WeWork's turnaround plan calls for it to stanch its losses while opening hundreds of new locations. Here's why business and real estate experts are baffled.
- Real-estate and business experts who spoke with Business Insider were baffled by the turnaround plan WeWork unveiled to employees on Friday.
- The company plans to shore up its bottom line and stanch its outflow of cash, but at the same time, it plans to open hundreds of new locations.
- Those goals would seem to be contradictory, because it's costly to open new locations, both in the short and long term.
- WeWork, which was weeks away from running out of cash before SoftBank bailed it out last month, has burned through billions of dollars, much of through the build out of new office centers, and it already has billions of dollars in rent bills that will come due starting next year even before its new expansion.
- Read more WeWork news here.
WeWork's got a turnaround plan. If you can make sense of it, you'll be better off than many real estate and business experts.
On Friday, the real-estate company's management team discussed with employees its new path forward. Part of the plan was expected - WeWork, which has been burning through cash like a California wildfire, is going to try to get that under control.
But part of the plan was a surprise. It's firebreak does not include cutting back on its hundreds of number of locations, whose opening and leasing costs have been the primary cause of its cash inferno. Instead, WeWork's new management team plans to open hundreds of additional locations in coming months, doubling its current count.
That baffled the experts, because, at least on the face of things, the two goals seemed mutually contradictory.
WeWork's plan "is not believable, because you can't say those two things simultaneously," said Tom Smith, a cofounder of Truss, an online commercial real-estate marketplace. He continued: "You don't have to go and get the opinion of a tenured economist to tell you that this doesn't pass the straight-face, common-sense test."
Representatives for WeWork did not respond to emails seeking comment.
The real estate giant's profligate spending has been legendary. Despite raising more than $8 billion in venture capital funding since it was founded in 2011, WeWork was weeks away from running out of cash when SoftBank bailed it out last month. The company burned through about $1 billion in the third quarter alone and around $2.5 billion in the first nine months of this year.
WeWork's new executive team has been touting fiscal responsibility
But after ousting founder and former CEO Adam Neumann, WeWork's new management team - led by co-CEOs Artie Minson and Sebastian Gunningham and executive chairman Marcelo Claure - has been trying to show that the company has a newfound sense of fiscal responsibility.
In the turnaround presentation, Claure further emphasized his team's new focus on the bottom line. The company is exploring ways to make money off its existing spaces, including by renting out conference rooms. It plans to start using dynamic pricing for its services to adjust to market demand. And outside of 12 core markets, where it will continue to sign lease agreements on its own, it plans in the future to explore office management, revenue-sharing, and joint-venture agreements that could allow it to shift some of its costs to partners.
WeWork's management set a goal of the company achieving a kind of profitability - if you grade on a curve and leave out a whole host of expenses - by 2021. They plan for the company to actually be generating cash by 2023.
But the turnaround plan left out what many real-estate and business experts thought would be an essential component - closing locations and shrinking WeWork's number of spaces. Instead, Claure and his team vowed to keep on opening locations.
But shrinking is not part of their plans
At the end of September, WeWork had 600 open locations in 122 cities, according to an investor presentation the company put together last month. Those numbers were up from 528 in 111 cities at the end of June and 425 in 100 cities at the end of last year.
And now, despite being near death a month ago, it plans to keep on opening more. By next year, WeWork's management team plans to have 1,200 open locations.
Jeff Langbaum was among those who expected WeWork, in the wake of its near-death experience, to take a quite different approach and severely cut back on its expansion. Langbaum, a real-estate analyst with Bloomberg Intelligence, was surprised that it's going to keep on expanding at a rapid pace.
"Going from running out of money over the next couple of weeks to continuing to try and double the size of your business ... they seem relatively incongruous," he said.
The reason why real-estate and business experts are skeptical that WeWork can push toward profitability while at the same time opening hundreds of new locations is because of the costs involved in leasing, opening, and renting out new spaces.
Building out and furnishing new spaces is costly
In the first six months of this year - a period in which it opened 103 locations - WeWork burned through $1.3 billion in cash on capital expenditures, costs that are largely associated with building out new spaces and providing them with furnishings. Such costs comprised the vast majority of its cash outflow during that period.
As it opens 600 new locations in coming months, those costs will almost certainly swell.
"It totally makes sense to be confused by" WeWork's plan to continue to rapidly expand and work toward shoring up its finances at the same time, said Walter Johnston, who focuses on the real-estate market as a vice president of credit ratings at the research firm DBRS Morningstar. "A lot of the cost associated with with WeWork's cash flow burn is wrapped up in [its] expansion," he continued. "The setting up of an office is usually the most cash-intensive part of the business plan."
For their part, in the investor presentation it put together last month, WeWork said the amount the company spends for each new desk it adds has been declining, going from $7,300 per workstation in 2014 to $3,700 each in the first half of this year. But that still implies that it expects a massive outflow of cash as it opens new centers.
