Description

A few key thesis points:

1.       The pandemic was disastrous for WeWork’s financial results in 2020-2021, but significantly beneficial for the company over the mid- to long-term for several reasons:

a.       Acceleration of secular demand for flexible leasing

b.       Lower lease rates – WeWork has exited its least profitable leases and renegotiated its remaining portfolio of leases down by ~20%

c.       Reduced competition – some of WeWork’s newer VC-funded competitors, such as Knotel, have gone bankrupt

2.       WeWork is the preeminent player in a massive and rapidly expanding TAM. According to a report from Savilis, Flex comprised 0.3% of US/EU office space in 2002, grew at a 10% CAGR to reach 0.5% of office space in 2010, and then accelerated to a 24% CAGR to reach 2% of office space in 2019. Brokers expect growth to further accelerate to a 30% CAGR over the next decade, with Flex reaching ~30% penetration in 2030. If WeWork merely retains its ~25% flex office market share over the next decade, it could grow core leasing revenue at a ~30% CAGR and the business will be ~15x bigger 10 years from now. It is more likely that WeWork actually expands market share, given its premium brand and the financial weakness of its competitors (e.g. Knotel went bankrupt and IWG is ~10x levered).

a.       The business currently has strong momentum coming out of the pandemic. It is currently winning 10%-30% of new office leases in its top ~10 markets (these are mostly the top cities in the US + London and Paris). The company’s market share is 1%-2% in these markets, so the fact that it is winning 10%-30% of new leases means its market share is accelerating dramatically.

3.       WeWork has a large captive audience of nearly 1 million customers, many of whom are high-earning tech employees working for the largest and most profitable companies in the world. This represents a golden opportunity for WeWork to cross-sell software and other services. IWG Group, which has a much lower-quality tenant base, generates ~20% incremental revenue from cross-selling services to its tenants. WeWork today only generates ~10% incremental revenue from ancillary services, but should be able to increase this materially over time (management expects this figure to exceed 20% by 2024).

a.       The company is guiding to $50m software revenue next year and expects this to increase into the hundreds of millions by 2024. The company’s key software product today is WeWork Workplace, which helps office tenants optimize and manage their office footprint. The software includes systems that track employee office usage and recommends cost efficiencies by reducing unused space. Based on our conversations with industry experts, the TAM for this product is ~$3bn in the US, and WeWork is well-positioned to be the industry leader here, given its real estate-related relationships with ~4,000 of the largest US companies, and its globally known brand.

4.       From 2023, FCF should be growing very fast – we estimate 2024 FCF of $1.3bn, roughly in line with the high end of management’s PSU incentive target) as occupancy increases and pricing grows faster than lease expenses due to a combination of inflation and supply/demand imbalance for flexible office space.

a.       IWG is the only public comp. It currently trades at 18x Street 2023E EBITDA, implying a FCF multiple >20x. The stock has historically traded at a MSD-HSD multiple of EBITDA, which implies a low-teens multiple of FCF for a business that was growing earnings at a HSD-LDD CAGR. WE should arguably trade at a substantial premium to IWG Group, given its premium brand and faster growth trajectory.

WeWork is a commercial real estate company that offers flexible/short term leasing arrangements for its tenants. The company was founded in 2010 and is based in NYC.

The company’s competitive moat today is 1) WeWork’s brand – it is known for upscale, hip, friendly, and comfortable office spaces; and 2) the scale of its office footprint. This scale enables WeWok to serve enterprise clients globally and/or individuals that travel frequently and want access to office space in various cities.

The company sells office space under a few different pricing tiers:

-          Pay-as-you-go shared workspace (customers can buy space by the day or hour)

-          All-access monthly subscriptions for ~$300/month that provide access to all WeWork’s 24/7 offices globally

-          Dedicated office space with shared or private amenities

-          Full floor office or building. This is the model used by enterprise customers, which comprise ~50% of WeWork’s business.

