Understanding WeWork Valuation – Is it really worth $47B

Wework Valuation

In this blog, we shall discuss about the latest real estate technology unicorn, WeWork valuation which has filed for an IPO.
The company is valued at $47B.We will look at the business model of WeWork, its revenue and cost drivers along with its future growth trajectory to assess if the company is really worth $47B.
Will Wework fail to get a better listing like Uber and Lyft or have a success like Beyond meat post IPO?

WeWork Business Model

1. Wework operates on the business principle of shared economy that has seen the emergence of similar business models like Uber/Lyft in ride sharing and AirBnB in housing.
2. WeWork operates in the real estate space and is an intermediary between the property owners/landlords and the companies that look for office spaces.
3. Wework rents or leases huge amount of spaces from landlords at a premium rate and renovates the spaces to build aesthetic offices which is then rented to freelancers, startups and enterprise businesses.
4. The value proposition is based on a networking effect which Wework calls as Flywheel effect.

Wework valuation – Flywheel effect

1. Wework adds value to the landlords as they lease massive real estate for a period of 5-10 years.For Landlords, it is easier to negotiate with a single tenant as against the current practices of negotiating with multiple tenants.
2. Wework then renovates these buildings by bearing huge construction expenses to come up with aesthetic working spaces for millenials.The company also offers free coffees and beers along with high wifi connectivity, facilities for printing and office supplies.These spaces are then rented to freelancers, startups and enterprise companies.
3. Wework also collects data about its members on space utilization, their movements and their priorities which helps them to come up with targeted offerings for each customer segments.As more members are enrolled, Wework expands to multiple locations, these data can turn out to be a strategic moat for the company.Wework aspires to be Google analytics for real estate by having a largest repository of data on space and real estate.
4. With this data, Wework can build up its office space that can increase customer experience of its members which would result in higher membership.
5. As more employees use Wework, then Wework will expand and lease additional real estate.This will give it an higher negotiating power with the landlords and thus can help in getting rental and lease discounts.
6. With more offices, more members will be added and with more members, more data will be collected which can help Wework in providing better target offerings which leads to higher customer experience. This leads to a Network effect and termed by Wework as Flywheel effect.
7. As Wework expands, its revenues will increase and due to scale, it can reduce its cost base.Hence over a longer term, it will become profitable.

Wework valuation – Revenue and Cost Drivers

• As we are clear with the Business model and what Weworks wants to achieve, let us look at its revenues and costs drivers to conclude if Wework can actually achieve this Flywheel effect.

Revenue Drivers

• The majority of the revenues for Wework will constitute the rental arbitrage which means that the rental income for Wework should be higher than the rental payments.

Wework gets revenues from the following:
Membership costs

• Wework charges annual membership for its members.When the customer becomes a member, they would be able to access the Wework ecosystem, which would include buying sales/marketing tools, office supplies and food at discount.
• In addition, the Wework app connects the customers to each other which can lead to a business opportunity for networking for customers.

Renting Desk spaces

• For freelancers and solopreneurs, Wework provides a desk which is charged at monthly basis. If freelancers wants a dedicated desk space, then higher cost will be charged.
• The freelancers will be provided other office facilities like Coffee, beer, high net connection and printing facilities.

Offices for Startups and Suites

• Startups and small companies that do not want to invest and manage offices can leverage Wework individual offices which will be provided with reception center, a dedicated floor along with other facilities like conference rooms and cafeterias.

• The advantage for the startup is that the rental contracts start from monthly basis, hence startups can wind up their offices if their business are at losses or can upgrade and move to expanded offices when their business improves.This facility eliminates them to be stuck on facilities costs which takes up a majority of time and costs.

Enterprise customers

• Wework has also started to pitch for large companies like Facebook and Salesforce where they build offices for their employees.
• The office layouts are selected by the customers and all the operations for maintaining the facility is taken care by Wework employees.
• For enterprises, facilities management is an overhead and reduces profitability. Since facilities management is a core competency for Wework, outsourcing it would provide higher efficiency and savings.

