. So some people are on month-to-month plans, but most people, 70% choose a plan that lasts more than 12 months. So that's the core business.

And then they also have kind of these new plans, maybe not, they were rolled out, I believe at the start of 2020, they call it WeWork Access. And so the first one is WeWork On Demand. This is pretty much a pay-as-you-go model where instead of getting locked into, let's call it a six-month subscription where you're paying for a dedicated desk every month. This is the pay-as-you-go model where people can book a coworking space for either a desk or a private office for a day or even a couple of hours. So if you need one meeting, you can just pay 30 bucks to have an office for an hour or

something like that. The second one is all access. So they introduced this in 2020 as well. And it's essentially a cheaper plan that allows people to book desks across a number of locations, depending on availability. So you get a lot of the benefits, but there's no guarantee you'll get the space where you want. I believe these plans start at around $130 a month, but they call them hot desks, which is basically just like, if there's desks available, you can go in. If you're on an all-access pass, and it applies to a lot of different locations, as opposed to if you just buy the typical dedicated desk, like renting out an office, you're locked into that one location. All-access allows you to kind of float between different WeWork spots. However, like I said, not all locations are included in the all-access pass, and there's no guarantee that you'll get space. So those are kind of the two other offers.

All-access has actually been growing pretty quickly, and it's a pretty compelling offering, and it's kind of a way, I think, to increase occupancy for what would otherwise be vacant spaces. The last one I'll talk about here is WeWork Workplace. So this is WeWork's office space management software. I think the most common use case for this is if you're an enterprise and you're renting out like a whole floor, this software helps those companies stay on top of what desks are available, what offices are open, which employees are coming in on which day. It's really meant just for the enterprise side of things. Maybe they do some outsourcing, like letting other companies use the software, but I don't really think that's that common. So that's the basics. There's a mobile app. It's pretty intuitive. Honestly, if you just looked at the business,

had no idea what the income statement looked like, I think it's a fairly compelling business model. Would you agree? Yeah. At its core, it's a commodity, but if you build the right brand within some of these capital-intensive, well, technically, they're not capital-intensive, but for all intents and purposes, they are capital-intensive. yeah the business can work if you have the right brand you can look at something like hotels some quality hotels that do well although we work you know office space i don't know if people care about it that much you can look at other commodity businesses like banks where you know there's trust there and there's probably economies of scale as someone gets really really large here but i'm not

sure because, you know, the, how do you describe it? The all access plan, you know, you get someone on the membership. If you only have 10 locations around the world, that's not very compelling, but if someone had a thousand locations, that could be quite compelling. So yeah, I think there are some advantages here. If you can do this right. The thing is, is it possible to do right? As we'll talk about later, it might be in kind of that Carvana open door bucket where it's so capital intensive. I'm not sure when the profitability actually comes through. And when we talk earnings, that'll show up. Okay. Before we get to that though, let's talk history. People have probably heard

about the founding story before. There is a docu-series or maybe it's just a TV show out on Hulu. There's documentaries that have been done. The TV show on Apple TV is fantastic. It's about six episodes and it is, if you like investing it's quite hilarious it's it's it's really well done it's the documentary that's on hulu right i think so yeah yeah yeah scott galloway has a uh couple cameos in there um who is has probably been the most the most vocal critic of this company over its over its life but um i'll try not to i'll try to be a little brief on the founding story because there's know i think the tv shows do a better job but i want to talk maybe more about the post adam

newman era so um let's start with the founding story in 2010 adam newman opened a space in soho manhattan and began renting the space out to other tenants kind of starting this model it was they were not the first person to introduce our first team to introduce this concept but i think they did a better job and maybe kind of highlighted the co-working idea more so than other people Um, anyway, it was quickly adopted by startups because it was really such a cost-effective way to find office space, particularly, particularly in New York. Um, and it kind of became a sort of a phenomenon in New York actually grew really fast. They attracted investors such as JP Morgan, T. Rowe Price, Goldman Sachs, a bunch of others. Um, and it was working. Okay. Like, like the

business model seemed like it was working. They were growing really quickly. I think they were the fastest growing leaser or leasee of office space in New York, and I think maybe even America, that was some quote I saw on a Wikipedia page, but the flood of funding, I think gave Newman, Adam Newman, the founder, a bit of a God complex and, or maybe just, how should I describe this, a improper sense of risk. And so basically the mentality was let's spend and grow in every possible direction without any regard for cost. And the more they did this, the more funding they got. And it was actually amplified really once SoftBank showed up.

