Ben: Capping off the spectacular retreat of a company valued at $47 billion just last month, WeWork announced that it was abandoning its IPO today, after finding very limited investor enthusiasm for its business of designing, building, and leasing office spaces around the world.
As many have noted, this debacle represents a harsh wake-up call for hot young companies that are nowhere near profitability. But last week, you wrote that WeWork’s too-easily-replicable business model is what really did it in. How much of the WeWork story is unique to it, and how much is a lesson for other “world-changing” companies out there?
Josh: I’m not sure the WeWork story is unique, but it’s definitely unusual. It’s different from a lot of the other unicorns whose valuations have been arguably too hot. In all these cases, the situation is that a company has a very high valuation not because it has high profits now but because investors are convinced it will be able to be very profitable in the future. These bets are not always wrong — there were a lot of articles clowning on LinkedIn for being overvalued circa 2013, arguing that it had done nothing to show why this model would be worth a lot of money, and now LinkedIn is very large and very profitable. It turned out the data the company had was really valuable, and you could eventually have an extremely lucrative ad-sales and employer-services platform built around it. But it always involves a leap of faith. You have to believe that the executive team (and very often, the founders in particular) have a strategy that will drastically transform the company’s financial position in the future.
Ben: Yeah, I’m pretty sure I thought at the time that the poorly designed jobs website I actively tried to avoid wouldn’t last.
But anyway, in WeWork’s case, a key problem is that the business model is not actually as novel as the company made it out to be. Shared short-term office-space rentals aren’t new; in fact, WeWork doesn’t even have 50 percent of the U.S. market for it, even though it has nearly 100 percent of the media and investor attention in the space.
WeWork has innovated somewhat in terms of how these offices are organized: They’ve improved design and offered some new amenities, and they have spearheaded layouts that some workers hate but that do lead to more intensive use of the real estate, with fewer square feet per worker. But those aren’t legally protectable innovations, nor are they very difficult for competitors to copy.
And that should put a ceiling on how much WeWork should be worth — the sky is not the limit for future profits. Even if the bet is right that total consumption of shared office space should rise because these innovations make a shared office more appropriate for more kinds of workers, and even if the bet is also right that larger corporations should increasingly outsource their office-space management to companies like WeWork, this is going to be a crowded industry with competitors competing down what WeWork can charge.
Ultimately, WeWork is a real-estate company with all the problems that entails — significant upfront costs for buildouts of offices (even when they do not own the buildings themselves), costs to manage those buildings, the need to sign long leases even though their own subleases to WeWork customers are short, which exposes the company to risk in the event that the economy turns down.
That doesn’t mean the business can’t be workable; it just means its profit margins should be a lot lower than, say, a software company’s, especially when it’s going to face the competition I described above. Yet for a long time, some eager private investors (especially the SoftBank Vision Fund) were distracted from these problems, I think because they found Adam Neumann and his vision so compelling. Neumann had some nonsense about how this was changing the world, not just offering incrementally better office space. His grandiosity was central to the idea that this company was transformative rather than just interesting. But he was also ridiculous. And as people decided his weird behaviors and ideas were not a good use of investor money and were turning off the public markets they wanted to IPO into, they decided they had to be rid of him. But without him, what was the argument that this company could be worth so much?
The whole premise of these unicorns — that they’ll zoom from unprofitability to massive profitability in a way that’s not obvious to the naked eye — has to be that they are unusual companies. If you go around showing everyone you’re a normal company, they may be less afraid that your CEO is going to leave a cereal box full of marijuana on a plane, but they’re also going to be less inclined to divorce your expectations of future profits from your current profits. A normal company will call for a normal analysis: If you want us to believe you’re profitable later, you should show us you’re profitable now. And WeWork is not profitable.
And while I find it plausible that WeWork can tweak its business to become profitable, including by greatly slowing or stopping its expansion, I don’t believe it can ever be so immensely profitable as to support a valuation anywhere near $47 billion.
Ben: As someone who doesn’t follow the twists and turns of these companies’ valuations closely, I’m confused as to how Neumann’s sheer force of personality was so successful for so long at keeping obvious questions about WeWork’s future viability at bay. Do we have Jeff Bezos and Steve Jobs to blame for that?
Josh: I’m not sure we should “blame” them as such. Sometimes an individual executive really does have a vision that creates tremendously more profits and value to consumers than a replacement executive could achieve. In Jobs’s case, in general, computers are a commodity product. Nobody has a strong brand preference for Dell over HP. He found a way to create a persistently differentiated product that could be sold at a premium price earning a high margin. Same in the smartphone space. And yes, private investors are looking for the next Steve Jobs. I don’t think that’s crazy as a broad concept — especially given that economic growth has slowed down and it’s harder to find breakout business opportunities. But I do think there has been irrational exuberance, and I also think some of the candidates for companies that could profitably grow like that have been sillier than others.
Ben: Is WeWork salvageable as a profitable company or concept?
Josh: As a profitable concept, yes. There’s real demand for this product. People need workspaces, the real estate is used more efficiently when you share common spaces rather than having tiny offices along snaking hallways, and so it will exist at some price.
As a profitable company, that depends on the terms of the leases it has signed.
If WeWork made decisions in the past that were based on unreasonable expectations about rents — if it’s not positioned to be profitable if they stop growing, as the company’s leaders have claimed periodically — then it could be insolvent.
Especially if the economy weakens.
Ben: Does all this say anything about the broader economy as a whole, or is its import restricted to WeWork and possibly other start-ups in the same universe?
Josh: I think the enthusiasm for implausible ideas about fantastical growth is a symptom of the same thing low interest rates are a symptom of: an economy where the growth outlook for the long term is weak.
There aren’t enough normal business ideas that can produce the kinds of returns people had become accustomed to.
Ben: Well, that’s not exactly comforting.
Josh: It’s not. Some of this is just about population growth that has slowed down. And some is persistently weak productivity growth, which I don’t think we have great explanations for. Some is that the productivity returns of technological advances specifically have been disappointing.
Incidentally, this is a good sign that the robots are not taking our jobs. If they were, there would be a lot of great investment opportunities in the robot companies.
Ben: Hey, that’s something! A robot could definitely not run this chat — yet.