IPOs, with a WeWork perspective
1/ There used to be a time when tech IPOs had all but disappeared. The reasons were many of course, but let me note three of them here. One, pointed out by Marc Andreessen, was the toughening of regulations for public companies. The post-Enron Sarbanes-Oxley Act raised the bar higher in terms of compliance, and every company that sells shares to the public must comply. It costs a lot of money, and most tech companies have (rightfully, I think) decided that their capital would be better invested in product and growth rather than in paying lawyers, auditors, and accountants to ensure compliance.
2/ Another factor is concentration in the investment banking industry. It’s an argument developed in Bill Janeway’s Doing Capitalism in the Innovation Economy. For a company to go public, it needs an underwriter. Years ago there were many of those, both large and boutique, all over the world. It made underwriting a commodity affordable for even young companies. But now investment banking has been consolidating for quite some time, and you can’t plan an IPO without dealing with behemoths such as Goldman Sachs or Morgan Stanley, which are not interested in small operations and tend to bill very high fees. The situation is even more dire in Europe, as the center of gravity for investment banking has been shifting more and more toward the US.
3/ The third factor why IPOs used to be scarce is what Steve Blank calls “The Revenge of the Founders”. When many tech companies went public at a rather early stage (that is, during the 1990s), the common practice was to complete the founding team (people like Larry Page and Sergey Brin) with so-called “adult supervision” (people like Eric Schmidt). Then came the 2008 financial crisis, and suddenly there was so much capital chasing so few deals that founders ended up having the upper hand: not only were they able to reject the idea of hiring “adult supervision”, but they also learned to be wary of any supervision at all. As going public means increased oversight and supervision, it’s only logical that founders have embraced the idea of keeping their company private for a longer time.
4/ Why have IPOs made a comeback recently? It’s not very clear. There is certainly a sheep-like effect, with the first company to go public dragging all the others behind them. After all, nobody wants to be left behind while lots of others are getting very wealthy. But mostly it’s because the stock market has been booming in the recent period, P/E ratios have risen to levels that make most tech companies appear highly valuable, and there has been a growing discussion about the middle class being deprived tech-driven value creation. This is why venture capitalists, founders, and others have decided it’s time for tech companies to go public again.
5/ WeWork, however, is late to the party. There have been disappointing IPOs, such as Uber’s, and life has been an ongoing struggle for some tech stocks such as Lyft, Slack, and Uber (again). Also, a recession might be coming, which creates two problems for WeWork. First, the stock market might be heading for a slowdown, and the youngest stocks, those which are not well understood, could be the first to take a hit. Second, WeWork’s financial model makes it vulnerable to an economic downturn: it has borrowed a lot of debt to sign leases all over the world; paying all that rent was often delayed by negotiating with landlords, but those costs will rise within a year or two; and it’s assumed that demand for WeWork’s product, which is both expensive AND flexible, will likely collapse if the economy is doing badly.
6/ It hasn’t helped that the company has garnered a terrible reputation over the years. I don’t mind the sophisticated practices on the corporate finance front. I actually like financial engineering and I even think that the infamous “community-adjusted EBITDA” somehow makes sense (on that, see my 2017 issue on Capitalists beat merchants every time). But, as pointed out by Ranjan Roy in The Margins, WeWork embodies all of the excesses of the 2010s: the arrogance of the founding team; the governance that’s heavily tweaked in their favor; the grand and nebulous mission statements; the partying; the misogyny; the fast growth fueled with cheap capital; the hasty diversification; the acquisitions that don’t make sense; and many others.
7/ And then there is all the discussion around WeWork as a tech company (or not). I laughed when I read earlier this year that “WeWork used artificial intelligence to learn that people drink coffee in the morning so they should hire a barista.” And the discussion about what exactly a tech company is is quite heated (you can read other interesting takes by David Galbraith, Andrew Hill, Christopher Mims, Benedict Evans, Can Duruk, Ben Thompson, and me.) As for me, I think that WeWork is a tech company in two regards. First, it’s a company that seizes the current transition as an opportunity to design a new product. (By the way, this is exactly how they pitched their first investors.) Second, it’s a company whose culture and business practices are deeply rooted in the new paradigm, as opposed to the “more of the same” approach that tends to reign in the conservative real estate industry. It’s a tech company just like there were mass production companies found not only in the car industry, but all across the economy.
8/ A compelling bullish case has been made by Alex Danco in his excellent newsletter Snippets 2.0. His main argument is that WeWork is all about scale. It might not be profitable anytime soon, especially in the context of a recession. But it has deployed so much capital in securing leases all over the world and building a fantastic brand that no matter what happens to WeWork (refinancing, change of management, etc.), it is here to stay. The moat that scale provides to them is so deep that it will be impossible for any competitor to catch up, especially in the context of an economic downturn. And this is without accounting for the network effects that WeWork could trigger while leveraging its physical assets. Also don’t miss this thread by Patrick McKenzie, as well as a rather bullish take by Stratechery's Ben Thompson.
9/ By the way, WeWork being competition-proof because of scale is very much in line with SoftBank’s investment thesis. I like to sum this up as “pick the winners”. To me, the genius of Masayoshi Son is in realizing that many obstacles to the growth of tech companies (regulations, tangible assets, geographic fragmentation) can be crushed or avoided with more capital. Therefore if a company raises much more than its competitors, it can not only race ahead, but it can also remove the obstacles on the road to becoming the global leader. If you have a lot of money as an investor, the conclusion is obvious: invest enough so that all your portfolio companies have a shot at total domination, and you’re certain to generate returns. It works in every industry—and in real estate, that’s WeWork.
10/ Now we realize that there is only so much that infinite capital can buy, and a successful IPO is not on the list. The most recent news is that SoftBank has been pressuring WeWork to postpone the IPO. I can’t imagine the level of tension in those calls and meeting rooms. In a way, that’s capitalism at its best: risky bets made on very large markets which you can win only if you have an eye for the long term. It’s good news that the whole story has been dragging on for many weeks. It has made it possible for all of us to see perspectives from many sides and to get an accelerated education in the connection between technology, real estate, the stock market, corporate finance, and macroeconomics.
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