In fact, in 2018, SoftBank acquired a warrant for $3 billion worth of shares that valued the company at $42 billion. And a year later, they pumped an additional $2 billion in at a $47 billion valuation. That was kind of the peak or the height of the rise. However, later that year, and we can maybe talk about whether or not this was the straw that broke the camel's back, WeWork filed their S1 in preparation to go public. And I think this was pretty much the beginning of their demise because it opened the company up to investor scrutiny and investors really pretty much tore them apart. SoftBank quickly realized that the market wanted nothing to do with WeWork. They were, I think their public valuation, according to what probably Wall Street's estimates were,

was going to be like 10 billion. After a year prior, WeWork pumped 2 billion into them at a $47 billion valuation. So they postponed IPO plans. They removed Newman as the CEO, and they began going into cost savings mode, there's actually, when you're reading the 10K on the first page, there's a direct quote that says, with a new leadership team comprised of seasoned professionals in the public and private sectors, in 2019, we began to execute a strategic plan to transform our business. The plan included robust expense management efforts, the exit of non-core businesses and material real estate portfolio optimization. So that is basically where we're at today. It's been cost savings mode for three years. They had-

Pandemics made it way harder too. Yeah, certainly. And let's not pretend there wasn't some self-inflicted wounds here. There was ridiculous corporate retreats. There was parties on islands there. I think there's huge celebrities that came to corporate parties, if I'm not mistaken. Yeah. All just a ton of money was wasted.

But here's some of the changes that have been made since. So since 2019, SG&A expenses, so sales general and administrative expenses, were reduced by $2 billion through layoffs, general cost savings. I think they sold their private jets. And then the sale of non-core assets. They went through some of the non-core assets that they sold, or basically the companies they acquired and then instantly resold. Flatiron was one. I don't really know what that is. Space IQ, which was a workplace management software.

Meetup, which was a platform that was meant to bring people together for face-to-face interactions. Managed by Q, which was another workplace management software. 424 Fifth Venture, some real estate investment. And then Team, with two E's instead of E-A-M, was yet another workplace management software company. So they just acquired and acquired and acquired. I guess they had unlimited funding. So that's what they did. And then there was also the WeLive stuff was under that corporate umbrella.

So they were trying to do apartment sharing, same idea. And basically, they just got rid of all this and said, we're going to co-working. We're trying to optimize the business that we have that might be able to work. They also reduced future lease payments by more than $11 billion through amendments or exits of certain leases where the economics don't make sense. However, these are long duration leases for the most part. Like I said, average 15 years. They had to pay to get out of a lot of these.

And that was kind of a point of contention on a recent conference call actually was because They didn't talk about how much they were paying to exit some of these leases. So it's not, if they had just like acquired the building itself, sure, they could have sold this and there'd maybe be some assets to, you know, get rid of here, but for them to kind of walk things back, it's an expensive process. Yeah. And they're still walking it back. They've mentioned that it's going to take a long time until they get through this.

They did mention, although they are a bit of a boy who cried wolf situation. So I don't know how much I believe them, but they did mention that in 2024, a lot of the leases will, like those expenses associated with getting rid of these leases, a lot of it will be done and they will be able to have renegotiated new contracts under leases that are now coming up for renewal. So they say that the expenses that are going to go down, but again, that's one of the key things if you're someone looking for the turnaround story here to get there. Now, I will have one note. Adam Neumann is doing that WeLive thing under another company. I forget the name, but apparently it's associated. There's something with crypto too in there. He's back. He's doing this stuff. And he says he wants to rejoin the board of WeWork, but I doubt they're going to let him.

If you want a good laugh, honestly, look up how is WeWork founded, click on the Wikipedia page and see some of the footnotes or just some of the bullet points of expenses that they had. They paid Adam Neumann $5.9 million for the use of the term, the We Company. Yeah, I think he's a known, I think we can say he's a known, maybe potential G word. Grifter. Followed by Rifter. Let's get to the industry and competition though, as we talk about, maybe finish talk about Newman and we'll talk about the business today. They operate in the global office space market, specifically in the co-working category, which the company helped popularize. They're probably the number one brand there. Co-working market is expected

to be around $17 billion in 2022 and expected to grow to $19 billion this year, and then $35 billion in 2027. So there has been a long-term tailwind within this space. WeWork itself talks about how there are various, quote unquote, TAMs. They still put out these presentations about exponential growth for co-working by 2030. You can decide yourself whether you believe that. I would be conservative. However, there is generally, I think, an industry tailwind that someone who could be the brand leader here could ride. I would say as a caveat though, I made this in bold for the newsletter, given the balance sheet issues, given the liquidity struggles that WeWork has, this will be virtually impossible to maintain the market growth rate

