Peak-Bubble for Junk Bonds, Says WeWork Bond Sale

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Wolf Richter,

When is it gonna pop?

The junk-bond market is still in total bubble bloom, simply ignoring the bloodletting in the Treasury market that pushed the 10-year yield to 3%, finally for the first time in over four years. But investors are lusting after higher yields, and companies are taking advantage of them while they still can, which makes sense, particularly if it’s a unicorn with long-term lease obligations out the wazoo, whose net loss – which doubled to nearly $1 billion – is bigger than its revenues.

A company like this needs a lot of cash to burn. After junk-rated Netflix’s lightning-fast “drive-by” bond sale of $1.9 billion on Monday, it’s now junk-rated WeWork’s turn with its own $500 million bond sale that may well be upsized by a large amount in face of ravenous investor demand.

WeWork essentially makes little ones out of big ones. It leases large office spaces on long terms, dolls them up in some creative way, and rents them out in small portions, down to the size of a desk, to companies or individuals needing a quick office setup for shorter periods of time. Many of its customers are themselves startups – on the time-honored circular principle of VC-funded startups feeding VC-funded startups.

The prospectus for the bond offering, obtained by Alphaville and the FT, points out that revenues jumped by 103% in 2017 from a year earlier, to $886 million, and that total expenses jumped 118% to $1.82 billion. Based on this well-established unicorn strategy, the net loss in 2017 jumped by 117% year-over-year to $933 million.

In other words, the more the company grows, the more it loses. But don’t even look at the losses. They don’t matter. It’s just other people’s money. The key metric to watch is something entirely different: “desks.”

WeWork claims that the number of desks has surged from 44,000 on December 1, 2015, to a whopping 251,000 on March 1, 2018. And there’s another metric: desk “occupancy,” which over the same period has increased from 76% in 2016 to 80%.

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So there is demand for desks at this price, just like there is demand for Ubers at their price, but these are not survivable prices. Investors have to subsidize them.

WeWork can nevertheless hold out for a little while. It still has about $2 billion in cash left over from the nearly $7 billion it raised from investors over the years. This includes the $4.4 billion that junk-rated SoftBank with its Vision Fund invested last August. That deal pushed WeWork’s “valuation” to $20 billion.

So now it’s time to raise more cash. Among the investment banks recruited to make this work are J.P. Morgan, BofAML, Citi, Deutsche Bank, Goldman Sachs, HSBC, Morgan Stanley, UBS, and Wells Fargo. The talk is $500 million of seven-year unsecured notes at 7.75–8.00%. Strong investor demand could push the total amount of bonds sold much higher, much like Netflix had upped its bond sale on Monday from $1.5 billion to $1.9 billion.

The book for the WeWork bond deal will close on Wednesday, and pricing is also expected during that time, moved up from Thursday, a source told S&P Global’s LCD. S&P rates the bonds themselves four notches into junk (B+) and the company five notches into junk (B).

Fitch, which rates the bonds three notches into junk (BB-), pointed out that WeWork already has existing debt consisting of a $650 million revolving credit facility and $500 million letter of credit reimbursement facility.

WeWork also has $5 billion in lease payments due over the next five years, not including any additional leases it will sign during its global expansion drive:

  • 2018: $706 million
  • 2019: $984 million
  • 2020: $1.1 billion
  • 2021: $1.1 billion
  • 2022: $1.1 billion
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Another $13 billion in lease payments come due in the years after 2022, according to Bloomberg. That’s some real money that a money-losing company must somehow obtain.

These are 10-year or 20-year office leases. They’re a fixed expense that doesn’t decline when business drops off. As such, they pose a special risk: WeWork’s customers rent their space on much shorter terms, even month-to-month. When things get tough, they can just ride off into the sunset after their short-term leases expire, leaving WeWork to sit on expensive and vacant office space with stale craft brew on tap at the lounge.

Startup investors willingly take huge risks. They assume that most of their investments will fail. But they hope that a few mega-winners will make it all worthwhile. With these mega-winners, they hope for an upside that is measured in multiples, such as 10x or more.

Investors in junk bonds of such cash-burning unicorns take only slightly less risk than late-stage equity investors, but have zero upside. All they get is the yield for however long the company manages to pay the coupon, and if they’re lucky, they get their money back when the bonds mature. That’s the best-case scenario. There is no upside.

But these days, with the junk bond bubble still red-hot, a yield of 7.75% sounds like a great deal, no matter what the risks, the cash burn, and the losses, especially if the only metric that really counts – desks – has quintupled over the past two years.

Wow, that was fast and huge. This junk-bond market is in peak-bubble mode. Read… Junk-rated Netflix Borrows $1.9 Bn, Most Ever, in “Drive-By” Bond Issue, to Burn $3-$4 Bn in 2018, Debt Soars to $8.4 billion


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