Earnings model – revenue build (see full model in attached appendix)

1.       In its core leasing business, WeWork currently makes money via three different models:

a.       Traditional lease arrangements where WeWork is responsible for 100% of capex and captures 100% of upside if the value of the space appreciates. This has been >95% of WeWork’s core leasing business to date.

b.       Revenue share arrangements where WeWork manages a flexible office space for a traditional landlord and invests a portion of the capex needed to build out the WeWork space. WeWork does not take leasing risk in these deals but does capture some upside if prices appreciate. Historically this has been an immaterial portion of WeWork’s business but the company thinks it will be ~2/3 of future core leasing growth. Historically, landlords have been reticent to do deals with WeWork partially due to fears that the company won’t be a going concern. As WeWork becomes FCF positive, it should be better positioned to do these deals with landlords.

c.       Management deals, in which WeWork collects a fixed fee for managing, branding and leasing a flex office building for a traditional office landlord. WeWork has no leasing or capex risk under this model, but also doesn’t capture any revenue upside if pricing appreciates.

2.       WeWork is planning to sell software that helps clients manage their real estate footprint. From the company: “WeWork Workplace is a Workplace Management SaaS technology that helps companies enable flexibility for employees, efficiently analyze and manage their workspaces, and bring their people back to work safely.” The company is partnering with Cushman & Wakefield to sell this software (C&W invested $150m in WeWork at $10/share in the SPAC transaction). Based on our conversations with industry experts, they expect the primary source of revenue for this business to be their existing ~4,000 enterprise customers, which alone could generate >$200m revenue for this business.

3.       WeWork sells “All Access” memberships that cost ~$300/customer and provide access to most of WeWork’s locations globally. WeWork is selling this to existing enterprise customers to offer their respective employees as a perk. WeWork currently has ~50k All Access customers (up from 0 earlier last year) and expects this to grow to ~150k memberships by ~2024.

4.       Marketplace – WeWork sells a variety of ancillary services to its customers, such as insurance, IT services, food & beverage, etc. For context, these types of services comprise ~20% of Regus revenue and just ~10% of WeWork revenue today. The company is looking to increase this to at least ~20% of office space revenue over the next few years, which would represent ~$600m incremental revenue by 2024.

Earnings model – income statement / cash flow (see full model in attached appendix)

1.       Revenue is currently primarily generated by core leasing, although other revenue streams should increase as a % of mix over the next few years

a.       Core leasing is 90% of revenue and is driven by:

                                                               i.      WeWork Workstations, which were 747,000 across 624 locations as of Nov 2021

                                                             ii.      Occupancy/memberships, which were 61%/458,000 as of Nov 2021

                                                           iii.      Average revenue per membership, which is currently ~$500/month

                                                           iv.      All Access is driven by number of memberships (~50,000 currently) and ARPU (~$300). This should add ~10% to core revenue by ~2023.

b.       Software revenue over the next few years will likely be driven primarily by penetration of WeWork’s existing ~4,000 enterprise customers, which alone could get WeWork to its 2024 target.

c.       Marketplace revenue is driven primarily by membership growth and the introduction of new ancillary services, which should add another ~10% to revenue over the next few years.

2.       Gross margins are driven by “location operating expenses,” which are primarily contractual, fixed leases that have a weighted-average remaining term of 13 years as of late 2021. As such, COGS are actually more fixed than variable on a given base of lease asses, i.e. incremental revenue from incremental occupancy is ~90% incremental margin. This is key to understanding the earnings model, as occupancy is currently low but increasing. As of 3Q21, location operating expenses were 120% of core revenue, but long-term management expects this to decrease to ~60% of revenue, which will be driven mostly by increasing occupancy (vs. needing to reduce building-level expenses).

3.       SG&A ex. D&A is currently ~$900m run rate, down from $2.7bn in 2019, and the company expects this to further reduce next year.

4.       Capex is currently ~$200m run rate, of which ~$50m is maintenance and the remainder is building-level growth and software development. The company is coming out of a massive building-level capex investment cycle, having spent a whopping $7bn on building capex over the past 3 years. This means that D&A will be significantly higher than capex over the next 5 years. Next year, D&A will likely be ~$400m higher than capex.

Earnings model relative to IWG Group

IWG’s public disclosures provide a helpful sanity check on our WeWork forecasts. IWG has a similar number of workstations to WeWork but its average building is ~1/4 the size of the average WeWork building, meaning its has lower building-level scale efficiency.

