WeWork has been all over the news lately and I thought it would be an interesting pause to actually take a deep dive into their financial statements to really dig in and see what made this another one of silicon valley’s unicorns. One comment at the outset is that I’m going to side-step all the governance issues and try to focus on the underlying business value.
Right away on page 3 of their S-1, WeWork notes that the company has reached a run-rate revenue of $3B. Their growth cannot be ignored, as the company has been growing 20% QoQ since 2017. One of their big selling points is that their annual lease cost is only $7,304 per desk vs. the traditional $21,594. With a membership base of 527k and a backlog of approx. $4B, this would seem to imply their revenue is locked-in for the next twelve months (527k x $7,304 = $3.8B). Despite the meteoric growth in revenue and subscribers (128k to 527k), their revenue per Member has remained very stable at approximately $1,550/member for the last 2 years. Effectively their entire growth is from more and more people utilizing their workspaces.
Looking a bit further down their financial statements (p. 112 of the S-1), they list 7 categories of expenses to run the business. Location operating expenses (direct costs related to underlying rent and location management), other operating expenses (tbd), pre-opening location expenses, sales and marketing expenses, growth and new market development (their core real-estate team for finding new assets), general and administrative, and depreciation and amortization. For the quarter ended June 30, all of these expenses added up to $1.5B. One of the tidbits that they mention is that pre-opening location expenses and location expenses includes a non-cash straight-line lease cost (which amortizes rent-free periods and contractual increases in lease costs). That adds $227mm of non-cash expenses that we can remove since it is an accounting burden (and can be captured elsewhere). There is also $130mm of depreciation and amortization, which is non-cash, and $48mm of stock-based compensation. So adjustingthose 3 out arrives at an EBIDA of $323mm loss in the most recent quarter.
WeWork broadly mentions that their target contribution margin percentage is 30%. That is (Revenue – Location Operating Expenses) / Revenue. Stripping out the accounting adjustments, their location operating expenses have been fairly stable around $925/workstation/quarter, meaning they’re close to their target margins. Going back to Q1, the $807mm of revenue leads to $259mm of contribution profit (despite an additional $583mm of other expenses). Benchmarking this against competitors, Regus target contribution margin is 20% with overheads being 18.5% of revenue. In WeWork’s calculations, their target excludes other operating expenses, pre-opening location expenses (timing is understandable here), and sales and marketing expenses.
For other operating expenses, pre-opening location expenses, and sales and marketing, these expenses have hovered around 25 – 30% for the last several quarters. These seem to be a sticky part of the expense structure, that is directly associated with the additional services they provide and their ability to fill the available workstations.
This leaves growth and new market development expenses and G&A. These have represented anywhere from 30% – 45% of sales (vs. Regus 18.5%). Regus has 9,615 employees vs. WeWorks 15,000. While the growth and new market development expenses may curtail as they reach saturation, we will assume this expense continues in the near term.
One thing that WeWork highlights in their IPO filing is the speed at which they build-out the space and how quickly they reach their target fill rate. They note in their filing that it costs approximately $3,661 to build each workstation and that it only takes them 5 months from possession to revenue-generation (on average they have a rent-free period of 9 months – p. 74 S-1). From there, fill rate goes from 52% to 84% rapidly, and stabilizes around 89% at 18 months (p 83 S-1). The assumption is that the remaining life of the lease, which averages 15 years, these metrics will stabilize and each property turns into a cash cow.
If we were to look at this from the perspective of a single workstation. It is approximately $1,100 to rent the workstation, $1,550 for rent per Member, and another $385 paid for other and sales expenses. This means that each individual workstation generates ~$125 – $130/quarter in profit that can be used to cover the cost of building out the space. Without meaningful improvements in rent or efficiency, each workstation will continue to hurt WeWork’s bottom line.
One major question from here starts does come up. While the operating expenses are heavy for this business, once the CapEx is factored in, the economics are difficult. If we take $3,661 per workstation, and assume a 12.5% cost of capital, and a lease term of 15 years, that comes out to an equivalent CapEx of $45/month or $135/quarter. Given WeWorks environment, I might scale down the life of the CapEx rather than for the term of the lease (e.g. desks break, or umbrella doors need to be replaced) to an average life of 10 years. This means that the equivalent CapEx is $161/quarter.
If we were to rebuild their business model from CapEx backwards. We come up with a very different picture. The target revenue per Member increases dramatically and moves much closer to industry comps that they list at the beginning of the prospectus. If they truly want a differentiated service, they will likely need to make a few hard choices, do they significantly mange expenses to keep their target rents? Do they start increasing rents to keep the business afloat? Or do they move into an entirely different subscription model where they can drive oversubscription in the properties?
TL;DR WeWork fundamentally needs to re-work their rent or expenses to keep the business as a valid model. At $3,650/workstation, even with target margins of 30%, they need to increase rents. Underlying Charts
Final Note: I did this entirely as a thought experiment and wanted to understand their business model better since they have been in the news so much. There are many of you with better expertise in this space that probably can pick this apart, which I encourage and ask you to do. I’m happy to share my excel file for those interested since everything here is all from publicly available information, so there is nothing proprietary.
Disclaimer: Consult your financial professional before making any investment decision.