WeWork's $47 billion, $4 billion lease disparity a recipe for disaster

WeWork's initial public offering paperwork, or S-1, offered some numbers that both sum up its business and highlight its risks.

The company touted its $4 billion in future lease commitments from its customers.

But it also disclosed that it had $47 billion in future lease obligations to its landlords.

Neither number is set in stone, but WeWork's customers could have an easier time getting out of their lease commitments than WeWork could have getting out of the obligations it's on the hook for with its landlords. That disparity presents a huge danger that could rock WeWork to its foundation if the economy were to stall.

Read all of BI's WeWork coverage here.

The paperwork WeWork filed last week ahead of its planned public offering had lots of numbers in it.

But two sets of related figures stood out: $4 billion and $47.2 billion on the one hand, and 15 months and 15 years on the other.

The first pair of figures represents lease obligations: $4 billion is how much the coworking company is due to receive from its clients in coming years, mostly by the end of 2020; and $47 billion represents the lease obligations that WeWork must pay to its own landlords, with the vast majority of that amount not coming due until after 2024.

The second set of figures represents lease durations. Fifteen months is the average lease commitment of WeWork's customers. Fifteen years is the average length of the leases WeWork is signing with building owners.

With those four numbers, you basically have WeWork's business model — it signs long-term leases on properties that it turns around and subleases for relatively short durations. But those numbers also clearly illustrate the big risk facing WeWork. Even as the company has attracted larger corporate customers and persuaded them to sign longer contracts, its own obligations have outpaced its clients' commitments by more than a factor of 10.

“They've got big long-term liabilities, and if the people who are their customers don't have long-term commitments to them, the risk is high,” said Robert Siegel, a lecturer in management at Stanford Graduate School of Business. “Forty-seven billion dollars,” he continued, “is a lot of money.”

WeWork touted the $4 billion and 15-month numbers

As might be expected, WeWork was much more eager to highlight some of those numbers than others.

In the filing for its initial public offering, the company bandied about the $4 billion number, which it described as its “committed revenue backlog.” It touted the fact that the backlog had grown by about eight times, from $500 million, in just 18 months.

Overall, the company mentioned the $4 billion figure at least eight times, starting on page four of the document, right in the part where it's pitching its stock offering to investors. WeWork also mentioned the number further down in a section where the company explained how it expected to fare in a downturn — a big concern of potential shareholders.

“We believe that the growth in committed revenue backlog provides greater visibility and predictability of our future revenue to help mitigate the impact of short to medium-term downturns in the economy,” the company said in the filing.

It gave a similarly prominent place to the 15-month figure. That figure too has grown recently, it noted on page four. At the beginning of December 2017, the average contract its customers were signing was just eight months. It also argued that these lengthening contracts would help it in a recession.

“Going forward, we believe that we are well positioned to navigate through further economic downturns,” the company said.

It wasn't so eager to highlight the $47 billion number

But the company didn't seem nearly as eager to highlight the other two numbers. It mentioned the $47.2 billion figure only three times and the 15-year figure just four times. It didn't bring either of them up until page 26, buried within a section of the document devoted to the risks to its business, a section often ignored because it's typically filled with boilerplate, cover-your-derriere-type items.

Forty-seven billion dollars is a lot of money.

However much WeWork wanted to tout or bury the particular numbers, the four numbers have to be taken together to understand the company's real business model. For all of its attempt to portray itself as a tech company — it mentions the word “technology” some 93 times in its filing — those numbers show its business is really more akin to that of a car- or furniture-rental company — or that of its coworking pioneer IWG, said Scott Galloway, a professor of marketing at New York University.

“This is a company that buys assets and [arbitrages] them” — takes advantage of price discrepancies — “through selling them short term,” Galloway said, continuing, “Hertz does the same thing.”

Read more: NYU professor calls WeWork 'WeWTF,' says any Wall Street analyst who believes it's worth over $10 billion is 'lying, stupid, or both'

Taken together, the two sets of figures are also key to understanding the real risk WeWork faces. In an economic downturn, it may not have enough revenue coming in to match all the money it's committed to spending. The contracts WeWork's own customers have with it will likely give them much more flexibility to renegotiate their leases than WeWork's contracts with its landlords will give it.

