WeWork: Behind Their Overpriced $9B SPAC

This report contains company financials based on publicly available information and data acquired by Sacra during the preparation of the report. Sacra did not receive any compensation from WeWork for the report. This report is not investment advice or an endorsement of any securities. Click here to read our complete disclaimers.

Last month, WeWork announced it would be going public again—this time, via a SPAC.

The $9B enterprise value of WeWork's SPAC is a big markdown to its previous $47B valuation, however, we believe it is still expensive despite improvements to the business and structural tailwinds. 

Last December, we published a report on WeWork. Our core thesis was that WeWork had a perfect mixture for turnaround with over-pessimistic news headlines, under-appreciated structural shifts, optimism from industry experts and stakeholder alignment between SoftBank, landlords and new management.

New disclosures from the company have confirmed some aspects of our thesis:

Ultimately, WeWork is more well-positioned than traditional landlords in a hybrid working environment. It is also better positioned than most flex-space providers due to its large global footprints. Some investors are clearly optimistic about this, as WeWork’s bond price has recovered from 28 cents to 99.8 cents on the dollar, a 300%+ peak to trough over the last 10 months. 

However, WeWork is still a cyclical, high risk, real estate business. $40B+ of operating leases remain unaccounted for in the capital structure in WeWork's SPAC deck, and the company has only $665M of cash on hand to deal with its significant interest expenses and capex. For WeWork to win, it will require fanatical execution not just on keeping costs low, but on growing and achieving high occupancy—and so far, the company has shown it can achieve either growth or higher occupancy, but not both.

Our view is that at $9B enterprise value or the $7.9B equity value, WeWork has fully priced in their future recovery, with ambitious long term occupancy forecasts on top of that.

We valued WeWork at $3.5B equity value last December. The company's 2020 occupancy was 46%, or 15% lower than our assumption. This caused a higher cash burn than in our base case. The company went on to end the year with a $3.2B net loss, and management expects cash on balance to reduce from $3.6B in Q320 to $665M by Q221.

Why is WeWork raising cash now? It needs to pay for its interest expense and capex. We estimate WeWork pays $300M net interest expense per year and has at least $400M net capex requirement. In other words, the remaining $665M cash on the balance sheet wouldn’t be enough to cover one year of interest expense and capex.

In addition, the pro forma valuation in the WeWork SPAC deck isn't capitalizing its $40B+ operating leases (operating leases are a form of debt, so they should be included in the capital structure). If we include operating leases in enterprise value, it reduces equity value to zero. We believe WeWork has some option value—but one gives up a lot of upside paying $7.9B.

WeWork’s equity value is also highly sensitive to occupancy rate and the cost of capital. For example, a 5% drop in long term occupancy rate equals a 60% drop in equity value. This exposes WeWork to execution risks if the company is unable to achieve its guided revenue projection.

WeWork's equity value is highly sensitive to changes in long term occupancy rate. 

It is almost a philosophical exercise to determine WeWork's cost of capital. If we capitalize operating leases, WeWork is 90%+ debt and <10% equity. Then, their cost of capital would be lower in the current low yield environment. However, the SPAC deck neglected the operating leases, flipping the debt to equity ratio and presenting the company as 90% equity and 10% debt. 

To illustrate the difference, with a 10.5% cost of capital, a 1% increase in cost of capital creates a 30% drop in equity value. 

WeWork's equity value given different costs of capital.

If we sensitize both occupancy and the cost of capital, we get to the following mix of equity values in $B. 

Sensitivity analysis of WeWork's equity value given different costs of capital and occupancy rates.

At $7.9B equity value assuming 95% occupancy post 2024E and 10.5% cost of capital, we believe WeWork has an unattractive risk-reward profile.

There were three notable changes in WeWork's March 2021 SPAC presentation: 

These changes—more granular than disclosures shared in the company's S-1—make clear that WeWork has a nuanced business.

