(Bloomberg Opinion) -- WeWork Cos. doesn’t seem to quite be working for junk-bond investors.
For a moment earlier this month, it looked as if its high-yield debt issued 13 months ago was going to climb back to 100 cents on the dollar, riding a wave of momentum from the company’s April 29 announcement that it filed paperwork confidentially with the U.S. Securities and Exchange Commission to hold an initial public offering. The world’s biggest co-working company, in other words, was poised to have the second-largest U.S. IPO of 2019 behind Uber Technologies Inc. And with that, the promise of a flood of cash to a business that runs staggering losses. The securities, which are rated below investment grade and mature in 2025, rose to as high as 99.75 cents on the dollar, up from 94.75 cents.
The pop didn’t last. This week, WeWork’s debt traded below that pre-IPO announcement level for the first time.
In a broad sense, this pullback seems only natural. The S&P 500 Index, after all, clocked in its all-time high on May 1.(1) Uber didn’t exactly have a spectacular public market debut this month, raising questions about the reception of similar mega-unicorn companies like WeWork, which wants to be known by the brand We Co., and Airbnb Inc.
Yet there are plenty of reasons WeWork is a uniquely risky bet for junk-bond buyers.
Let’s start with Ellen Huet’s Businessweek feature this month on the shared-office-space provider. In it, she revealed for the first time that “WeWork is creating an investment fund that aims to raise billions of dollars to buy stakes in buildings where it will be a major tenant.” Conflicts of interest seem destined to come into play. Adam Neumann, WeWork’s CEO and co-founder, told Huet: “Everyone wants to know what ARK is. I think it’s going to be amazing.”
With that sort of unabashed confidence in mind, it’s easy to see how the company reportedly issued $702 million of junk bonds instead of $500 million, simply because 702 was deemed a lucky number. What’s an extra $202 million of debt in the capital structure, after all?
Among the biggest public holders of those bonds are Lord Abbett & Co. and the Teachers Insurance and Annuity Association of America, which as of their most recent filings own about 6% and 5% of the debt, respectively, data compiled by Bloomberg show. Representatives for the fund managers said they don’t comment on individual holdings.
Bondholders could very well be fine, as long as WeWork retains its ability to attract funding. The debt matures in six years, which wouldn’t feel like an especially long time in most cases. But it does when lending to a company with WeWork’s kind of cash drain. How confident can anyone be that it’ll weather a downturn? As Scott Crowe at CenterSquare Investment Management noted skeptically to Huet: “They don’t make money even with the economy roaring.”
My Bloomberg Opinion colleagues Lionel Laurent and Marcus Ashworth wrote in early January that SoftBank Group Corp.’s decision to invest only $2 billion in WeWork, rather than closer to $16 billion, should have raised alarm bells around the startup. In the bond market, it did — but only briefly. After reaching a low of 86 cents on the dollar on Jan. 7 (equivalent to an 11% yield), the debt soared with other speculative-grade securities as the Federal Reserve took an abruptly dovish pivot.
An IPO, of course, could provide a cash injection to WeWork and at least give bondholders comfort that public equity investors would take the biggest hit if Neumann’s ambitions don’t work out. Even in an IPO, according to Bloomberg Intelligence’s Jeffrey Langbaum, SoftBank’s actions could be the most telling. “The level of liquidation that SoftBank is pursuing will be of interest,” he wrote last week. “This is especially true considering its last investment was made at a $47 billion valuation.”
Bond investors, meanwhile, are getting paid quite well. WeWork’s 9% yield compares with just 6.38% on a similar-maturity Bloomberg Barclays index of single-B U.S. corporate bonds. After the IPO announcement, the yield fell to 8%. Triple-C securities yield close to 10%. If you believe the credit ratings, the current price levels are intriguing.
At the same time, it’s hard to shake the feeling that investing in WeWork is like walking on thin ice. It reports what can be described generously as self-made financial metrics. It’s now renting more space to large companies, but it’s unclear what will keep smaller members from quickly terminating their membership if the economy falters. It’s too soon to say whether ARK will be “amazing,” as Neumann says. WeWork’s bond documents state clearly in italics: “We have a history of losses and we may be unable to achieve profitability at a company level.”
So far, that hasn’t mattered. The company manages to find the cash it needs (mostly thanks to SoftBank), all the while becoming the biggest private office tenant in London, Manhattan and Washington on its way to 425 office locations in 36 countries overall. It’s growing its way out of any real financial trouble.
Neumann told Huet he wanted the Businessweek article to convey “Not just numbers. Give them something they can use.” But it’s precisely hard figures that drive bond market decisions. He may be able to get away with optimistic statements to stockholders, who stand to benefit handsomely on the upside, but debt investors are trained to protect their investment and obsess over the downside.
As things stand, the bullish case seems to be that the company keeps doing what it’s doing, expanding rapidly and running losses to cover expenses, perhaps eventually turning a profit. The bearish case is WeWork is largely wiped out in a recession and bondholders — who, again, snapped up $702 million of debt instead of $500 million — recoup a fraction of what they’re owed. Those don’t seem like balanced risks.
The bonds’ decline over the past few weeks is hardly apocalyptic. Still, WeWork should see it as a reminder that it can’t take its investors for granted. At any sign of serious trouble, it can bet bond traders will get out just as fast as its own members.
(1) It's still down only half a much as WeWork's bonds, on a percentage basis.
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Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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