Is Valuation a Joke? The WeWork Saga

Investing is an evocative subject. It’s as much an art as it is a science.

It’s a science because like most other fields of science, there are certain laws, some time-tested techniques and some processes one can follow to get predictably similar results; In stock market speak - generate positive returns on capital over a (long) period of time.

It’s also an art because knowing what/how not to do it is just as important as knowing what/how to do it. And (un)fortunately enough, one only becomes an artist with time, experience and more often than not costly mistakes.

Public vs. Private Markets

When it comes to investment avenues, public markets offer a relatively stable option which are available to the vast majority. Public markets typically feature small ticket sizes, high(er) liquidity, good governance regimes (atleast on paper), proven track record and many more checks and balances to ensure that the public is not fleeced out of their hard-earned money.

However, stability is not particularly known to be the best of friends with growth and innovation - basically risk taking.

How must we go about innovation then? And more importantly, supporting such innovation.

Well, the answer lies with private money. This often manifests itself through Private Equity for companies that have a sales record and through Venture Capital where money is invested in a ‘innovative’ (read:technology driven) company (read:startup) that builds a disruptive product which can earn huge dividends if supported during early-stage (seed, idea, Series A/B). You get the drift.

The World of Venture Capital

Generally, a group of high net-worth individuals (& networks) come together to back (financially and otherwise) founders/innovators in the disruptive startup category. These HNIs become VCs, micro-VCs, or at times macro-VCs.

The entrepreneurs/founders typically have the courage and the necessary insanity to go on a roller-coaster ride that can either lead them to the halls of Valhalla or the golden city of El Dorado. No matter the result, a great tale is almost always in the offing.

Sometimes though, things take an unprecedented turn - unexpected by the masses and uncontrollable by the classes.

Often, one such contentious factor is a concept called valuations. What is a company worth; How exactly is that company worth so much; Or rather why.

The investors collectively, during one or more investment rounds, decide to pay a premium on the company’s share capital thus driving its perceived value to the sky. Hey, they don’t call it a rocket ship for no reason, okay?

However, certain things must be noted here:

• It is the monetary worth
• It is an estimate
• And it is done by a valuer, who typically has incentives to write up the value of the asset. Basically, skin in the game.

That last bit is the most interesting of the lot - skin in the game.

Source: Softbank Group

Enter Softbank

This brings us to a modern day bank. Or a software behemoth. Or the 5th largest telecom operator in the world. Or debatably the largest venture capital firm in the world (a Macro-VC?). Well, it’s called Softbank. It does many things.

It is also known to invest large sums of money in companies of varying shapes and sizes and likes to declare them market winners. Something like I decide to date a girl and then announce that she’s won the beauty pageant, one where I’m the biggest sponsor. Wink wink nudge nudge.

One such ‘girl’ happens to be the former darling of the startup world - WeWork or as it’s called now The We Company. Softbank invested USD 2 Billion in WeWork at a valuation of USD 47 Billion in January early this year. WeWork, having just been declared winner by it’s openly rich boyfriend became a little too reckless and filed its S-1 for an IPO (Initial Public Offering) at a proposed valuation of USD 65 Billion.

Source: The We Company

And all the while, it was running credit card bills of upto USD 2 Billion a year. Or maybe credit card dues. Or community adjusted EBITDA. Or operating losses. If you can’t seem to read it straight, worry not! You’re not alone.

Some really smart folks at the likes of Goldman and JP Morgan wanted to play ball and decided to help take the company public. At that valuation. With those credit card bills.

The Fall from Grace

Then something happened. The other suitors, presumably rich and discerning in their own right and always on the lookout for another damsel to fund, started noticing that this one has been particularly erratic. It’s very high maintenance, has a drinking problem, spends too much money, and faces commitment issues.

These suitors on the Street started dissecting this ‘model’ on its financial and business model and started applying some real math to it. And then it hit them. And then it hit the Valley. Okay maybe not the Valley. But turns out, like an(y) early-stage damsel, The We Company really needed the money, the valuation was secondary at this point.

