When it comes to new and exciting industries, investors have been primed by the winner-take-all world of tech investing. In other words, the belief that the sort of market dominance and attendant profitability that companies with strong network effects, like Facebook Inc. (NASDAQ:FB) and Alphabet Inc. (NASDAQ:GOOG) (NASDAQ:GOOGL), have enjoyed can be replicated in other industries.
The We Co. (WE) presents a timely, and arguably particularly egregious, example of this situation.
Dreaming of scale
WeWork, as the We Co. is still generally known, does not want to be thought of as a property or leasing business. Rather, it hopes to be seen as a tech disruptor, with a promise to do to the workplace what Amazon.com Inc. (NASDAQ:AMZN) has done to retail. This is a fundamental tenet of the WeWork bull thesis.
A key advantage for WeWork has been an apparent absence of competition. Thus far, conventional competitors have been constrained by the mundane needs of remaining profitable. Yet, as a few fresh upstarts like Knotel have shown, WeWork is no longer the only landlord willing to burn cash to build scale. That is bad news for a story that depends on a wildly optimistic total addressable market, as well as an ability to eventually raise prices once a position of unassailable market power has been achieved.
The lessons of the ride-hailing industry, which has seen a similar tradeoff of losses for scale, should loom large with WeWork. Sometimes scale is not enough. Moreover, oftentimes scale is nothing but an illusory advantage, especially when barriers to entry are quite low. Again, the apparent structural unprofitability of the likes of Lyft Inc. (NASDAQ:LYFT) cannot be ignored in the context of WeWork.
The network effects and market dominance the company promises in its S-1 filing are not likely to emerge, even temporarily.
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Child of the capital glut
There can be little doubt we live in an era of unprecedented capital glut. The Federal Reserve, like most leading central banks around the world, has maintained unprecedentedly low interest rates for a historically long period of time, leading to the predominance of so-called zero interest policy, as well as an increasingly frequent incidence of negative interest rate policy.
Stratechery's Ben Thompson recently offered some insight into how this macroeconomic and financial reality has resulted in bull and bear WeWork theses that share surprising amounts in common:
"I would argue that the WeWork bull case and bear case have more in common than it seems: both are the logical conclusion of effectively unlimited capital. The bull case is that WeWork has seized the opportunity presented by that capital to make a credible play to be the office of choice for companies all over the world, effectively intermediating and commoditizing traditional landlords. It is utterly audacious, and for that reason free of competition. The bear case, meanwhile, is that unlimited capital has resulted in a complete lack of accountability and a predictable litany of abuses, both in terms of corporate risk-taking and personal rent-seeking. Perhaps the real question, then, is what has driven the capital glut that has both helped WeWork's business and harmed WeWork's corporate governance? Is it merely the current economic cycle, which means a recession will not only pressure WeWork's finances but also turn off the spigot of cash? Or has there been a fundamental shift in the global economy, as the increased impact of technology, with its capital-intensive business model that throws off huge amounts of cash, drives more and more global output?"
Even if its valuation slides, WeWork has such a massive putative market capitalization that it could finance massive expansion for years to come.
Betting against dumb money
So long as WeWork can maintain anything close to its pre-initial public offering valuation, it will not want for cash.
Provided the capital glut continues, which seems likely to a degree even in the event of a recession, WeWork may well be able to keep finding sources of cash to fuel its insatiable appetite. Bears hoping the capital taps will be switched off overnight should think again. Whether it can sustain a valuation in the face of such dilution is a more complicated issue, but there is plenty of dumb money out there right now.
Yet, as a long-term short play, there can be little doubt the company remains an obvious shorting opportunity. The rise of competitors willing to engage in the same external capital-fueled growth binges that have driven WeWork into the valuation stratosphere may further complicate things for the would-be king of co-working.
A competitive market, fancifully optimistic outlook and insatiable thirst for fresh capital would be bad enough, but the darkening global economic outlook makes WeWork (and its cyclical exposure) look downright lethal.
We see little to recommend itself in this IPO. On the long side, anyway.
Disclosure: No positions.
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- WE 15-Year Financial Data
- The intrinsic value of WE
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