Description

Our team has been working to develop a game plan for investing during the pandemic.  We have identified four key criteria to look for in core long positions.

First, each company must have a strong balance sheet that will allow it to survive a protracted crisis.  Second, each company must have a business that will continue to perform well for the next 3-6 months (or longer) and that is generating positive free cash flow.  Third, each stock must have substantial upside to compensate us for investing in the current environment.  Fourth, each company should be in a stronger competitive position as we (hopefully) come out the other side of the pandemic, as weaker competitors struggle to navigate the crisis.

Our favorite current investment that meets all these criteria is IWG PLC (“IWG”).

Built To Survive

IWG is a 1.5B GBP market cap company listed on the London Stock Exchange.  As little as six weeks ago, its market cap was 4.2B GBP.

IWG is the world’s #1 provider of flexible and co-working office space, with 3,500 locations in 121 countries that serve more than 2.5 million people each year.  IWG’s brands include Regus, Signature by Regus, Spaces, No. 18, and HQ.

We consider IWG to be a better-run, more-profitable, and far larger (5x the size) version of WeWork.  We call it “WeWork done right.”

Founded in 1989, IWG has survived (and learned from) three recessions, iterating its business model into a battle-tested, sophisticated machine.  IWG spends 60% less net cap-ex per workstation than WeWork but receives 34% more revenue per workstation. As a result, IWG’s mature location contribution margin is +28.0% superior to those of WeWork…+21% versus WeWork at -7%.

IWG’s business is built to survive.  92% of the company’s revenues are subscription-based.  Tenant rents are direct-debited from bank accounts (so IWG does not have to chase down invoices).  The average tenant lease is 12 months (up from 8 months a few years ago as IWG’s tenant mix has shifted strongly towards large multi-nationals with good credit).  IWG has excellent visibility on revenues and occupies a priority position to receive payment.

Even better, IWG has tremendous flexibility with its own leases.  IWG can exit 95% of its office leases in under six months.  28% of its locations are profit-shares with landlords (i.e., 100% variable cost to IWG).  All IWG locations are individually incorporated, so each location is bankruptcy-remote.

There is a common misconception that IWG operates like a bank – that it “borrows short and lends long” and is therefore subject to a liquidity crunch in times of stress.  The reality is the 180-degree opposite.  IWG’s tenant agreements on average are twice the duration of its office leases.  IWG sits in an extremely strong position.

Importantly, it’s hard for customers to leave IWG.  Another misconception is that IWG caters to start-ups and SME’s, but the reality is most of IWG’s business today is with multi-nationals.  They have global workforces, and IWG is the only co-working company that can offer a global footprint.  The reliable high-speed internet access (which most of the world’s residences don’t have), institutional-quality cybersecurity, and integration into company business continuity plans make IWG office space mission critical to many firms large and small.

Navigating The Pandemic

As soon as a recession hits, IWG activates its well-honed playbook for what to do in a downturn (they pushed the button one week ago).  The company stops dividends, buybacks, and growth cap-ex, and negotiates hard for rent relief with landlords.  IWG then passes along the rent abatement to customers to maintain healthy occupancy.  A business that usually runs with modest free cash flow (as IWG plows its capital into high-return growth cap-ex) suddenly becomes a cash flow machine.  In the current environment, we think IWG can generate in excess of 400M GBP of free cash flow over the next 12 months, putting the company on a multiple of less than 4x FCF/market cap.  The company describes this as an “offensive” not “defensive” playbook – in past recessions, IWG has picked up distressed assets for pennies-on-the-dollar.  The company fully intends to build up its war chest to not only survive but also capitalize on the current environment.

Our due diligence indicates IWG is doing well through the pandemic so far.  Occupancy levels remain higher today than three months ago.  Nearly all IWG locations remain open, though many have reduced staffing or electronic-only entry depending on geography.  Inquiries from new customers have actually surged as multi-nationals conclude they need access to back-up locations in the event primary offices become inaccessible.  To-date, IWG’s business has been resilient across its geographies.

The case study of China is of particular note.  At the peak of the C19 outbreak, IWG closed 90 of its 200+ Chinese locations.  Today, every one of those offices is open – and the company describes tenant traffic as having made “a v-shaped recovery.”  A similar rebound has played out in South Korea.  One of our worries was whether co-working spaces would decline in popularity post-outbreak, but that does not appear to be happening in economies that have successfully recovered.

