Business Public Markets

WeWork Files Its S-1: We Dive Into the Numbers And Pose Some Questions

Earlier today WeWork filed to go public. The firm, backed by SoftBank and a host of other investors intends to go public this year. The firm is also pursuing a large debt facility. Previously this morning we published a dive into the company’s financial results through the lens of its revenue growth, operating and net losses, and cash consumption.

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The following piece is broken into small sections, each centered around a question. Feel free to skip about and read the bits that you find the most interesting. One final note: Parts of this aren’t going to have training wheels, per se.

Let’s go!

What Are WeWork’s Gross Margins?

Good luck finding the cost of revenue line item in the WeWork S-1. It’s not that simple, naturally.

Happily, WeWork has a method for describing what appears to be a cost-of-revenue-like item, allowing us to generate something similar to a gross margin figure.

The company calls the line item “Location Operating Expenses,” which it defines as follows:

Location operating expenses are expensed as incurred and relate only to WeWork and WeLive locations that are open for member operations. The primary components of location operating expenses are rent expense, tenancy costs including the Company’s share of real estate and related taxes and common area maintenance charges, personnel and related expenses, stock-based compensation expense, building operational costs such as utilities, maintenance, and cleaning, insurance costs, office expenses such as telephone, internet, and printing costs, security expenses, credit card processing fees, food and other consumables, and other costs of operating our collaborative workspace locations. Employee compensation costs included in location operating expenses relate to the salaries, bonuses and benefits relating to the teams managing our community location on a daily basis, including member relations, new member sales and member retention, and facilities management, as well as costs for corporate functions that directly support the operations of our locations, such as personnel costs associated with the Company’s billings, collections, purchasing, and accounts payable functions. Sales incentive bonuses are also paid to employees as a means of compensating the community team members responsible for location level sales and member retention efforts.

I apologize for the large paragraph, but the firm includes rent costs, taxes, building-upkeep costs, onsite staffing costs, onsite office costs, and some offsite costs that are used to “support” the buildings in question in the line item. So, Location Operating Expenses seem to account for the direct costs of running buildings, making Location Operating Expenses a workable cognate for the cost of revenue stemming from WeWork and WeLive locations (the vast bulk of WeWork’s revenue). (Also bear in mind that Location Operating Expenses do not include “depreciation and amortization” costs, per WeWork. Those are listed separately.)

Now that we have a way to calculate gross profit from the company’s buildings, what do the results show us? Observe the following pairings of WeWork revenue, and same-period Location Operating Expenses:

  • WeWork H1 2018 results: Revenue of $763.8 million, Location Operating Expenses of $636.0 million (83.3 percent of revenue consumed by location operating costs)
  • WeWork H1 2019 results: Revenue of $1.54 billion, Location Operating Expenses of $1.23 billion (80.3 percent of revenue consumed by location operating costs)

So WeWork’s cognate to gross margins grew from about 17 percent in the first half of 2018 to about 20 percent in the first half of 2019. Those are decidedly not software-style gross margins that usually rise above the 70 percent mark. (And we’re mixing revenue to some degree in our math, possibly assisting WeWork’s numbers margins in looking better than they are.)

Why do we care? WeWork is spending mightily to grow not-very-profitable revenue. That’s worth remembering.

How Much Debt Is The Firm In?

Some, but it’s a bit annoying to untangle. After futzing about in the company’s debt notes (page 195 in its S-1), here are the key bits.

WeWork has a number of credit agreements that it intends to replace. The firm does note, however, that at “June 30, 2019, $1.0 billion of stand-by letters of credit were outstanding under a combination of the credit agreement and the letter of credit reimbursement agreement.” So that’s $1 billion, provided we are reading the text correctly.

Moving on, in the past, the company “issued $702.0 million in aggregate principal amount of 7.875% senior notes due 2025,” something that we knew. According to the firm, it “repurchased $33.0 million aggregate principal amount of the senior notes for total consideration of $32.4 million” in the first half of 2019. So, the full tally from this bit of debt is probably less than the initial dollar amount.

And yet WeWork notes “[t]otal liabilities” of $24.6 billion as of June 30, 2019? What’s up with that? The firm has $1.29 billion in “[a]ccounts payable and accrued expenses” helping give it a “current liabilities” figure of $2.6 billion. But take into account its long-term lease obligations of $17.9 billion, toss in long-term debt ($1.34 billion, according to the company), and WeWork sports long-term liabilities of just under $25 billion as of the end of Q2 2019.

Summing, that’s less debt than I expected, but a higher total liabilities result than I anticipated

What Do WeWork’s Relative Results Tell Us?

We’ve gone over the firm’s growth results, so I’m not going to retread that ground here. However, it is worth looking at the firm’s changing cost makeup. What follows are the company’s big results, broken into percentages:

As you can quickly see, the firm’s location operating expenses are falling as a percent of revenue (as we saw before). However, when you add depreciation and amortization to the firm’s location operating costs, the firm’s effective margins appear weak.