unless they go through some sort of licensing strategy because they're trying to reduce their lease obligations and taking on a significant amount of new leases may be out of the question for a long time here. Competitors, there are many. They include, I think the number one would be Regus and Space, which is either Space or Spaces. They're under the IWG brand. They're the biggest ones out there. There's Impact Hub. There's tons of them around. There's even local ones. We were at a local one at one point. As a note, I think as a broader topic, as we try to study companies on this show. When there is an endless amount of competitors that I can find when I'm doing this section, that is an indication to me that this might be a commodity industry. It might

not have much to differentiate itself with. This might not be a winner-takes-most industry with oligopolistic factors, card networks, consumer brands, et cetera, et cetera. Now, if we look at their biggest competitor, IWG, I wanted to give some reference here for financials. Again, this is the parent company of their biggest competitors, Regus and Spaces. They grew revenue 18% year over year in 2022 on a constant currency basis. And WeWork grew the revenue by 26% year over year. So WeWork did much better, I guess, or a little bit better. But I would have to note here, IWG is profitable. Then another meta competitor is the industry dynamics around returning to the office or work from home. As we talked about, the pandemic really

hit them hard. Everyone seems to have an opinion on what's going to be the end state of work from home or return to the office. Honestly, I have no clue. It really just seems to be really in flux. What do you think, Brian? Everyone has a hot take on work from home. So I'm curious, any thoughts? I think probably the most important thing is occupancy for the current amount of US office space, occupancy rates are going to be lower than it was prior to 2020. Yeah. And it might be lower for a while. It's going to be lower for at least a few years, if not maybe 10 years. And I wrote that down as well here. A glass half full perspective though on this, because that's a big headed one for someone like WeWork and anyone

else trying to rent out office space, is WeWork is gaining market share while the industry goes through this cyclical downturn. Here's a quote from the proxy. At the market level, WeWork's 2022 gross sales in Manhattan were equivalent to 18% of the traditional office market leasing on a square foot basis, while WeWork's portfolio accounts for approximately 1% of total office stock. So they're 18% of the growth, 1% of the total office stock. If we look at a graphic here that i have in the newsletter maybe i'll share the screen just for it's pretty easy this is from a recent bloomberg report and it shows that office space in the united states is actually shrinking so generally they have a chart here of two things they have new construction for office spaces and

that's in black that's on the positive line and then the negative line space being removed generally there's a little bit amount of space being removed each year and a lot more of new construction. In 2023, we actually saw that hit negative. So you can maybe spin that as a good thing because we're rationalizing supply, but I don't know how many years we're going to need to rationalize supply. And if it's multiple, as we get into it, we were just going to be in a lot more trouble. Anything else on that, Ryan, before we get to management and ownership? No, I think it's obviously a massive market to go after. And it's maybe just important to mention that i mean we work isn't the only one in commercial real estate that's hurting a little

bit like their landlords are in precarious positions as well yep everyone is in this industry at least anyone with big exposure to office space specifically and it could be honestly a good time if they started the company right now it'd probably be the optimal time to do so yeah with all the funding they have or assuming they got the same funding over again yeah That'd be a better time to do it. The leases are going to be much cheaper. Yeah. All right.

Let's go to management and ownership. There has been a recent shakeup at WeWork's executives week after the stock collapsed this spring. As Ryan mentioned, a lot of those losses, which we'll get into the structure that they did this deal with SoftBank. A lot of the losses here on the common stock were this spring. So since February, 2020, the CEO of WeWork was Sandeep Mathrani. I hope I'm saying that right.

He led the analyst call for Q1 results in May. he wrote a long letter for the proxy statement filed in early May. He was saying things like, this is WeWork's moment, and quote, at the end of the year, 68 of 99 total markets were over 70% occupancy rate, including New York, London, San Francisco, and making up 75% of revenue. All sounds nice, right? He was talking about occupancy rates getting higher. Everything sounds good. Well, the board of directors didn't think so. And as we get into the earnings next, you'll see why. On May 16th, WeWork announced that Mothrani would be leaving the company effective only 10 days after this on May 26th and getting replaced by an interim CEO

from the board named David Tolley. Tolley actually only joined the board of directors earlier this year. So it sounds like he was ousted. Sounds like we don't really know exactly what happened. Obviously, in the press, they all said, blah, blah, blah. We love each other. We're the cult of way, blah, blah, blah. But it looks like this was pretty big time conflict here, as I would say. Other notes, I guess, from the proxy, SoftBank can have no more than 49.9% voting power on the stock. And as we get to the ownership table here, after the deal that Ryan will probably mention in the balance sheet section, they own 88% of this company. So I thought that was really interesting. They had $1.5 million in director compensation in 2022.