-          IWG gross margins have historically been 20%-25% (we model WeWork core gross margins of 29% in 2023 and 35% in 2024 vs. company midterm target of ~40%). WeWork should command higher gross margins due to its premium brand and greater building-level scale. WeWork has already seen gross margins at this ~40% level at its mature/high-occupancy buildings.

-          IWG only spends ~$350m/year in SG&A, less than half of WeWork’s current $950m run rate or projected $800m next year. WeWork has invested much more in the quality of its product/user experience, which supports our view on relative gross margins between the two companies.

-          IWG has underinvested in capex/building development over the past 5-10 years and was entering an investment cycle before the pandemic, having spent $1bn capex in 2019, up from an average of $380m from 2012-2017.

Balance Sheet

WeWork has $2.9bn debt and $2.3bn cash post-SPAC. Within the debt, $2.2bn was issued by Softbank at a 5% coupon. The debt is now trading at a ~9.5% yield. The debt matures in 2025 and is callable.

The company is currently burning cash at a ~$200m quarterly run rate and expects to be cash flow positive late next year, so shouldn’t have to raise money to fund growth and has a solid cushion even if COVID recovery is delayed (company could fund another ~10 quarters at current cash burn rate).

Management

The board has replaced Adam Neumann with a management team of proven real estate operators. That said, the current executive team seems to lack Neumann’s charisma. Earlier in November, Neumann did his first public interview since leaving WeWork. It sounds like he wants to return at some point if the board will allow it.

Based on SPAC filings, management comp is primarily driven by share price performance and FCF targets. There are two key targets management needs to hit before year-end 2024:

• Unlevered FCF target $1bn with max vesting at $1.3bn. Based on trailing 4 quarters rather than quarterly run rate, i.e. the company would have to produce these FCF figures for the full year 2024 at the latest.
• Stock price $20 with max vesting at $25 (current price $7.83 as of Dec 16, 2021)

Management/Board Bios:

-          CEO Sandeep Mathrania joined in Feb 2020 after Neumann’s departure. He had spent his entire career in real estate, culminating in a CEO role at Brookfield Properties, which is a division of the publicly traded Brookfield Asset Management. This is his first time running a public company, and he didn’t come across well at WeWork’s first investor presentation in August 2021. That said, we were impressed at his charisma/leadership potential when we met him in Dec 2021, and he seems to know the real estate side of the business inside out.

o   Based on his latest comp package disclosed in the SPAC S-4, he will earn up to 1.5m PSUs based on the above targets.

-          Chairman Marcelo Claure has served as CEO of Softbank since May 2018 and was previously CEO of Sprint, where he led an impressive turnaround.

-          COO Anthony Yazbeck has been at the company since 2016 when he joined as COO of the European business. He previously ran a Rocket Internet portfolio company and founded/exited 2 other companies in Europe. He started his career as a programmer/web developer.

-          CFO Ben Dunham was previously head of finance at Pizza Hut, where he spent 9 years.

-          Lead Director Bruce Dunlevie is General Partner at Benchmark.

-          The Board is controlled by Softbank with strong representation from Benchmark as well. Other notable board members include Vivek Ranadive (who led the WE SPAC), Murray Rode (former Chairman/former CEO of Tibco Software), Vijay Advani (Chairman of Nuveen), Lori Wright (Microsoft exec who led Microsoft CRM and Office 365 products), Jeff Sine (Chairman of Raine Group) and Deven Parekh (Insight Venture Partners).

The company went public via SPAC on October 15. The Street generally perceives SPACs as shady, and there has been a barrage of recent TMT IPOs that have overwhelmed analysts.

The pandemic made an already bad situation for WeWork in late 2019 much worse, as occupancy plummeted in 2020 and cash burn continued despite massive SG&A reductions.

No sell side analysts have initiated coverage on the stock yet, and WeWork’s earnings model is very hairy for a TMT stock, likely making analysts disinclined to kick the tires on WE. It doesn’t help that the company is still burning >$1bn cash this year (although we expect FCF breakeven next year).

Moreover, WeWork has been the laughingstock of the finance community… it’s a potentially embarrassing idea to pitch to your PM. There was a Hulu documentary published in April 2021 that (aptly) dramatized WeWork’s epic fall from grace under Adam Neumann. The company was valued as high as $47bn in a 2019 private funding round and is now valued at <$10bn as a public company.