Firstly, commercial real estate is ultimately a cyclical industry. The long-term leases last for 15 to 20 years, which would cover potentially two or three real estate cycles. Last year was WeWork’s first economic downturn, it is just too early to conclude a cross-cycle contribution margin. Similar to cross-cycle contribution margin, in an ideal world, we’d want to look at the normalized occupancy across the cycle, i.e. the occupancy that, on average, can be maintained in the building. 

WeWork estimates that the contribution margin on mature locations is 27%, but currently mature markets only account for 47% of the total revenue. 

Source: WeWork March 2021 SPAC deck 

Secondly, since 2020, WeWork has launched a new product called All Access. It leverages WeWork’s global footprint in 150 cities and over 850 offices. WeWork All Access (“WAA”) optimizes the fleet and improves the asset turnover of existing office space. Given the proximity of WeWork offices in city centers, WAA members can self-regulate and find vacant desks. Management projects a higher occupancy rate due to WAA and an additional revenue of $481M over the next three years. 

Nevertheless, an important nuance is that there are two types of occupancy in the flex space. Physical occupancy is the number of people who are actually in the building, and economic occupancy (undisclosed) is the percentage of income-generating members. During high demand, physical occupancy can be as high as 100%. Economic occupancy, however, never reaches 100% because some members are on a discounted membership, bringing down effective revenue. Relating back to the management’s projection, even if WeWork reaches 95% total occupancy with WAA, their economic occupancy could well be lower. 

Thirdly, the SPAC deck makes no mention of WeWork’s operating leases. As of 2019, WeWork had signed $47B future lease commitments. Recent changes in lease accounting standards require companies to record operating leases on the balance sheet at the present value of future lease payments, and WeWork has not done so here. 

Source: WeWork S1 2019

We estimate $45B lease commitments were still outstanding at the beginning of 2020. Assuming WeWork managed to exit 10% of these leases last year, the balance would still be sizable. 

We believe the capital structure outlined in the SPAC deck is incomplete because the present value of leases needs to be added to total debt and deducted from enterprise value.

Key to our earlier analysis of WeWork's turnaround strategy was the idea that WeWork could negotiate discounts or deferrals to help it stay in business through the pandemic.

Through our primary research, we've learned that some landlords have been very accepting of this given the current economic climate—and have been quite responsive to WeWork’s requests.

WeWork overall has been cooperative in dealing with landlords. WeWork’s biggest competitor IWG has been through a handful of economic downturns in the last 30 years, but every time, they had a very strained relationship with the landlords. Last year, Regus, who is one of IWG’s subsidiaries, threatened to file bankruptcy.

Since these flex space providers structure each of their asset as an SPV, during a downturn, Regus can just dissolve the SPVs, hand the lease back to the landlords and walk away. This has been a reason for landlords not looking favorably at flex space providers. 

In contrast, under its new management, WeWork has aimed to work with landlords in a less adversarial way. From our research, we learned that WeWork is making sure it has the liquidity that is required to sustain itself in the short term. WeWork is treating landlords more like partners and prioritizing building trust and negotiating its way out of the pandemic.

That works for the landlords too, because if WeWork files bankruptcy and leaves, the landlord is also exposed to a vacant building in an extremely difficult economic climate.

This is a valuable lifeline for WeWork, which previously expected to operate at 60-70% occupancy and has seen that drop to 40-50%. Even though WeWork isn’t able to generate enough revenue, if it exits the building, the landlord would have a vacant building without rental income, meaning it is in the landlords’ interest to keep WeWork in the building.

Accumulating goodwill like this is critical for WeWork. The medium term impact of a more cooperative relationship with the landlords is that WeWork has a safety net. If reopening is further delayed in the long-term, WeWork can turn to the landlords for more rent deferrals.

In our December report on WeWork, we explained the path to profitability that we saw for the company—and how the company's new management had begun taking the steps necessary for a turnaround.

Since then, WeWork has continued to improve its governance, improve its cost discipline and improve its revenue mix. However, problems remain. Fundamentally, this is still a low margin, cyclical business with duration mismatch. We are cautiously optimistic about WeWork’s future—but the challenges and execution risks are far from over.

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