Adam Newman still owns 20 million Class C shares, but they have been voted to be equivalent to just one vote per share now. So that got changed. So he doesn't have any control of the business anymore. David Tolley, who's the interim CEO, owns zero shares of the stock. And in 2022, the board paid the executives, again, the stock that's now 99% here, they paid them $3 million in cash bonuses for, quote, hitting strategic objectives. That was the biggest red flag for me. Mothrani, the guy who just got ousted, was paid $6.5 million last year.

Again, I will highlight on the ownership table here, SoftBank as a combined entity owns 88% of the stock. Ryan, let's move to earnings. And if you have any thoughts on management ownership, given if you want yeah i mean it's funny like hitting strategic objectives it's kind of such an abstract like it yes technically they brought mothrani in to try to reduce the cost structure and they did and he did do that but he got he got paid a lot of money and they're still not in a sustainable place so i don't know i guess he did technically do his job but and you know what i think if you i listened to the conference call um the most recent quarterly conference call as opposed to reading the transcript like i normally do if you go and

listen to it you will not be surprised why um he was probably ousted like the analysts were yelling at him basically without without yelling at him they were like it reminded me of the 2001 and ron call yeah the it seemed i remember reading it when i i guess i didn't listen it would have been fascinating but that one alms went back and forth it was like you promised free cash flow 2022 you didn't happen and promise free cash flow early 2023 it didn't happen now you're pushing it out to late 2024 and then the soft bank deal which you'll get into totally screwed every other common stockholder i felt like they probably felt like eduardo savern from the social network when the guy brings the pen and he's like why don't you sign this eduardo and then yeah but we don't need

get down that rabbit hole, but why don't you get earnings? Sure. And we'll talk a little bit more about the conference call in a little bit, because it was really fascinating and it paints a good picture of where the business is at today. But in 2022, they did north of $3 billion in revenue, and that was actually growing 26% year over year. And that's despite them reducing locations. So the big highlight there is that occupancy rates in general, relative to COVID, have certainly accelerated. So over the last year, they went from 65% to 75%. There was a little bit of slowdown in the most recent quarter, but the Sandeep did call out a couple legit reasons why that might've been affected. There was a big enterprise customer

in the UK that kind of heard it short-term and that it's more of just a seasonally slow quarter also. So in general, occupancy rates have gone up and that's really helped the company grow the revenue line. Average revenue per membership has been basically flat over the last year. However, when we get to the expenses, this is where it's concerning. Operating losses of $1.6 billion in 2022, that's a minus 50% operating margin, but that does not paint the whole picture because they pay $500 million in interest expenses annually, or they did last year. So the net loss is more than $2 billion. Now, the most recent quarter, I'll go through some of the numbers, but the big thing that

happened was this recapitalization essentially. So let me go through the revenue first. It was up, I think 11% year over year, higher occupancy rates relative to last year. But like I said, it's down. Yeah, that was a big, I think that was a huge negative. They thought it was going to approach 80% and actually tick downward, which I guess is not a surprise looking back. now that we've seen vacancies rise, but in late 2022, I think you would have bet that the

occupancy rates would continue to climb. Yeah. I mean, it's still up year over year, so that's why you're going to see the revenue figure move up. But at this point, you can start to look at this business. I think you have to start looking at them sequentially, which means on a quarter to quarter basis, because you don't know how long they're going to be around for. So you got to get the most recent data you can. Operating margins have improved. They're negative 24% now, net margins are below negative 30%, but they are guiding for positive adjusted EBITDA next quarter. Now, if that meant anything, that'd be great, but it does not because the interest expense is enormous. And so it's along with depreciation and amortization,

which are both really certainly real costs for a business like we work with so much property and equipment. But I guess the important thing to understand earnings-wise is that management has now laid out a business plan that assumes they can be free cashflow positive by year end 2024. They have consistently pushed that back. So there's no promise that'll happen. And frankly, the CEO and the CFO made some, I think, bold statements in the most recent conference call that may have hurt them because they talked about any chance of raising capital and they made projections that they felt like they probably had to make to please shareholders that maybe they might not be able to meet. But let's go through the balance sheet because

like we've alluded to, they just did a big and really complicated recapitalization with a bunch of convertible debt. So it's a little complicated, but I think the important thing to understand here is that if you're looking at it for 2022, the interest expense then is not going to be carried forward because they were able to reduce their short-term cash interest expense. So let's go to the assets first. They don't own their land. So I think they maybe own their land in a couple of cases, but mostly they don't. So really the only important assets here are the property and equipment. So the stuff that's in the buildings, like the desks, all the different things they own that they've put in to kind of reconfigure this coworking space.