While WeWork is still burning cash presently, there is clear visibility to positive FCF next year and significant cash generation in 2023-2024 (we model $1bn-$2bn FCF in 2024) that provides ample support for the company’s current EV of ~$7bn.

Moreover, while the pandemic was disastrous for WeWork from 2020-2021 due to lower occupancy, it should benefit WeWork significantly going forward, for several reasons:

-          Acceleration of secular demand for flexible leasing

-          Lower lease rates – WeWork has exited its least profitable leases and renegotiated its remaining portfolio of leases down by ~20%

-          Reduced competition – some of WeWork’s newer VC-funded competitors, such as Knotel, have gone bankrupt

1.       The pandemic was disastrous for WeWork’s financial results in 2020-2021, but significantly beneficial for the company over the mid- to long-term for several reasons:

a.       Acceleration of secular demand for flexible office space. Pre-pandemic, flexible office space was growing nicely (details below) but the pandemic is causing growth to accelerate ~3x as employers value office space flexibility more now than before. According to the top US brokerages, pre-pandemic, flexible office was expected to reach ~10% penetration of total office space by 2030. These brokers have revised their forecasts to ~30% penetration by 2030. Our independent industry research directionally supports this view.

b.       Lease restructuring opportunity. Pre-pandemic, one of WeWork’s major challenges was that it was stuck with some badly executed lease agreements. The pandemic enabled WeWork to renegotiate its leases, exiting the ones that didn’t have a clear path to profitability, and repricing many of the leases the company is retaining. On average, WeWork has reduced the pricing on its remaining leases by ~20%. This represents ~$6bn in cost savings over the remaining life of its current leases (per company SEC filings).

c.       Our industry research suggests that the pandemic has caused a sharp reduction in flexible office supply as WeWork’s top competitor, IWG Group, has retrenched to cover its large interest expenses (IWG is extremely levered at ~10x net debt/2023E EBITDA), and Knotel, a VC-funded competitor, went bankrupt. Post-pandemic, competition will likely be more rational, which should be a major driver of WeWork pricing power once occupancy increases and supply runs out. Pricing in some markets, such as London, is already above pre-pandemic levels, and pricing across WeWork’s entire portfolio is only 5% below pre-pandemic levels as of 3Q21, despite occupancy still only at 56% (although increasing rapidly).

2.       WeWork is the preeminent player in a massive and rapidly expanding TAM. According to a report from Savilis, Flex comprised 0.3% of US/EU office space in 2002, grew at a 10% CAGR to reach 0.5% of office space in 2010, and then accelerated to a 24% CAGR to reach 2% of office space in 2019. Brokers expect growth to further accelerate to a 30% CAGR over the next decade, with Flex reaching ~30% penetration in 2030. If WeWork merely retains its ~25% flex office market share over the next decade, it could grow core leasing revenue at a ~30% CAGR and the business will be ~15x bigger 10 years from now. It is more likely that WeWork actually expands market share, given its premium brand and the financial weakness of its competitors (e.g. Knotel went bankrupt and IWG is ~10x levered).

a.       The business currently has strong momentum coming out of the pandemic. It is currently winning 10%-30% of new office leases in its top ~10 markets (these are mostly the top cities in the US + London and Paris). The company’s market share is 1%-2% in these markets, so the fact that it is winning 10%-30% of new leases means its market share is accelerating dramatically.

3.       WeWork has built a formidable competitive moat via its strong brand, analogous to Four Seasons or Ritz Carlton in the hotel space. In 2019 I recall seeing that WeWork had raised money at a~$47bn valuation and scratching my head wondering how a capital-intensive business with no competitive moat could fetch such a lofty valuation. What I missed was the value of WeWork’s brand (although I’m not arguing the business is today worth $47bn), which the company spent ~$15bn in capital establishing over the past 10 years. The industry experts we spoke with emphasized the value of WeWork’s brand, saying it is analogous to the top hotel brands. If you are an employer looking for perks to attract employees, a WeWork membership has much more appeal than a membership to another, unknown flexible office provider.