Whenever the pandemic abates – whether that be weeks or months or quarters or years – we believe IWG will occupy a much stronger competitive position.  IWG’s balance sheet is clean with only half-a-turn of net debt and over 600M GBP of additional liquidity on its revolver (in place through 2025).  Importantly, the company is generating substantial positive free cash flow, just like it did in 2008-2009.  At the current run-rate, IWG’s debt should be fully paid off in 2-3 quarters.  In contrast, numerous small VC-backed co-working firms are facing distress – and WeWork’s bonds are trading at 30c on the dollar.  As the global economy emerges from the shock of the pandemic, IWG will face weakened (or less) competition and have plenty of opportunity for attractive tuck-in M&A.

The Stock

Which brings us to the investment case.  We think IWG’s balance sheet is a fortress, the company is producing prodigious free cash flow, IWG’s financials have so far been largely unaffected by the pandemic, and the company’s competitive position will only strengthen as we emerge from the downturn.  But what’s the risk/reward?

We find it compelling.  From the current price of 167p, the shares would need to triple to reach their price from six weeks ago.  We estimate the shares trade at under 4x run-rate free cash flow – and that the company can be debt free in a matter of months.

The upside, however, could be even greater than just a triple.  Prior to the downturn, IWG had begun converting to a franchise model.  Starting in 2019, the company successfully executed a half-dozen agreements at agreed multiples above 3x revenues (Japan, Taiwan, Switzerland, Monaco, etc.) with dozens more franchise deals in process.  If IWG were to sell the remainder of its footprint for 3x revenues, and assuming a peer multiple for the franchisor business that would remain, IWG’s implied value would be roughly 1100p.  That represents 6.6x upside from current levels.

This checks each of the boxes on our list.  A good balance sheet.  A business that is currently doing well (this is not an airline or restaurant where the business disappeared overnight).  3x upside in a recovery with 6-7x upside in a bull case.  The Founder/CEO owns almost 30% of the company and has gone into the market to personally purchase another $10M+ worth of stock in the last ten days.  Board members have personally bought too.  The competition is not well-funded and on the ropes, whereas IWG will have liquidity of close to a billion pounds by the end of Q2.  IWG is positioned to not only survive, but also thrive in the months and years ahead.  With the stock down 65% vs. the market down 20%, we think the market has far overdiscounted the risk to the business - and that the investment risk/reward is now compelling.

Risks

In a world where the pandemic is on everyone’s mind, there are a number of risks to consider.

Inquiries may be at a record high – but signed contracts are not.  With so many countries in lockdown, it is more difficult to close deals.  Should the crisis last months, we think revenues this year can be flat or up (remember 92% of revenues are subscription with an average tenant lease of 12 months).  If the crisis lasts a couple years, revenues will eventually begin to decline.  As countries restart their economies, IWG is poised to capitalize on pent-up demand (as indicated by growth in inquiries).  But until that happens, IWG’s revenue momentum is likely to be muted.

Another risk is whether the co-working model is permanently impaired.  Based on the experience in Asia (and the bump in inquiries around the world), we doubt that will be the case.  But the C19 pandemic will likely change how people live and act, so this bears watching.

Finally, the pandemic could evolve in unexpected ways.  Could more markets or countries enter lockdown?  We think that likely.  Could the pandemic last a while?  The more time it takes to resolve, the longer it will be before IWG is able to conclude additional franchise deals.

Whatever the path, we are confident IWG is in a strong position.  The company has spent 30 years doing all it can to build shock-absorbers into its business model.  IWG’s balance sheet is built to last, and we believe the company will emerge even stronger when the downturn ends.  Combined with IWG’s excellent liquidity and compelling valuation, this is exactly what we’re looking for in today’s uncertain investing environment.

Disclaimer

The author of this posting and related persons or entities ("Author") currently holds a long position in this security. Author may purchase additional shares, or sell some or all of Author's shares, at any time. Author has no obligation to inform anyone of any changes to Author's view of IWG LN. Please consult your financial, legal, and/or tax advisors before making any investment decisions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in IWG LN. READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE. As with all investments, caveat emptor.

Catalyst

-The market discovering IWG's business is resilient

-IWG reporting healthy operating numbers and strong free cash flow

-Humanity getting its arms around the C19 pandemic

-IWG concluding "offensive" M&A and restarting its franchising process