I Don't Get WEWORK, part II

Now for part II, is wework scaling up something that is working (i.e., already profitable on a per location basis)? I think this would be the assumption of most outside observers. wework builds and operates shared offices, and they are taking a great deal of investor funding to do more of that. It makes sense, right?

Sort of. Firstly, if you're making good money on a per location basis you don't necessarily need much outside capital. Take a look at this chart from Chipotle:

Chipotle Capex

Look carefully and you can see that for this period Chipotle funded their growth entirely through cash flow. They spent 800k to develop locations and earned 20% on each one. With that return funding entirely through internal cash flow more or less puts a 20% cap on your growth rate (because you only get 20% of your investment back to reinvest), but that's still really fast. The more profitable you are on a per location basis, the more you can reinvest to build the next year. It's the catch-22 of growth - if a business is doing really well they don't need your money. So the fact that wework is taking in insane amounts of outside capital and spending it like water tell us that its not actually not very profitable with its current locations. 

Then what is going on? wework isn't that profitable on a per location basis - otherwise they could fund most of this themselves. Maybe wework is just an immense rush. Maybe the 10% or 20% margins they have just can't fund the 100% growth rate they want. In this scenario, wework is profitable but they want to grow faster than their profits will allow. Why grow at this breakneck pace?

Well they could just be super profitable and want to capture the profits at scale faster. If you've got a great business, it makes sense to grow it from 10 to 100 locations as fast as possible, and it may make sense to take outside capital to do so. But if you do have a great business, and you've proven it works, why not just go to a bank? Apparently wework has taken out $702 in debt via a bond issuance (now rated junk!), but that isn't quite the same. If you've really got lightning in a bottle you can typically show it to people and they are so, so happy to give you money. If wework's model works that well, it would make sense to fund the whole shebang through debt, rather than try to sell a majority stake to softbank (which ultimately failed). 

I think the reason all these loss making enterprises ultimately go to the market is they run out of schmucks in the valley and are looking for the next one. I also think Uber, Lyft and potentially wework are going to be in for a rude awakening (eventually). The sad thing is, plenty of awful business go public, raise large sums, allow insiders to cash out, and then just ultimately wither away and die. So the fact that wework wants to go public doesn't actually tell me very much. 

Finally, wework could be a type C company, that is, a company that needs to achieve scale to make profit. There are many business like this. Every car company needs scale to achieve sufficient efficiency to be profitable. The same is true for software companies, oil refineries and utilities. Sometimes the fundamental economics/technology of the product demand a certain scale. If the business is new or highly uncertain, then the founders will needs lots of capital to reach to the scale they need if what they are doing is capital intensive. 


But what wework does is neither capital intensive nor amenable to scale. Leasing and redoing an office can't be that much money, even in crazy expensive markets like New York (maybe, what, $10 million dollars for a floor?). It turns out that landlords cover most of the cost anyway, "Today the average U.S. landlord covers about 70% of the costs." Moreover, each location (for the most part) stands on its own. The returns to having many locations (cross locational synergies) just don't strike me as particularly high. wework simply shouldn't need scale to be profitable the way, for instance, a manufacturer would. They may dream of all sorts of add on support service revenues, but, as I said before, I don't think that will be the secret sauce that makes wework work. 


From what I can tell, wework isn't that profitable on its current locations (or it wouldn't need to raise so much investor money) and it shouldn't need scale to be profitable. What I think is going on is wework is growing because it doesn't know what else to do. In order to justify an insane and ever growing valuation, you need growth. Losing that would basically doom the company and certainly destroy all the insiders' paper wealth. Remember too that they are paying people with stock - the moment that looks like it isn't worth that much they will start losing talent and the ability to hire. I think wework found some really, really dumb money (softbank) and now that that is tapped out, they are going to the public markets for the final cash out. 

This isn't to say wework won't or doesn't make money. Its hard for me to see how shared office spaces wouldn't make some money. There is clearly a large desire and a decent willingness to pay. There is no doubt that these spaces add value for their clients. But given the limited barriers to entry and what I believe is likely limited customer loyalty, it won't ever be an extremely profitable business either. wework isn't selling software, even if they want to. The business is much more like a Chipotle than it is like Facebook. If wework is smart and doesn't take on too much debt, I can see the company surviving once the markets wake up, albeit at a much more appropriate valuation. If they do take on crazy debt and the music stops....well then there will be a lot of trendy office space available. 

I could probably (definitely) write a great deal more about wework - but in the absence of data I don't really see the point. I think wework is a good idea that got great amounts of capital - and consequently went overboard. If wework does ultimately fail, I think it would be a textbook example of how the distortion of the venture growth cycle can actually be bad for otherwise good businesses (although that is definitely not always the case).






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