And then the cash. After this recent recap, they're going to have about $422 million in cash. Liabilities. Here's where it gets a little complicated. First of all, so WeWork has now $2.4 billion in total outstanding debt. This debt is comprised of nine different debt structures that in total have a weighted average interest rate of about 13%. I'm going to go through some of these just to show you how complicated it is. And if you try to read the language in the 10K, uh, best of luck. So they've got, um, well, they got rid of their senior letters of credit tranche. They moved to a junior letters of credit tranche. They have senior secured notes, first lien backstop notes, first lien delayed draw notes, second lien exchange notes,

second lien convertible exchange notes, basically this long list of all different types of debt structures. Anyway, basically the reason they did this is they were able to extend the maturities out to 2027, but in the process, it pretty much tripled the share count. So very dilutive. Yep. I got it up here right now. The shares outstanding are up 198%. And it's because they gifted a lot of the debt holders, SoftBank, the shares in a conversion, debt to equity conversion. I guess to summarize, WeWork has essentially $2 billion in net debt. That's mostly due in four years, but they raised this money at the expense of shareholders. Shareholders noticed because the stock has thus dropped 90% since,

and that's in a matter of like two or three months. Management says they'll be profitable in two years, but they've consistently pushed that back. Essentially, at the end of this balance sheet segment, I always try to get to kind of what is it concerning? And the answer here is yes, this is a bad balance sheet and they'll probably end up entirely owned by SoftBank. Yeah, or yeah, I guess they're maybe the other debt holders as well.

I think two other notes I would have here. One is they're getting a lot of payment in kind here, which I think means, again, there could be some intricacies, but I think it means you don't pay the interest expense. I guess we can look up the exact definition of that. You don't pay it at the time. It kind of just gets added up until the actual principal is due. And then the second one, their interest expense on this stuff, on this new debt is significantly higher.

So we'll see how everything plays out. Yeah. Basically what Brett's saying is that it's helped them in the short term, but in 2027, they're going to have a massive chunk of change due because I think a lot of these are term loans too. So like the principal won't get paid back for some time. So they may have gotten rid of some of the term loans also. Yeah, it's too complicated for an audio recording, but yeah. They bought themselves four years, and if they are generating a healthy amount of profits, maybe there's the chance that someone else steps in and kind of gives them a different, you know, they can roll the debt in more favorable ways or something like that. But really, I mean, they've got a lot of, they owe a lot of money within the next four years, and they don't generate money now. Yep, yep. All right. Let's get valuation again. This is a difficult one because we kind of have to price in the restructuring and the collapsed stock price. Even with the collapsed stock price,

they have a market cap of approximately $486 million. If we want to go through a hypothetical, if we took WeWork back to its SPAC price of $10 a share, its market cap would actually be $21 billion with its current shares outstanding. So significantly higher from here. And that's quite the hefty multiple. It shows how when a company gets in trouble and has to heavily dilute shareholders, that can, if you can do the math, very much hurt you. If we add back the pro forma debt from the Q1 earnings presentation, which I honestly wouldn't do net debt, I would probably do total debt because that cash is going to not be available for shareholders, but let's just be lenient. We're going to use it. They have $2.4 billion, or excuse me, WeWork has an enterprise

value, if you add that to the market cap, of $2.4 billion. We use, and this is the metric I'm going to use here because it kind of shows how much room they're going to have to pay their SG&A and their interest expense and all that good stuff. I'm using revenue minus location expenses, which is essentially a gross profit figure. We are currently, if we do an EV to gross profit on a trailing basis, we are currently at an EV to gross profit of 5.7. So really not even that cheap on a unit economics basis, unless you believe they have significant pricing power on their current leases. But with the 30% vacancies in a lot of markets, I don't really know how that happens. The last note I had for the newsletter here was, are you confused yet, Ryan? Because I

think I'm still confused. They try to make it very confusing. I think that leads into one of, I have a question here about what do we look for to disqualify a growth stock as uninvestable? I think one of the first things for me, and you as well, I know this is true, is getting too confused looking at the SEC filings, because you're worried that you're obviously missing something that could be detrimental. Yeah. I mean, if they do a poor job explaining things, management teams should be able to lay it out in a simple manner for most people to understand. And I think even really advanced expert investors could look at these and be like, what the hell is going on? So they made it very confusing. But on top of that, I have a new one, too, that disqualifies.