“As long as the economy holds up ... [WeWork's] business model works,” said Jeff Langbaum, a real-estate industry analyst for Bloomberg Intelligence. “If there's a pullback,” and its customers start dropping their spaces or forcing the company to lower their rent, he continued, “WeWork is still on the hook for whatever leases it has signed for the long term.”

WeWork has tried to insulate itself from its lease commitments

WeWork has protected itself from some of this risk. Most of its leases are held by so-called special purpose entities, or SPEs. That structure means that those particular obligations are held by subsidiaries that are legally separate from their corporate parent. If the company got into trouble filling particular properties, it could put those subsidiaries into bankruptcy and protect the larger corporation.

Of the $47.2 billion in outstanding obligations, WeWork's corporate parent itself has only guaranteed $4.5 billion. It has another $1.6 billion in letters of credit, security deposits, and surety bonds that it's also committed toward paying those obligations. But that leaves some $41.1 billion that's essentially unguaranteed and that WeWork could potentially walk away from in a downturn.

However, it might not be as easy as all that. Its landlords would almost certainly try to enforce their agreements with WeWork if it tried to skip out on them. It also would face reputational harm — and a huge risk to the future of its business — if it started sending its subsidiaries into bankruptcy and having them default on their loans instead of keeping up with the rent they owe.

“If one of the SPEs were to default, no landlord's ever going to rent to a WeWork SPE after that,” said Walter Johnston, who focuses on the real estate market as a vice president of credit ratings at the research firm Morningstar.

Even shorter term, the company could see its revenue and cash flow constrict markedly if it started shuttering some of its subsidiaries. That decline in cash flow could still imperil the corporate parent, even if it's able to protect itself from the outstanding leases.

“At the end of the day, it's cash flow that WeWork had been receiving that it's no longer receiving,” Langbaum said. In a downturn, he continued, “we don't know, exactly, how their business will hold up.”

But WeWorks' customers could have an easier time breaking their agreements

And while, because of the SPEs and WeWork's limited corporate guarantees, the $47.2 billion number may not be all it seems, neither is the $4 billion in lease commitments that WeWork says it has. Indeed, that number may be more at risk in a downturn than the larger figure.

In its filing, WeWork notes that the vast majority of its own leases with landlords don't include any kind of early termination clauses. By contrast, the contracts its clients sign with it are much more flexible. As it noted in the document, many of its customers can cancel their deals with only a month's notice. That's part of the intrinsic appeal of WeWork — there's no need for members to commit to a long term lease.

This four billion has to be massively discounted

And even customers who have signed up with WeWork for longer terms would likely have a relatively easy time breaking their agreements, said Tom Smith, a cofounder of Truss, an online commercial real-estate marketplace. In addition to its short notice provisions, the company often asks for much smaller security deposits and has much lower early termination fees — when it requires them — than other landlords, he said.

What's more, traditional landlords often require individual business owners to personally guarantee that they will pay their leases, Smith said. Those guarantees provide a big disincentive to the owners to default on those obligations, even if their businesses start struggling, because they, and not just their corporations, are on the hook.

But Smith said he's never seen WeWork, which lists space on his site, ask for a personal guarantee as part of its member contracts.

“Its almost a feature of WeWork's membership agreement that it does not,” he said.

There's no way to tell from the company's filing how much of its $4 billion revenue backlog number is at risk if there's a downturn and its clients start terminating their agreements early or simply defaulting on them. It would be good to know — but WeWork doesn't disclose — what portion of a member's outstanding lease obligation it typically recovers when the member cancels or defaults, Smith said.

But thanks to the ease with which WeWork members can get out from under their commitments, Smith thinks WeWork could see only a small portion of that backlogged revenue in the case of a downturn.

“This four billion has to be massively discounted,” he said. “This four billion,” he continued, “is not like another real-estate company's four billion in revenue backlog, I assure you.”

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