It's hard to tell apart business journalism and PR: the Wework edition

Most of business journalism reads like PR put out by companies. Still, some pieces are more blatant than others. The NY Times just printed an example of such gibberish, this opinion piece about Wework.

Wework is one of those "unicorn" startups that investors are hoping to sell to the public before the impending stock market collapse for gazillion dollars. Its main business is renting office space to mostly small businesses, entrepreneurs, or small divisions of large companies. The primary "innovation" is the short-term lease, as short as month-by-month. (Disclosure: my startup was a sub-tenant of Wework through the Harvard Business School Startup Studio. I am a satisfied customer.)

As with many successful startups, Wework offers a product to a segment of customers who find it irresistible. For a startup business like mine, it's much too risky to commit to a 10- or 20-year commercial lease. Most startups fail within a short few years, and the entrepreneurs are already taking on a lot of other risks. So they have an attractive product but does it have a viable business model to deliver that product profitably?

With few exceptions, Wework does not own the buildings it leases out - it has signed long-term leases with landlords, and then rent to startups and smaller businesses who sign short-term leases, thus the risk of the long-term lease shifts from the entrepreneurs to Wework.

The Times article presents an argument by analogy to refute an obvious weakness of Wework's business model. This same weakness has felled many bankrupt companies in the past. When you have long-term obligations and short-term revenue sources, you're highly vulnerable to the "credit crunch." This scenario played out in the Great Recession when many companies suddenly found that banks were unwilling to roll over their debt, which immediately put them out of existence. In the case of Wework, critics also worry that even the revenue sources will disappear since many startups will fold due to lack of customers and/or funding during a recession.

The reporter (Andrew Ross Sorkin) now builds a very flimsy argument based on "too big to fail." It cites some absolute numbers, such as square feet of space it has signed leases for, number of workers using the space, number of employees, etc. Then he arrived at the conclusion that: "when the next economic downturn comes — and it will — WeWork’s landlords will actually be less likely to evict the company if it doesn’t pay its rent."

For an argument based on big numbers, this one is particularly unmoored. None of those numbers are provided in context. What proportion of occupied commercial real estate has Wework leased out? What proportion of revenues does Wework contribute to the biggest landlords? The 1,300 employees may make Wework "one of the biggest architecture firms in the world" but the number does not qualify it as "too big to fail". (Fact check: the largest architecture firm is Gensler, according to Architectural Record, which employs over 5,000, according to Wikipedia. So Gensler is about 4 times the size of Wework.)

In addition, the argument misleads readers about what happened during the Great Recession. The banks who were the creditors did not renegotiate contracts with the debtors who no longer could pay. Far from it, they got bailed out by the U.S. government, using the argument that the failure of those loans would "bring down the entire global economy as we know it". 

This brings me to the final, and most salient, issue. What would those generous landlords be saving in this case? Not the global economy, but a business yet to find a self-sustainable business model - as Sorkin himself cited earlier in the article. Wework is currently running losses of over a billion dollars a year. According to Bloomberg, Wework made ~$800 million in 2017, and spent $1.8 billion. We also know Wework has sold junk bonds but I'm not sure we know the full amount of debt it is carrying on its books.

Wework has made some small steps to reducing its risk. It has indeed attracted some larger companies to rent space with longer leases. But those companies are doing it because the "longer" leases are still much shorter than what they could get from traditional landlords. Usually, the space is used by short-term, even experimental, business units.

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Now on to something of interest only to number geeks. I have questions about this statement: "the company says its average customer has a lease of seven to eight months and new customers are signing leases that average 20 months."

I wonder how this "average" is computed. Note that most of the little guys are on month-by-month leases, which renew until cancelled. This is "right-censored" data in which we don't know the end date yet, so a lot of assumptions and projections go into that average. It's got to be an average of projections as opposed to an average of observed data.

Also, I expect that the distribution of the size of customers will be heavily "right-skewed": a vast majority of customers will be freelancers, and small offices (who sign very short leases), with a few larger tenants (signing longer leases). It's challenging to interpret an "average" unless we also know the "median".

 

Comments

[Mike]

This is a great post. If you take everything at face value in the article you might think WeWork is one of the best companies in the world. But your analysis really hit the nail on the head, there's nothing about them that makes them "too big too fail". If WeWork were to disappear wouldn't the building owners try to rent out to the very companies renting from WeWork?

If the building owners really believed WeWork's model was worthwhile what stops them from copying it? Just cut out the middleman.

[Kaiser]

Mike: yes, the fundamental issue is that Wework's product is to offer startups or startup divisions that have a high chance of failing a less risky option. That is exactly the risk Wework assumes and what investors are worried about. Of course, those investors would love to find someone else to bear the risk...

[Ken]

It is quite likely that the rental agreements with the landlords would, in the event of rent not being paid, allow the landlords to take over the building including fittings and negotiate with the current sub letters.This would be especially so with clients like Microsoft who would not want a situation where they were kicked out because WeWork went bust.