Welive and Wegrow

• Wework has also diversified its rental business to apartments sharing and starting school for children.
• The objective is to cross sell additional offerings to the members in network.The schools are in the same place as the rental buildings.
• Wework has acquired companies in this space to increase their revenues from these offerings.These businesses at this point are not generating enough revenues, thus making the coworking business as the significant revenue generator.

Value added Services

• Wework is also offering value added services like providing real estate consulting called “Powered by We”.
• The data collected by Wework on its members help the company to analyse and come up with targeted service offerings to optimize the space and increase the employees per unit space while at the same time not comprise on the customer experience.
• Wework can sell these advisory services to other corporates and advise them on how to better optimize their space in offices.

Cost Drivers
Wework biggest cost driver would be the rental leases and construction costs.
Rental leases

• Majority of the costs goes to leasing rental spaces.Wework enters into lease with landlords for 5-10 years.
• Already it has invested $18B on rentals in next 5 years.

Construction costs

• Once the spaces are rented, Wework would spend to optimize the spaces and also provide an enriching customer experience.
• Wework has acquired companies in Construction space to further optimize and increase the customer experience.
• Wework also has acquired data analytics companies to analyse the space usage and come up with better insights to improve the space utilization.

Sales and Marketing

• Wework spends 32% of its revenues on sales and marketing in order to bring more members into its network.
• Wework would be more focused on targeting enterprise customers as this would give them bulk of customers as against targeting freelancers or startups.
• As of now, enterprise customers contribute to 30% of Wework revenues.

Current Profitability

• Wework is not profitable and is burning cash.
• Operating income is positive which validates the strength of the business model.Wework is offering more discounts to retain and acquire customers.

Wework valuation – Risks in the current business model

1. Wework business model has its share of risks.Wework enters into long term lease agreements with landlords but offers short term leases to customers.This gap can lead to financial risk during the downturn or recession where startups would either close their offices or freelancers would lose their jobs.In this case, Wework has to still bear the rental payments.To mitigate this, Wework is targeting more enterprise customers as they will enter into longer lease agreements which will protect them during the downturn.
2. Wework business model is not disruptive and has many competitors.Its nearest competitor IWG is profitable but is valued at $3B which is less than 10% of Wework valuation.Since the entry barrier is low, Wework would need to spend more on Sales and marketing to retain their customer base and prevent them to move to competitors. This will also make it difficult for them to capture more share of enterprise customers or get favorable rates from landlords.
3. The current business model will face losses in a downturn or recession.As real estate is a commodity, companies will consolidate and close their facilities during the recession. This will impact the earnings of Wework.
4. Wework biggest investor Softbank has scaled down its planned investment in the company which indicates the company is not meeting the targets to get additional funding.

Final thoughts on Wework Valuation

1. Valuation of Wework would be focused on numbers of members in its network that is using Wework services.
2. The valuation should focus on revenue/member.At this stage, Wework is burning cash and looking at the competition, market dynamics and the macroeconomic climate we can clearly tell Wework is overvalued and would not be able to perform well post IPO.

Conclusion

1. Wework valuation of $47B is far higher than the intrinsic value and is estimated based on the long term profitability that it can achieve through the network effects.
2. Wework follows the Amazon model: focus on building out infrastructure and achieving brand power first, then focus on profitability later.
3. As the real estate market is a commodity and is subjected to high volatility during the economic downturns, it would be difficult for Wework to have a good run during the recession.Many of its competitors like IWG had filed for bankruptcy during the recession period.
4. Due to the lower entry barrier and high competition in this space, Wework needs to spend more on Sales and Marketing to acquire and retain customers.It also needs to acquire competitors who are entering this space.Hence at this point, it would be difficult that Wework achieve its flywheel effect to get profitable in longer term.