WeWork is about to run out of cash, so it needs someone to give it more cash. This has the company’s new leadership choosing between two unappealing options: borrowing money, and thus piling large amounts of new interest expense onto an already-unprofitable enterprise; or selling more equity, presumably at a drastically lower valuation than the last time it took equity investment, and diluting the existing shareholders.
SoftBank, WeWork’s longtime sugar daddy, could inject even more capital. The Japanese firm and its Vision Fund investment vehicle have already invested $10 billion into WeWork and they are discussing a further $5 billion, mostly in the form of equity. We don’t yet know what valuation the new investment would imply, and how much WeWork’s prior investors (including SoftBank) would have to write down the value of their existing stakes in the company.
And then there is an ugly debt option. According to Bloomberg, the other rescue package WeWork is considering, from J.P. Morgan, would entail $2 billion in unsecured bonds paying an interest rate of 15 percent. That’s high even for junk bonds; 15 percent would be an attractive return on equity, in many situations. (The package would total about $5 billion and include secured debt that would likely bear a lower interest rate.)
These 15 percent bonds wouldn’t be normal unsecured debt. For one thing, they would be “payment in kind” bonds, meaning instead of receiving periodic payments entirely in cash, bondholders would receive part of their coupon in the form of more bonds. That’s probably necessary since one of WeWork’s key problems is that it doesn’t have enough cash. But it also means the company would grow more and more indebted to the bondholders over time. And, also according to Bloomberg, if WeWork gets to a valuation of $20 billion, the bondholders would get a hefty bonus payment that “could boost their return to around 30 percent.” Wow! Keep in mind, a few months ago, investment bankers were telling WeWork it might already be worth $65 billion.
I understand why a potential investor would demand the world in exchange for lending into a firm as speculative as WeWork. But think about what this means for you if you are an existing equity investor. WeWork is taking on more debt, which means higher leverage and greater risk of bankruptcy, which would wipe out your equity and leave you with nothing. The debt bears a really high interest rate, meaning that even in a situation where WeWork has fixed its business, interest will eat up lots of revenues that otherwise could be profits available to you. You likely can’t get any of your money back until the bondholders are paid in full. And, in the upside case where the company is doing great and there’s enough money to go around for everyone, the bondholders get a bunch of extra money for their trouble.
The advantage of debt over equity is supposed to be that debt avoids diluting the existing equity owners. But WeWork’s equity owners would properly see this style of debt as an effective dilution, but one where they sit behind the dilutive investment in line for repayment. Horrible.
That may be why, as Matt Levine notes, SoftBank is sweetening its equity offer. Earlier in the week, reports were that SoftBank wanted to take majority control of WeWork in exchange for a new equity investment. But now Bloomberg reports SoftBank has a proposal where it would not gain majority control. In addition to preserving the rights of other investors (like former CEO Adam Neumann) that might also mean SoftBank is agreeing to accept a smaller fraction of the company in exchange for $5 billion.
In theory, a new equity investment in a troubled firm of uncertain value like WeWork should be structured on extractive terms. To the extent SoftBank’s equity-investment offer looks attractive to WeWork’s existing ownership group, that may be because SoftBank is going to overpay again, even if not by as much as it did last time. And that may mean this new chapter for WeWork is not so different from the previous ones: SoftBank’s desire not to look like it made dumb investments in the past will drive it to throw good money after bad, just to demonstrate that someone (itself) is willing to buy the things it bought in the past, at some price.
The unicorn bust has shown that private investors — with SoftBank playing an outsize role — have been willing to buy “hot” companies at valuations the public market cannot support. When a company goes public, it becomes impossible to pretend anymore. But so long as WeWork stays private, SoftBank can continue to set the market price for WeWork shares, so long as it’s willing to be the sole buyer.