Can a failed IPO be a sign that the stock market is healthy?
Today WeWork announced that it will withdraw its IPO filing. WeWork is a money-losing company with an inflated valuation and some of the worst corporate-governance abuses I have ever seen. That it was rejected by stock market investors tells me we are far from the bubble days of 1999 or 2006.
WeWork’s Shaky Business
WeWork leases office space on a large scale, long-term basis and re-lets the space for short-term co-working rentals, particularly to technology startups. This simple description of their business model shows its inherent self-destructiveness: WeWork has taken on long-term liabilities (10 year leases) in order to sell a product that customers could cancel tomorrow (short-term desk rentals). Today, in a strong economy, they are not profitable. In a recession, WeWork will see revenues plummet while their customers close-up shop, but WeWork’s landlords will insist they keep paying rent. A company that will struggle to survive the next recession isn’t worth $47 billion, their most recent private market valuation.
However, even if you somehow believe WeWork can turn a profit and that it can find a way to survive as its customers struggle in a recession, numerous other red flags – including cases of self-dealing by Founder/CEO Adam Neumann – are more than sufficient to pass on the investment:
- Neumann has super-voting rights that give him majority control of the company.
- Neumann owns ten buildings that are leased to WeWork at a profit.
- Neumann owned the rights to the “We” trademark which he sold to the company for $5.9 million in stock.
- Nearly 20 friends and family of Neumann are employed by WeWork, including some who work on personal deals for Neumann.
- Neumann has sold $700 million of stock.
Nothing says “sold to you, sucker” like a founder selling hundreds of millions of dollars of stock before the company even IPOs (meanwhile employees are stuck with underwater stock options). All of this is in plain sight and disclosed in company filings. It is no wonder the stock market balked. The mystery is why the private markets did not.
WeWork’s pushed for an IPO because they must raise capital. The company is burning through cash, losing nearly $1.7 billion in 2018 while taking in $1.8 billion in revenue. While rapidly growing companies often show losses, WeWork’s losses are growing and they desperately need to raise additional capital just to keep operating, much less show the growth necessary to prop up their valuation. In attempt to mollify investors during the failed IPO process, WeWork cut their proposed valuation, WeWork modified Neumann’s super-voting rights and announced they would lay off excess workers to stem their losses, and Neumann decided to step down as CEO and returned the trademark payment. I have no idea why these changes were not imposed by venture capital investors, but the discipline imposed by the stock market sends a message that inflated valuations and self-dealing will not be tolerated.
A Healthy Stock Market Rejects IPO Fantasies
The healthy skepticism shown by public market investors that in the past have been all-too-eager to buy into IPO fantasies is a sign of a healthy stock market.
Many investors will find this assertion hard to swallow as they have been argued we are in a stock market bubble as valuations have risen over the decade since the Great Recession. However, if we consider how this would have played out in bubbles past, it is easy to see why we are not in one today. If we were in another bubble, investors would have invented stories about Total Addressable Market that claim how big a company like WeWork could grow, which in the office space market could be almost any number you wanted. They would have fawned over the founder’s visionary leadership. They would have disregarded the corporate governance issues and self-dealing as long as the company maintained growth rates and the valuation climbed. In previous bubbles the stock market would have ignored the red flags and gobbled up shares of a WeWork IPO. This is what happened in private markets, but the public markets said no.
As an investor focused on value, I certainly agree with skeptics that valuations are stretched in many industries and some stock prices are based on rosy predictions of the future. Nonetheless, that investors are capable of tapping the brakes and showing skepticism demonstrates that they are still giving at least some consideration to business value.
I do not say this as a prediction of the short term direction of the stock market; indeed, we may see a near-term decline in the market as investors reassess the prospects of many high-growth yet profitless companies. But this is not the kind of market euphoria that marks the top of a bubble waiting to pop.