If analysts are kind of pushing back, if they're pushing back against executives and executives say, we've already mentioned this, we've already talked about this. Or if they say, like we've already said, like we mentioned earlier, and there's been a huge event that's happened since, it doesn't matter what you said earlier. And it's also, I think we're going to see it in a second, but executives tend to rephrase what they said earlier. And that happened in a huge way. And I'm glad some of the analysts called them out for it on the most recent conference call. Yeah. And I just highlighted another big one that we look at, and this is what disqualified us.

Like, I mean, a good example is kind of in a similar space. So it's on top of mind is Opendoor. What disqualifies us a lot from looking at a growth stock is unproven unit economics, where you can get into trouble on the operating expense line. A company that we followed and owned for a long time, Spotify, has seen that operating expense line be a little troublesome, but they have consistent, at least, unit economics where we work it's just if you have negative gross margins for a significant amount of time that should disqualify something right away from being investable okay let's move on through the

show so we don't want to go too long anecdotal evidence ryan what do you think about these things have you worked in one before uh not specifically a we work but i know a lot of people that use we work and i've been in one i've visited people that use um um friends of the show it's i mean it really is still like a pretty cost-effective solution to get office space especially if you're like a solo entrepreneur or something like that you're just kind of you don't have the means for a home office or you for whatever reason you want an actual office you can get a shared desk at kind of one of these floors where it feels professional they've got a good kind of community in there and i think it's i like the business yeah and they pay for all the

utilities to take care of that i mean we used to have that for a little bit i i agree with that i think it seems fine palm steps fine could see it growing but they do highlight one thing that actually i think is a low light and they talk about how they have large corporations that use them and their partners i think it was 50 or more of the fortune 500 if this is great because they're large businesses, right? That's a big opportunity. But I think they kind of look at WeWork as a, okay, we can just spit up office space for them if we want. We can take it down if we want. It's very uncertain where if you have a big company like Google that's using your stuff and they do a big layoff, well, they could just say, actually, we're just going to cancel this

right away. And being with the big enterprises, as opposed to smaller companies, I worry about how much power WeWork has. And you mentioned how it's a cost-effective way to get your office space. Well, yeah, that makes sense because they've been unprofitable for their entire history. So they're basically giving this stuff away at a huge discount. The only way, as we'll talk about maybe in the future growth opportunities here, is to lower their costs or increase the cost for their customers by 20, 30, 40%. Now let's move to those future growth opportunities. Ryan, what do you have here? It seems like they're in streamlined mode. So it's really, how are they going to save costs or increase revenue without growing their costs at the same time?

Yeah. Well, I'll say I do like the all access memberships and you're going to talk about that, but that's certainly one of them. But the other one for me is that, and they're definitely already in the process of doing this, but landlords, WeWork's not in a good spot, but landlords are not in a good spot either and if you think about it from the landlord's perspective or the building owner which they hilariously they hilariously call this like their network oh yeah in one of their they're like we have a we have a vast network of landlords or like partners or something like that i'm like i'm surprised that i just call my landlord my my network now yeah i'm surprised i don't call each person the node in their physical api or something like that you know you know what

Yeah. But they don't want to deal with extra vacancies either, these bigger companies. It's so hard to get probably occupants to fill out a whole floor right now. And if you think about it from the landlord's perspective, WeWork's doing them a huge service. They do all the work for them essentially, and they just fill up the space and give them rent. So I think going to them and trying to negotiate longer term, lower cost leases can be effective right now because I think the landlords can know like, Hey, like, you know, they're probably on the verge of going bankrupt. So either we give them a longer duration, lower cost stay, or we have to go out and get a new customer. Yep. And now I'll talk about mine, which is kind of growing that revenue. And I

I think the key thing, again, is you have to get more revenue out of the existing footprint. There's really no other way to positive cash flow and covering these interest expenses. One way to do that is expanding the WeWork All Access program. They hit 75,000 subscribers at the end of Q1 2023. That's up from only 20,000 in Q2 2021. The membership program cost of the base rate, it says $150 a month. But when I went there, they were offering on the website, they were offering 15% off for the first six months.

So I think they're really struggling at that price still. They're trying to give heavy discounts to get people into this thing. And essentially, like Ryan mentioned, lets you work at any of the locations any day of the week, or not any of the locations, but a good amount of locations any day of the week. You just have to book ahead of time. And yeah, there's risk there, but it's also very flexible. Last quarter, it hit $59 million in revenue, which I think was around 7% of overall sales.