4.       WeWork has a large captive audience of nearly 1 million customers, many of whom are high-earning tech employees working for the largest and most profitable companies in the world. This represents a golden opportunity for WeWork to cross-sell software and other services. IWG Group, which has a much lower-quality tenant base, generates ~20% incremental revenue from cross-selling services to its tenants. WeWork today only generates ~10% incremental revenue from ancillary services, but should be able to increase this materially over time.

a.       The company is guiding to $50m software revenue next year and expects this to increase into the hundreds of millions by 2024. The company’s key software product today is WeWork Workplace, which helps office tenants optimize and manage their office footprint. The software includes systems that track employee office usage and recommends cost efficiencies by reducing unused space. Based on our conversations with industry experts, the TAM for this product is ~$3bn in the US, and WeWork is well-positioned to be the industry leader here, given its real estate-related relationships with ~4,000 of the largest US companies, and its globally known brand.

5.       WeWork is coming out of a capex investing cycle and should generate ~$700m FCF in 2023 and ~$1.3bn FCF in 2024, meaning the company will be generating plenty of FCF to support its current valuation of ~$7bn. The company is guiding to EBITDA breakeven by the end of 1H22 and could see EBITDA margins in the 25%-30% range by 2025, meaning the company could be generating ~$2-$3bn in EBITDA in 3-5 years. Capex will likely be $200m-$300m going forward, meaning the company will be generating significant FCF. The company is known for massive cash burn (it was burning cash at $2bn annually in 2019 before Adam Neumann stepped down) but has since reduced SG&A by nearly 80% and has completed most of the capex investment needed to build out its current portfolio of buildings.

Setup / Path to Getting Paid

There are a number of puts and takes here. Overall, I think there is limited visibility on the setup over the next 3-6 months given it’s hard to say what Street expectations are.

Positives:

-          I think Street initiating reports will help people kick the tires and ultimately make it much easier for people to own the stock. The stock has been somewhat caught in no-man’s land, given today WeWork it is technically a real estate business, but the stock will likely be covered by TMT analysts. The earnings model is hairy, and the business is hard for TMT investors to wrap their hands around. As such, Street research will be important here. I don’t think the hairiness of the model is a long-term issue for how the stock will be valued, given the success of asset-heavy “internet” stories such as W, CVNA or OPEN (these have all sold off recently but still trade at massive multiples of EV/future FCF.

-          The earnings model optics are about to inflect positively. Revenue will go from DD declines for the past 5 quarters to ~+15% y/y in 4Q21 and ~+50% growth next year. These types of revenue inflections tend to be good for TMT stocks.

o   Additionally, margins will inflect to positive territory in 2H22 and profit will be growing extremely fast off a low base in 2023-2025.

-          The company will likely go live with its first WeWork Workplace software customer in early 2022, and will start disclosing SaaS revenue next year, which will be in hyper growth mode (albeit off a base of 0).

Negatives

-          There is a chance the Omicron variant causes a delay in occupancy recovery.

-          Softbank may start selling stock in Oct 2022 once its lockup expires.

-          The company is still burning cash and likely will not be FCF positive till 2H22.

-          Street initiation reports could be negative. 

-          We don’t really know what “Street expectations” are for the next few quarters, given there is no Street coverage yet.

1.       It’s hard to know how much revenue from ancillary services to underwrite over the next 3-5 years. That said, there is a wide margin of safety here (see valuation math below).

2.       This is a new management team that still needs to prove it can effectively run a hybrid tech/real estate business. That said, even if these guys are merely strong real estate operators, WE is likely a good buy at these levels.

3.       Occupancy could recover more slowly than expected due to Omicron, other COVID variants, or other reasons. It’s hard to precisely model this, given the lack of precedent. For WeWork to reach FCF breakeven, occupancy needs to get close to 80%, up from 61% as of November (on track to end the year at ~64%). Occupancy increased 6% in 3Q and is tracking to increase 8% this quarter. If the current trajectory continues, the company would get to 80% by mid-2022 and will easily get there by the end of 2022. In other words, the recovery trajectory over the past 6 months, despite the COVID delta variant, merely needs to continue for WeWork to be FCF breakeven by mid-2022.

4.       Softbank could start selling stock late next year (their lockup expires in October 2022 and they own 46% of WE).

See appendix for our granular model build.