Assuming it doubles its number of desks from the 676,000 it had at the end of September along with doubling its number of locations, it could expect to spend a whopping $2.5 billion on capital expenditures opening those new sites. That's more than a third of the $6.5 billion WeWork is getting from SoftBank as part of its bailout package.
Discounts are often used to fill new locations
But opening new locations incurs other costs beyond just those associated with the build-out. It's common practice in the real estate industry when opening a new building or office space to offer discounts to prospective tenants to fill up the space. And WeWork has tended to be much more aggressive about handing out those discounts than traditional landlords or even other rivals in the coworking segment that it competes in. As Business Insider reported, it has in the past offered deals in which it essentially saw no revenue over a two-year rental agreement.
And whatever the intentions of WeWork's management, the company may need to still heavily rely on discounts to get people in the door of its new offices. That's because WeWork's reputation has suffered heavily in the last couple of months due to its failed public offering, massive valuation decline, and near bankruptcy. Potential customers could be turned off by the idea that WeWork's business is foundering or could be worried that its services will suffer thanks to its cutbacks.
Claure seemingly recognized WeWork's image problem when he recently hired branding guru Maurice Levy to head the company's marketing efforts.
"The WeWork brand right now is trashed and tarnished," said Robert Siegel, a lecturer in management at Stanford Graduate School of Business.
Filling so many centers at once will likely be a tough task
And WeWork faces lots of competition. There are at least 250 other coworking providers in the US alone, Truss' Smith said - up from just 50 a few years ago. Many of the workers and managers WeWork has shed are going to those rivals, helping them to better compete for space and deals, he said.
"If you thought the competitive landscape was challenging for WeWork's expansion and profitability plans before, it's lot harder now," Smith said.
Even assuming that WeWork can secure 600 new locations in the timeframe it's talking about - which Smith says is an open question - opening that many in that short of a time period and then trying to fill them all will be extraordinarily difficult. Given the sheer numbers of new locations, it's likely that at least some of them will be in suburban locations where WeWork to date hasn't shown that there's a demand for its service, Smith said.
"There's a general feeling that the markets that would be most responsive to their model" - places like New York and London - "are pretty saturated," Smith said. That saturation and the increased competition WeWork faces "makes absorption of doubling of centers seem, even at their current brutal margins, seem unbelievable."
In other words, WeWork can't expect to fill all the new locations that it will be opening without some massive discounting.
WeWork has some big bills coming due
And there's another, obvious, cost to opening new centers - rent. Typically in the real estate business, landlords offer tenants who sign long-term leases a discount off their initial rent payments. Sometimes this comes in the form of a credit for some of the improvements they make, other times it's just a reduction in initial rent charges.
But landlords usually make up those discounts and credits in the latter years of the leases with higher rent charges. And some of the rent that WeWork has deferred in the past is already about to start coming due.
At the end of last year, WeWork had some $2.8 billion in deferred rent - essentially the accumulation of these kinds of discounts - on its books. It added about $1.3 billion of that last year as its location count swelled.
Next year, some of those rent bills will start coming due. It has at least $2.2 billion in lease payments due next year. All the new centers could only add to that bill next year and in the years to come.
"It is interesting that they see this as their turnaround plan, because it seems like a pretty cash-intensive operation," said Johnston.
The company says new buildings quickly start generating cash
To be sure, WeWork asserts that on a site-by-site basis, its locations quickly start generating cash, at least if you exclude certain costs. On average, seven to 12 months after its centers open, their "contribution margin" - a kind of per-site operating profit - is 5% of revenue, according to the company's investor presentation. Sites that have been operating for more than 24 months have contribution margins of 21% on average.
It's possible that WeWork's unit economics are such that its massive expansion could make sense, some business experts said. If it's able to quickly get those new locations up to where they are generating cash, the build-out could be worth the big investment they said.
If what WeWork says about the profitability of its individual locations is true, "then theoretically, this level expansion doesn't preclude them from reaching profitability" by its target date, said Langbaum.
WeWork will likely need to raise more money at some point. But after its failed IPO and its cash crunch, the company faces intense skepticism from the investment community, said Siegel. The company's managers know they need to rebuild trust with clients, landlords, and Wall Street. In that environment, it's hard to believe that the company didn't put a lot of thought into its new turnaround plan, he said.
"The people who are involved with that company are not dumb," Siegel said. "You can't imagine they're going to repeat the same mistakes that happened before," he continued. "It's almost inconceivable."
But even Siegel thinks it shouldn't be taken as a given that WeWork's new plan will work or even makes sense.
"Given that it was a house of cards before, having a healthy skepticism is probably warranted," he said. "It's incumbent on WeWork to prove ... that they really have changed the business."
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- Read more about WeWork:
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- SoftBank likely had the Vision Fund on its mind when it decided to rescue WeWork
- WeWork used massive discounts - in some cases, essentially giving away space for 2 years - to try to poach customers from rivals