So quite sizable, and it's growing quickly. But again, it needs to grow much, much quicker if it's going to be that significant in the next few quarters for them to get to that positive cashflow. Ryan, let's move to highlights and lowlights as we move to close things out. What did you like, dislike about this business? Well, I guess my highlights, they are in some ways a verb, kind of. They've willed themselves to being the go-to name in coworking. So that's, I guess, positive. It might've cost them a lot of money. And I will mention, actually, let's do a quick trivia. What do you think their cumulative net losses since inception i think i saw this it was like 16

billion 14 billion somewhere 16 billion so it cost them just 16 billion dollars to be the premier brand in co-working you know maybe it'll be worth it eventually i guess other than that i do like the model or i like the concept and i think if it's run properly it can be a win-win win for everyone it's a win for the landlords it's a win for we work because they can upcharge a little bit and it's a win for renters because they can or for uh people that are using the space because they can get a cost-effective way to uh um you know have office space however it's not being run properly right now so i guess it's it's all kind of theoretical but uh the second one for me second highlight is their largest supplier the actual building owners aren't really in a

a great position to be forcing their hand. Maybe some of them are, but the problem is, I guess my thought here is that the areas where WeWork has the largest vacancies are probably the same areas where the actual landlords have big vacancies too, so they can hopefully negotiate better contracts on those, which is where they need them. So anyway, I guess that's a positive in some ways. the positive is that they're not the only one that's screwed. Low lights though.

I think the previous management team was pretty dishonest. One of the analysts, Alex Goldfarb, props to him, kept pushing back on free cashflow. And he was like, basically he was like, listen, you said it was going to be middle of the year, 2023. Then you said it was going to be end of the year, 2023. Now you're saying end of the year, 2024. And then the CEO or maybe it was the CFO was like, no, we've been pretty consistent about that. We've been mentioning that. I don't know where you got that. And then he's like, his exact quote was, no, it hasn't been consistent. This has been a topic that you guys know I regularly ask and focus on. This is a change from what you guys laid out before. And it's a little troubling because the $90 million of cash interest savings was supposed to be an acceleration.

and then there was kind of like a bit of a long pause on on when you listen and it's kind of funny to hear those because you don't see them in the transcripts what do they respond and say i think he just went into like basically the guidance and like why the ceo kind of took over for the cfo at that point was like actually well you know let's uh i think what my friend here is trying to say is and then i can't really remember he basically got into the nitty-gritty of the guidance. And it was kind of hard to follow, but anyway, so that, that was a low light for me. The balance sheet's incredibly complicated. It seems like bankruptcy is pretty much the likely scenario at this point. So that's, you know, kind of a, like a major low light because

it means shareholders get nothing. So yeah, there's an endless list of low lights. Yeah. I wrote down on my low lights page. Do I even need to write them down? But the highlights though, I think of the same one. The brand is strong. I'm on tech and startups if the startup cycle kind of reverses we get a lot of startups going yeah that could help spur demand and it can be more cost conscious uh but i think today people may be more price sensitive across looking at the various co-working spaces because i know when we looked at some there's about 10 different offerings maybe we looked at and we just went hey what's the one that's not terrible but a decent price and you can negotiate down about a hundred dollars a month

I think it's still a good value though, because they take that holistic fee or one fee and you basically don't have to cover anything. They do utilities, they do everything, they do your mail, everything like that. So you don't have to worry about a lot of stuff. And that is quite valuable. I think there's really good price to pay for that. And I'm surprised they haven't pushed price even further. I would do that on a per month basis because what was it in the 400s range? I think honestly, they should go higher, but maybe they're not comfortable with that. Maybe there's a reason And they're not comfortable with that because that would very significantly increase vacancy rates.

And then the other highlight for me is that the business model has worked. If you look at IWG, which again is Regus, they're profitable. They were struggling when WeWork was going crazy and that was due to WeWork, but they were profitable last quarter, even with this vacancy stuff. And this business model can work. They don't even have nearly as strong a brand as WeWork. so yeah i think low lights though you still got the newman ick here their aggressive cost structure still sticking around you know gross moderns are barely positive blah blah yeah they're

gonna run out of 12 executives yeah you did see that huh i didn't see they had 12 executives for a company that's about to go bankrupt and they also are again struggling with costs and paying their directors a lot of money paying their executives a lot of bonuses paying for a compensation consultancies, give them cover to pay for all this stuff. Yeah. And then other is the industry dynamics. You have the overall return to office trend that happened in 2022 has totally stalled out now. This can be seen in WeWork's vacancy rate stagnating in recent quarters, or really last quarter is the big one. And then the data coming out of the US cities in Q2 is not in WeWork's favor at all either. So I think it's potentially going to get even worse.