WE looks extremely cheap relative relative IWG Group. The stock is currently trading at ~8x our 2023E FCF of ~$700m (which is in line with the $500-$1bn figure management has indicated they are targeting). Note that I did not back solve our model to this figure – this is the outcome of my bottoms-up model that contains reasonable assumptions.

From 2023, FCF should be growing very fast – I estimate 2024 FCF of $1.3bn, roughly in line with the high end of management’s PSU incentive target) as occupancy increases and pricing grows faster than lease expenses due to a combination of inflation and supply/demand imbalance for flexible office space.

IWG is the only public comp. It currently trades at 18x Street 2023E EBITDA, implying a FCF multiple >20x. The stock has historically traded at a MSD-HSD multiple of EBITDA, which implies a low-teens multiple of FCF for a business that was growing earnings at a HSD-LDD CAGR. WE should arguably trade at a substantial premium to IWG Group, given its premium brand and faster growth trajectory.

Comparing IWG to WE on a multiple of revenue or workstations is an interesting sanity check. IWG trades at 3.6x EV/2022 revenue, whereas WE trades at 1.4x. WE is also cheap on an EV/workstations basis, given it has slightly more workstations than IWG despite having a lower EV (WE has 766,000 while IWG has 678,000).

Even if WeWork generates $0 incremental revenue from ancillary services, the company will do ~$1bn FCF by 2024 and will be growing FCF fast off a low base, meaning the stock will likely trade at a DD multiple. A mid-teens multiple on ~$1bn FCF implies a market cap of ~$15bn, whereas the market cap is currently $6bn.

Base case: Assuming occupancy improves to pre-COVID levels of ~85% over the next 3 years and the company hits its target for core leasing unit economics, which appear reasonable based on the current trajectory, it will generate ~$1.3bn FCF in 2024. This assumes ~$450m incremental revenue from ancillary services (representing 9% of core leasing revenue) such as WeWork Workplace software, IT services, insurance, food & beverage, etc. If the stock trades at 15x FCF, we get a company worth ~$23bn on our 2024E FCF, meaning the stock is a multi-bagger from current EV of $7bn (net cash is close to 0 and doesn’t materially impact the math here).

Bear case: it’s hard to come up with a meaningfully precise ~25% probability bear case here given the degree of leverage in the model that is driven by occupancy and ARPU. Assuming occupancy is 80% in 2024 and ancillary revenue growth adds just $150m annualized incremental revenue by 2024, WE generates $400m FCF in 2024 and ~$1bn in 2026, assuming occupancy of 85% in 2026. If we assume a ~10x FCF multiple, we get a negative return on our 2024 FCF and a modestly positive IRR on our 2026 estimate. For conservatism, I think we should operate under the assumption that we lose some money under a 3-year ~25% probability bear case. On a 5-year basis, I do think it’s hard to lose money in WE from these levels, given the building-level unit economics and value of the WeWork brand.

Bull case: company hits its initial target (announced mid-2021) for $2bn EBITDA in 2024 and has 5+ years runway to consistently grow EBITDA ~30% on a combination of strong core leasing unit economics and sales of ancillary services. Stock trades at ~20x EBITDA, meaning the business is worth ~$40bn 3 years from now, up ~7x from current levels.

Catalyst

-          I think Street initiating reports will help people kick the tires and ultimately make it much easier for people to own the stock. The stock has been somewhat caught in no-man’s land, given today WeWork it is technically a real estate business, but the stock will likely be covered by TMT analysts. The earnings model is hairy, and the business is hard for TMT investors to wrap their hands around. As such, Street research will be important here. I don’t think the hairiness of the model is a long-term issue for how the stock will be valued, given the success of asset-heavy “internet” stories such as W, CVNA or OPEN (these have all sold off recently but still trade at massive multiples of EV/future FCF.

-          The earnings model optics are about to inflect positively. Revenue will go from DD declines for the past 5 quarters to ~+15% y/y in 4Q21 and ~+50% growth next year. These types of revenue inflections tend to be good for TMT stocks.

o   Additionally, margins will inflect to positive territory in 2H22 and profit will be growing extremely fast off a low base in 2023-2025.

-          The company will likely go live with its first software customer in 1Q22, and will start disclosing SaaS revenue next year, which will be in hyper growth mode (albeit off a base of 0).