Signature Fixed Income Due Diligence: WeWork = NoWork

Carlton Ling's picture

Background on WeWork

As you have probably read, WeWork’s much hyped equity initial public offering (IPO) failed.  For the record, we are not invested in either their shares or the previously issued high-yield bonds.  Although we have no investment in WeWork, we thought we could use it as an interesting example of the Signature Global Asset Management (Signature) investment process and the need for cross-asset collaboration.

To give some context, WeWork is a company that offers short-term shared office space that is geared towards building a "community" for its tenants.  They commit to long-term leases, finish the office space with modern furniture and amenities, and rent the shared space to their “members” for short periods of time. 

Credit investing is inherently asymmetrical and evaluating downside risk is key. It’s the ones you avoid that make a big difference. In 2018 (before the company's IPO announcement), WeWork issued $702M in high-yield bonds at 7.875% due in 2025 that were originally rated Caa1/B+. This bond was particularly interesting to us as it represented about 120 basis points of incremental yield over a bond with similar ratings and duration[1].

As part of our due diligence, I collaborated with Josh Varghese from Signature’s real estate team to fully understand the company.  Our research did not result in an investment in the high-yield bonds and in hindsight, it reached the correct decision as we avoided material losses.  The Signature investment approach fully utilizes the depth of our fixed income and equity resources and in this case allowed our equity real estate team to also fine tune their investment decision well in advance of the IPO.  The company's valuation ahead of the IPO process reached as high as $47B on paper, but by the time the IPO was cancelled it had dropped down to $8B.  Similarly, the bonds that were issued in April 2018 are now trading around $76.

WeWork: NoAssets + NoEarnings + NoBarriers + NoCapital + NoGoverance = NoWork:

To better understand why we chose not to invest in WeWork bonds, we felt a closer examination of our process might help.  

NoAssets (net): The company has more liabilities than it has assets.  Due to operating losses the company has a $2.3B equity deficit.  Against minimal hard assets, significant capital expenditures drove total debt and lease obligations to $18B.

NoEarnings: Between January 2016 and June 2019, the company had a cumulative loss of $3.6B. That’s billion with a b. During this same period it consumed an even greater amount of cash, $7B in operating and investing activities.  What concerned us was that as WeWork grows, each new leased office site adds to the cash pressure since it takes years to reach breakeven after requiring significant upfront capital to build and market.  With no signs that cash burn is abating we question how long it will take their business model to become profitable?

Wework - NoBarriers: WeWork office space has its appeal and gets rave reviews.  Some of their sites incorporate unique amenities that include fitness studios and beer taps.  These features are all intriguing, but nothing I would consider proprietary and all things competitors can do.

As well, the WeWork model needs office space to work.  If this kind of business model is sufficiently profitable, competing real estate companies that already own the space could easily step in and do it themselves. 

NoCapital: The most significant barrier for WeWork may be access to capital and it seems WeWork might be on the wrong side of the wall.  As the company’s already weak credit ratings (now B by S&P and CCC at Fitch) deteriorate, landlords may be less willing to underwrite leases to them. The most concerning risk though is the company’s asset / liability mismatch, as the rental business is providing short-term rentals but has entered into long-term leases. Asset/liability mismatches –  either by currency, tenor, or floating vs. fixed – are classic risks that are often mismanaged and misunderstood.

NoGovernance: WeWork has not yet reached the maturity level expected of a public company.  There is evidence of self-dealing, conflicts of interest and a dual class voting structure that served to benefit Adam Neumann, the then chief executive officer and holder of majority voting rights. Ahead of the IPO filing, Neumann rebranded WeWork to The We Company and paid himself almost $6M for the trademark rights.  In addition, the company had leased properties in which Neumann held ownership stakes.  Furthermore, Neumann was on compensation committees that determined his pay. 

We also had concerns over corporate transparency.  In our years of investment experience, we had not come across a situation where a rating agency withdraws its ratings just four months after being issued.  That happened when Moody's withdrew its rating citing "insufficient or otherwise inadequate information to support maintenance of the ratings."

Wework: NoAssets + NoEarnings + NoBarriers + NoCapital + NoGoverance = NoWork

Conclusion: As I mentioned before, credit investing is inherently asymmetrical and evaluating downside risk is key. It’s the ones you avoid that make a big difference. Having the scale and resources of Signature and ability to quickly collaborate with the Signature real estate portfolio managers enabled us to quickly understand this opportunity and make what turned out to be the right decision to not invest.

If you have any further questions about Signature, please don’t hesitate to contact us through your CI sales team or financial advisor.

Thank you,

Carlton Ling

 

Carlton Ling is the Vice-President of Portfolio management and a Portfolio Manager at Signature. He does not have a material interest in the securities discussed herein; however, he is an investor in certain Signature funds which may hold these securities.

Source: Signature Global Asset Management, Bloomberg Finance L.P., as of November 19, 2019.

 

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Published November 20, 2019.

 

[1] Per BAML ICE Single-B index, using 2025 bonds rated B2

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