So, as a token of commitment, the Macro-VC we spoke about earlier, invested some cool USD 750 Million in The We Company at a revised valuation of USD 20 Billion. Yes, from a proposed valuation of 62, we’re now down to 20. Try to keep up okay?

However, the market was still not pleased with how they’d reported their numbers and started calling the Board out on its accounting jiu jitsu. The courtship is the hardest they say. But nobody tells that it doesn’t get any easier!

And so, as a last ditch effort, more so to support a debt deal with Goldman, The We Company and its board decided to lower the valuation to USD 12 Billion in the hopes that the public will be able to digest a company which is worth almost as much as the amount of capital it has raised. What if it still has a high credit card bill, it’s jewellery is probably worth as much. Huh!

The fact that the last offer price was roughly 80% lower than the initially proposed price was supposed to just be a footnote. Nobody was supposed to pay too much attention to it anyway. Have you ever asked that beautiful girl at the poker table about which Ivy did she go to? Guessed it, probably not.

To some of us - well, most of us - this begs the question - Is valuation a joke? How can a company lose more than 80% of its valuation in less than 6 weeks. Was it over-valued earlier or is it undervalued now?!

The beauty of the question lies in that it almost answers itself.

Incentives and Illusions

Softbank, a publicly traded company on the Tokyo Stock Exchange, declares its private investments as assets in its balance sheet. The underlying or perceived value of those assets affects Softbank’s market capitalisation and overall perception. Its ability to raise more capital and take bolder bets hinges on that perception.

And hence, Softbank has an inherent incentive to write-up its investments (during follow-on rounds), sometimes even to the point of irrationality. Since, it’s the only such Macro-VC in the global town of Venture Capital, it gets to act like a bully on the playground and call the shots. It’s like there are several white dudes who drive a Ferrari LaFerrari. But, then suddenly comes this mysterious guy who drives a Bugatti La Voiture Noire. Gasps.

Now, it can be argued that it was a visionary move and Softbank saw value where others didn’t; the classic contrarian argument.

However, a contrarian if often on successful if it’s able to convince all the others to buy into it’s version of the truth (in this case, future). Or if it’s the only man standing in the aisle. Or if it becomes the so-called one-eyed man in the land of the blind.

Which then is the case here?

Softbank ‘invested’ in WeWork multiple times at different valuations. In January 2019, they invested USD 2 Billion at a USD 47 Billion valuation. They recently put another USD 750 Million at marked down valuation of USD 20 Billion.

In total, they’ve invested anywhere close to ~USD 11 Billion in The We Company. Writing up or down it’s value multiple times and as the suitors so demanded.

All of this could have worked in Softbank’s favour had WeWork been a disruptive technology company. But turns out, it was ‘only’ a real-estate company masquerading as a technology company. Boo.

The Business Model Problem

This particular damsel has a lifestyle (the business and financial model our friends at Goldman and JMP dissected earlier, remember?) that requires massive amounts of money.

It requires large amounts of capital to acquire and upgrade assets. Which, it subleases to smaller/individual buyers. These individual buyers are Gig economy workers. Individuals and small businesses who want to modernise their work-place and operate out of swanky lifestyle offices without the need for long-term commitment. Everybody wants to be near the damsel but they’re all also really commitment phobic.

And these gig workers, have the least amount of monetary cushion during an economic slowdown. Oh honey, you got no money?

During such a slowdown, our damsel still has to pay it’s credit cards bills - the rental leases WeWork has signed run for a few decades at a time and sublease agreements with the smaller companies (which comprise close to 40% of the company’s overall revenue) are at best a few months only. This leaves our damsel in distress further exacerbating its losses. Credit card debts are real.

Conclusion

So, coming back to our original point - of investment as an art and science. Well, it’s an ever evolving subject and while things generally follow some rules, sometimes they don’t. Sometimes, we make money, sometimes, we lose money. Sometimes, the girl likes us back, sometimes she doesn’t. Sometimes we find suitors, sometimes we don’t. Let’s celebrate the wins and learn from the losses. For there’s plenty of fish in the ocean.

Oh, and yeah, always remember - What goes up, must come down; what goes down, may never come up again.