Other people's money

Wednesday, July 26, 2017

Wework has raised $760m (US) in a new series G funding round, which according to sources close to the deal, puts the company’s valuation at $20billion. This valuation is absurd.

Sure the business is going through phenomenal growth but how hard is it to grow with other people’s money, a lot of other people’s money?

The growth seems rushed. The market research appears to be minimal and the strategy being applied to spending other people’s money seems to be ‘build them and they will come’.  So where is the value?

Would they follow the same methodology if they were spending their own hard earned cash? I can’t help but feel that they would have a very different approach.

Having been entrenched in the growth of the flexible office sector for the last 20 years I have some concerns. I have seen aggressive expansion plans before and the one thing they all have in common is large landlord incentives and/or other people’s money.

Growing in this sector attracts significant set up costs (fit out, technology, furniture) followed by working capital to cover property costs, staff and running costs during ‘fill-up’. Based on the average size of Wework facilities (colossal if you didn’t know!), both of these costs will be enormous.  

Where there are fit out contributions and rent free incentives available on long leases combined with large floorplates there will always be initial cash-flow, but it will be a race against time to reach a mature occupancy at a sustainable rate before these incentives run out. Thereafter you start to burn cash, other people’s cash.

I have seen it before on a much smaller scale where as soon as the growth ‘money train’ stops the business collapses. Let me explain:

Imagine a scenario where you open Location A and you fill it quickly and cheaply to generate early cash-flow, you get ahead from a cash-flow perspective but you’re income will not be enough when the real costs kick in. You then use the spare cash to expand into Location B. You get more landlord incentives and follow the same pattern. By the time you get to Location C, Location A is out of its incentive period and losing money so the excess cash you get from Locations B & C goes to funding the negative cash flow in Location A and the expansion into Location D. This perpetual cash hole gets bigger and the only way to fill the gap is through increasing the rate of growth or significantly altering the income profile on the existing locations, the latter being a very slow and difficult process.

If you assume that 1 in 5 mature locations consistently make money (by mature I mean out of landlord incentives with full operating costs) then you will need to have at least 8 new openings to be able to continue the growth and fund the loss making 4. The quicker you get bigger the worse this becomes.

If you then add into the mix Wework’s tech focus, where 90% of businesses fail and less than 5% succeed, should investors be worried? What Wework have done is reinvigorate the serviced office sector. Yep I said it, the serviced office sector. They are not co-working, co-working is not a sector, co-working is part of the serviced office model. Remember hot-desks? Imagine that with exposed bricks, soy latte and hipster beards where everyone wants to ‘reach out’.

They are the ‘new’ serviced offices and serviced offices have been growing in popularity long before Wework. They have captured the attention of corporates to embrace a new way of working and that is a good thing but they are serviced offices without service. They provide a cool environment with free beer and places to hang-out but is that conducive with taking your business to the next level?

They have ‘community managers’ who probably float around the office on roller-skates helping you to ‘connect’ with the person next door (because clearly you aren’t capable of talking to your neighbor yourself!) but where is the real service? The service you need to flourish, the service that removes the distractions and allows you to focus, the service that gives you back the most valuable commodity of all – time.

Other people's money

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