And then the deal with SoftBank was really tough. Now SoftBank's the majority owner. They really gifted a lot of this stuff. They screwed over a lot of the other shareholders, I think, or maybe. I think if you're a shareholder, there's maybe, I don't know if I, there's some blame to you for not looking at this income statement and balance sheet beforehand, but I think they basically admitted that they were insolvent and SoftBank had to come for a rescue by basically diluting the bejesus out of the rest of the shareholder base.

and then yeah the trustworthiness among the executive team right i already mentioned that but you know i could i will say it looks like they're gonna have to do a reverse stock split i think to stay listed on the new york stock exchange their last hope is to be a meme stock yeah this could be a meme stock they need to pull a carvana and then raise like a billion dollars by memeing this thing maybe this new ceo is going to do that this is not we would never buy a stock because of that do not buy it because it's going to be a meme stock but there's potential obviously this could set up to be like that because it's a penny stock now let's move the ticker is we that's a good that's a good meme stock ticker yeah yeah all right bull case ryan what do you think

well the uh the old management team's most recent guidance indicated that they think they can be free cash flow positive by the end of 2024 if they're able to do that and they don't have to raise any more money, there's a path to sustainability until the bulk of the debt comes due. Really, if they can be generating consistent cash flow, maybe there's a chance they roll the debt and get out of this hole. I will say the CEO explicitly said this. I'll read the dialogue. The analyst asked, even with this new projection, you guys do not see a need to access any additional term loans or additional capital, right? And Sandeep Mothrani, the CEO, said, correct. So if he's honest there, but maybe that's why he was canned.

They're going to need more money now. But if that's right, and they do get to free cash flow positive by the end of 2024, let's call it 2%, maybe 3% free cash flow margins, we're looking at $75, maybe $100 million in free cashflow on the current revenue base. Who knows whether that'll be up or down by that point because they are still getting rid of a lot of their leases.

I think the equity could be worth something in that case. It's priced so low that, yeah, the equity could be worth something. But again, we'll talk about the bear case. It's pretty simple. There's likely going to be dilution. SoftBank could take you out. Yeah, they could just file for bankruptcy

and then SoftBank already takes this over. it's a very high risk situation. Maybe if you believe in the story, it's probably too cheap. Maybe if you believe in the story, you buy some options here. That could be the way to play it, but it's still very, very risky,

but high risk, potentially high reward. It's just such a sticky situation. We're trying to pull the bull case into here. Just, I think long story short, it's very, very risky, but if they pull things out, it's probably a 10 beggar. Yeah. All right. Probability is probably pretty low on that.

Let me put some numbers in here for that. So I don't know how far away they are from generating positive income. 2022, WeWork had $1.7 billion in SG&A pre-opening interest and capital expenses. This excludes depreciation and other non-cash charges. In 2022, they generated $331 million in gross profit, which again is revenue minus location operating expenses. Can they get to $2 billion in gross profit through price increases and better lease negotiations, basically getting a better spread there? Maybe, Ryan's shaking his head, but there's still a long ways off. And I would bet it's multiple years until they get there, which is again, why i would bet i don't think this company exists in a few quarters or if it soft bank takes this

over i think that's pretty clear it's going to happen bear case so ryan i think it's easy they're just run out of money right unless you have any other final thoughts yeah i mean they don't make it to profitability which seems like a very possible scenario um and the equity is worth zero yeah you lose 100 the downside is you lose 100 of your investment And now we've been kind of making fun of SoftBank here because they just screwed all the shareholders. They are one of the largest shareholders. I mean, they're left holding the biggest bag of anyone here. Yeah, I think honestly, they should just take this out and make it a subsidiary of SoftBank and then get it to profitability because SoftBank is such a giant company, right?

I think they just have to do that. it's just going to be ended up being a full subsidiary of South Bank where they can kind of get through this period without having to worry about all this stuff. I don't know why they haven't done that already, but who knows? Because they got outside shareholders footing the bill for some of it. I guess for the, not much anymore with that price. Okay. Let's wrap things up. We're finishing out the fallen angels month with a stock that we are actually interested in. It's called Coupang, a South Korean company. We don't own it, but we'll go through why we kind to like the company, give some blah, blah, blah, all the Arch Capital episode type stuff.

Going to be a really fun one. Thank you everyone for listening. As we give the disclosure here, we are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you everyone again for tuning in. Hopefully getting a good case study on a company that goes down 99%. And we'll see you next time. We'll see you next time.