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Bloomberg Law Analysis

ANALYSIS: Profitability Risks Dim WeWork’s IPO Optimism

Aug. 20, 2019, 1:44 PM

If you are not already an adherent of the power of We, see if you can trace the source of these giddy quotations:

“We dedicate this to the power of We—greater than any one of us, but inside each of us.”

“Individuals are more productive when they are able to express their full and authentic selves.”

“If we created a community that helped people live life with purpose, we could have a meaningful impact on the world.”

No, it’s not a self-help book or a banner you see at a booth on Club Day as college freshmen seek involvement on campus. These aspirational words actually come from the registration statement filed by WeWork’s parent company for its initial public offering. The lofty language may sound inspiring, but nearly 30 pages of risk factors and cautionary notes could temper the enthusiasm for this particular unicorn’s venture into the public market.

The registration statement cautions investors on a wide variety of potential pitfalls. WeWorks advises that the company faces potential harm “if our employees, members of our community or other people who enter our spaces act badly.” The company may fail to manage its growth effectively, and may find further growth and expansion to be a rocky road.

In addition, the founder, Adam Neumann, will control the company even after the IPO. To date, he does not have a track record of establishing successful businesses, and the company disclosed numerous transactions with Neumann and other related parties. For example, with regard to intellectual property, “In July 2019, WE Holdings LLC assigned residual rights related to “we” family trademarks to the Company, which we desired to obtain following our rebranding in early 2019. In consideration of this contribution and in lieu of paying cash, the Company issued to WE Holdings LLC partnership interests in the We Company Partnership with a fair market value of approximately $5.9 million, which was determined pursuant to a third-party appraisal.”

Risky Business

Four noted risks struck me as particularly worrisome, however:
1. An economic downturn or subsequent declines in market rents may result in increased member terminations and could adversely affect our results of operations.

This risk element seems particularly timely, with the current news cycle dominated by talk of the yield curve inversion and the potential for a significant downturn. An economic slowdown could have a significant impact on a business model that relies on short-term revenue to make the payments on long-term lease obligations.

2. The long-term and fixed-cost nature of our leases may limit our operating flexibility and could adversely affect our liquidity and results of operations.

Even absent an economic slowdown, the mismatch of long-term obligations with short-term revenue generation is problematic. WeWork must constantly fill the holes left by shifts in its transient client base.

3. If our involvement in online news articles published about the Company were held to be in violation of the Securities Act, we could be required to repurchase securities sold in this offering. You should rely only on statements made in this prospectus in determining whether to purchase our shares.

Oops. The remedy of a statutory put is a drastic consequence of a Securities Act Section 5 violation. In May 2019, Axios and Business Insider published comments from discussions with founder and CEO Adam Neumann and CFO Artie Minson. Rescission is an unlikely remedy, but other sanctions, such as a cooling-off period or other undertakings, could be costly and burdensome.

4. We have a history of losses and, especially if we continue to grow at an accelerated rate, we may be unable to achieve profitability at a company level (as determined in accordance with GAAP) for the foreseeable future.

Therein lies the rub. The Form S-1 stated that “we incurred net losses in the years ended December 31, 2016, 2017 and 2018 and in the six months ended June 30, 2018 and 2019, and we do not intend to achieve positive GAAP net income for the foreseeable future.” The company has been bleeding cash for the last several years, and has not identified a viable path to profitability.

We Will See

It will be interesting to see how the SEC’s Corporation Finance staff reacts to the filing. Of even greater interest will be the market’s reaction. Investors have not been kind recently to many founder-driven public offerings. The market will likely be skeptical of a company with no positive earnings history, massive long-term lease obligations, a questionable governance structure and a dominant, charismatic but unproven founder, as it attempts to raise public capital in an uncertain economy.

WeWorks has invested heavily in this offering. The company employed top-notch legal talent to oversee its registration documents, with Skadden, Arps, Slate, Meagher & Flom LLP and Simpson Thacher & Bartlett LLP involved in the process. The company and its founder are colorful and ambitious, and have certainly generated a signicant buzz around the offering.

Reality may well intrude on the optimism, however. WeWork lost $3 billion from 2016 to 2018, and $900 million in the first six months of 2019. As its registration statement cautioned, the costs driving these losses “will continue to increase as we continue to grow our business.” The company strives to provide “flexible access to beautiful spaces,” but it remains to be seen whether those “beautiful spaces” will be awash in a sea of red ink.