There’s no point in being rude to WeWork at this juncture. The company’s market cap has fallen to around $130 million, it has billions of dollars in debt, and it said recently that it may struggle to stay in business as its cash balance dwindles. WeWork sees several avenues to right the ship before it runs out of cash: Reduce rent and tenancy costs, limit user churn, reduce its overall cost basis and raise new capital.
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It is not clear how much relief those endeavors will bring, but WeWork is certainly not going out without a fight. Its debt restructuring effort earlier this year is more evidence of that intent.
As we enter what could be the last few months of WeWork, we can draw several lessons from its Icarus-esque rise and fall. You could argue that WeWork is a warning against granting founders too much control for too long: Its founder was famed for his ability to sell and raise capital, but lax controls failed to prevent delusion from replacing ambition at the company. You could also make the case that WeWork became too complicated a financial entity for its own good.
But here’s the lesson I want to take away from WeWork’s saga: Venture capital can be excellent for quickly scaling technology startups, but the model is not a good fit for lower-margin businesses.
Costs, losses, weights
In its most recent quarter, WeWork reported revenue of $844 million, up 3.6% from a year ago. The company improved its bottom line, too, narrowing its net loss to $397 million from $635 million, and shrinking adjusted EBITDA losses to $36 million from $134 million.
Those figures, however, did nothing to offset the fact that the company still had a free cash flow deficit of $646 million in H1 2023. That kind of cash burn is a tough obstacle to overcome for a company that’s worth less than a quarter of its free cash flow deficit from just the first two quarters of the year.
WeWork’s description of its liquidity isn’t encouraging, either:
As of June 30, 2023, the Company had $205 million in cash and cash equivalents, including $46 million held at its consolidated VIEs, and $475 million in delayed draw note commitments, resulting in total liquidity of $680 million. The Company issued $175 million of the delayed draw notes in July 2023.
It’s no surprise that the company’s “losses and [its] projected cash needs, which have been impacted by the recent increases in member churn, combined with [its] current liquidity level [leave] substantial doubt . . . about the Company’s ability to continue as a going concern.”
Did it have to be this way? I don’t think so. WeWork clearly had an idea — there’s a good book about that — that resonated with its customer base. However, in its pursuit of ever-larger checks, the company prioritized revenue growth over the health of its business. The blame for WeWork getting out of shape so fast does not rest solely with investors per se. I’d hazard the fault lies with everyone who was involved.
When you pour capital into a business with limited gross margins to help it increase revenue while accreting long-term liabilities, you can spend your way to a point of no return. Why do margins matter, then? Because all the money that WeWork spent on growth has left it with a revenue base that is simply not profitable; what all that fundraised money bought is actually not worth that much.
In Q2 2023, here’s how the company’s gross profit stacked up:
- Revenue: $844 million.
- “Location operating expenses — cost of revenue” sans depreciation and amortization: $725 million.
- Gross profit sans depreciation and amortization: $119 million.
For a company that has selling, general and administrative costs of $150 million before taking into account debt costs, it’s clear that WeWork remains far from even reaching operating profitability. And we may be being too generous here by not counting the depreciation and amortization costs in our math. Indeed, in its Q1 2023 report, WeWork said that its very non-GAAP “building margin” metric came to –$20 million, inclusive of depreciation and amortization, and +$120 million without.
It’s very cool that WeWork has a revenue run rate of $3.38 billion, but if that revenue costs a lot to generate, it’s hard to arrive at the company’s value — apart from knowing that it is not much. Investors seem to agree with that estimation, with the company’s shares down 22% to $0.16 this morning following the going concern warning and the Q2 results.
You can get mad if you want to. WeWork raised a lot of money that could have gone to founders with models that are a better fit for venture-style growth. Heck, some of those dollars could have backed underrepresented founders, too. But hubris is a human quality and the majority of venture bets fail. None of this is exceptional, per se, except the scale of this possible failure.
WeWork can try to spin a good tale about being asset-light and the like, but it was fundamentally a low-margin business that took out longer leases than it sold. If it had scaled slowly, expanding when it could afford to with its own cash flows, the company would have been a smaller but healthier business today.
Rent the Runway’s market cap of about $100 million is further testament to the fact that it can be a good idea to raise venture capital to scale a business with highly valuable revenue, provided you can generate operating leverage later. But that is just not doable when you can only manage modest gross margins or worse.
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