BY GUY CARSON
A big story in equities markets in recent weeks has been the WeWork Initial Public Offering (IPO) and its subsequent withdrawal. WeWork is a fast growing provider of shared office spaces which is owned by Private Equity (PE) investors. Given the recent record boom in PE this failed IPO has significant implications for both private and public markets as well as global views on asset allocation.
In recent years private equity allocations from Pension funds and the like have risen as allocators have been searching for return in a low interest rate world. From a portfolio construction point of view, Private Equity can do miracles. It can boost returns through levels of leverage that public market investors are not comfortable with as well as give the illusion of lower risk via lower volatility.
The increasing allocation to PE has increased competition for deals and pushed up valuations. As the cycle matures, Private Equity funds will need to exit these investments and the assets in a number of cases will come to the public markets. The IPO of WeWork tested the public markets’ appetite for these assets and came up short.
WeWork raised capital from private investors back in January at a valuation of $47 billion; however, the recent indications from the public markets is that they would only accept a valuation of $10-12 billion. The nervousness in public market circles comes down to three main points:
- Recent high profile IPOs such as Uber and Lyft which have not traded well in the secondary market;
- The company’s financials and in particular the increasing cash burn;
- And corporate governance issues.
If we look at the recent high profile IPOs we can see why the market is nervous. Uber floated back in May at $45 per share and has traded down to below $35 per share. Lyft floated back in June at $72 per share and has traded down below $50 per share.
One aspect of the WeWork float that is similar to both the Uber and Lyft floats is that the company does not make a profit and will not make one for the foreseeable future. Supporters of the company will say that they are long term focused but to many there is an element of 1999 at play.
Looking at the financials for WeWork, one cansee a company rapidly growing. In 2018 the company’s revenue more than doubled from $886 million to over $1.8 billion. However at the same time, the net loss widened by over 80% from $884 million to over $1.6 billion. In the first six months of 2019, the company has lost $690 million.
Funding these loses is a key consideration for WeWork. It had a banking syndicate lined up to provide a loan of $6 billion but that was conditional on a successful IPO. It will now be back to the drawing board with regards to funding and that will likely involve existing investors tipping more money in.
The final issue for the company has been corporate governance. This was highlighted by a recent rebranding it undertook. The company decided prior to its IPO that it reorganise and rebrand as “The We Company” as opposed to “WeWork”.
In doing so it wanted the trademark rights to the word “We”. Those rights however were owned by a company called We Holdings LLC. So WeWork paid We Holdings LLC $5.9 million for the rights. The major issue is that WeWork cofounder Adam Neumann happened to be a managing member of We Holdings.
This transaction was disclosed in the filing documents for IPO and the uproar on its discovery has forced the payment to be cancelled and the money returned. Question marks remain however around management and corporate governance.
There are significant implications for the PE market on the back of this failed IPO. As can be seen in the chart below, allocations to PE have been high for a sustained period. The last five years have all seen inflows to PE above or around the levels of the previous peak back in 2007/08.
In turn this means more capital competing for fewer opportunities and that has pushed valuations up to record levels. Never before have PE investors paid so much for assets.
Higher valuations means future returns will be lower. At some point this could impact demand for PE allocations and that would reduce liquidity in an already illiquid asset class. Asset divestments would become challenged and the cycle would end.
To this end, Softbank, the world’s largest technology investor now finds itself in a difficult situation. They recently participated in the latest WeWork raising, investing $2 billion at the $47 billion valuation. An IPO at the $10-12 billion price tag would have caused a significant write-down for their Vision Fund which they now won’t have to wear. This is quite convenient as Softbank is in the process of raising $100 billion in Vision Fund 2 and a loss in their current fund would be detrimental to those efforts. It’s also important to note they are the largest investor in Uber which has not been a stellar performer in recent times.
It’s important that investors realise that risk is increasing in the Private Equity space. To highlight this we would like to remind everyone that we did see our first major blow-up last year in Theranos; the story of which is covered superbly by John Carreyrou in his book “Bad Blood”. Theranos was once valued at more than $9 billion and was essentially a fraud.
The investment implications are that investors need to be cautious around current private market valuations and also need to be cautious around new IPOs. Private Equity firms will be pushing more companies back into the public space; the question is whether there is appetite for them.
The advisers we work with are staying out of PE and have been circumspect around IPOs. They have chosen to seek returns and opportunities elsewhere. If you wish to discover more about our investment options and how they could help you please contact Guy Carson at firstname.lastname@example.org.
Disclaimer: The above contains the opinion of the author and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.