More notable, I’d reckon, are certain cost categories that are growing as a percent of revenue. For example, WeWork spent 8 percent of revenue on “growth and new market development expenses” in 2016. That rose to 24 percent in H1 2019. Sales and marketing costs? A slim 10 percent of revenue in 2016, and a sharper 21 percent in H1 2019.

The firm has kept its total operating costs at 189 percent of revenue in both H1 2018 an H1 2019, which could hearten investors. But the company’s cost profile as a percent of revenue, instead of getting better with scale, has remained flat in aggregate.

Finally, you can see the impact of the firm’s “other income” in H1 2019 (the key bump came in Q1 2019, for reference) that helped boost its two-quarter results. (In Q2 2019, a period that featured only a $91.8 million “other income” boost and not a $378.2 million bump as Q1 2019 saw, WeWork’s net loss stretched to $509.5 million).

All told, WeWork’s cost structure is super high, and not getting better as a percent of revenue.

Community-Adjusted EBITDA?

There are no mentions of “community adjusted” EBITDA in the S-1. Or “community-adjusted” EBITDA, for that matter.

But the firm does have “Adjusted EBITDA including non-cash GAAP straight-line lease cost,” and the same metric excluding the non-GAAP straight-line lease costs. These are very WeWork metrics that we should define now, as the company will tout them as its adjusted profit metrics of choice.

Here’s the definition for both from the same paragraph (Bolding, formatting: Crunchbase News):

We define “adjusted EBITDA including non-cash GAAP straight-line lease cost” as net loss before income tax (benefit) provision, interest and other (income) expense, depreciation and amortization expense, stock-based compensation expense, expense related to stock-based payments for services rendered by consultants, income or expense relating to the changes in fair value of assets and liabilities remeasured to fair value on a recurring basis, expense related to costs associated with mergers, acquisitions, divestitures and capital raising activities, legal, tax and regulatory reserves or settlements, significant non-ordinary course asset impairment charges and, to the extent applicable, any impact of discontinued operations, restructuring charges, and other gains and losses on operating assets.

We define “adjusted EBITDA excluding non-cash GAAP straight-line lease cost” as adjusted EBITDA including non-cash GAAP straight-line lease cost, further adjusted to exclude the non-cash GAAP straight-line lease cost adjustment.

As you expected, WeWork does better with each of these metrics than it does when observing its operating losses.

For example, looking at the adjusted EBITDA result that excludes straight-line lease costs, WeWork’s losses came to just $213.5 million in Q1 2019 and $297.2 million in Q2 2019. WeWork’s GAAP operating losses during those periods came to $639.7 million and  $729.7 million, respectively.

Want to see the adjusted profit metrics in action? Here you go!

Now, that chart from the company’s contribution section, but you can see contribution including the lease costs ($142 million) and excluding ($340 million). Fun!

Other Revenue Streams?

WeWork’s income is driven by its “membership and service” top line category. That’s the WeWork that you recognize. The firm also reports “other revenue,” which it defines as:

Other revenue includes revenue from our Powered by We solution performed and recognized using the percentage-of-completion method based primarily on contract cost incurred to date compared to total estimated contract cost, as well as income generated from sponsorships and ticket sales from branded events and revenue generated by any new solutions or services not directly related to the membership and service revenue earned through the operation of our workplace solutions, such as Flatiron School and Meetup.

It’s not a big portion of the firm’s revenue, though it does constitute a regular percentage. For example, in Q1 2019 WeWork generated $628.1 million in membership and services revenue, while other revenue came to $100.2 million. And in Q2 2019, those figures changed to $720.6 million and $86.4 million, respectively.

So, no, WeWork isn’t yet a software company.

Are Big Companies Powering WeWork’s Growth?

Somewhat, but the category is showing less growth over time. WeWork shared its “Enterprise membership percentage” for a host of quarters. The figure, showing the “percentage of our memberships attributable to organizations with 500 or more full-time employees” rose from 22 percent in Q2 2017, to 30 percent in Q2 2018, to 38 percent at year-end.

However, after rising to 41 percent in Q1 2019, the figure fell to 40 percent in Q2 2019. That means that the enterprise share of WeWork memberships fell from Q1 to Q2. I suspect that total enterprise seats grew, but not as fast as they once had.

Looking back in time, we can see similar slack percentage growth results in early 2018 when compared to the firm’s Q4 2017 result. However, as WeWork wants to tout growth in this metric, not retrenchment.

Still, that’s a somewhat attractive chart.

What Is WeWork Worth?

I have no idea. The company has impressive revenue growth, a huge cost structure, shocking operating losses, and titanically negative free cash flow. If it can pick up a few billion in debt to defray its costs, lowering its need for IPO-era dilution, perhaps it can entice investors at a valuation that it finds attractive.

But as WeWork’s gross margins are obfuscated, it’s hard to get a handle on what its revenue should be worth. What can we can say is that at a $47 billion valuation, WeWork is valued more like a software company than a real estate firm. And that’s going to be interesting to watch Wall Street tangle with.

Illustration: Li-Anne Dias.


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