WeWork as an intermediary with a duration mismatch
Back in May, I wrote a post I titled "2019 may be the best time to IPO". The gist of the post was that unicorns were seeing the best market conditions imaginable for conducting an initial public offering. But, the window for loss-making companies for getting an IPO off the ground at high valuations could close quickly. I believe we are seeing that now.
As I put it in May regarding an article about the dubious business model of dockless scooter companies:
My first thought when I read this article on the scooter company Bird was that now would be a perfect time for it to schedule an IPO. Perhaps it waited too long. It seems like every cash-burning unicorn company is preparing for IPO now, so primed are investors for growth opportunities.
Does it matter that the dockless rental concept has run into the kind of snafus that chased the Chinese dockless bike company Mobike out of Manchester, England? I say no. Right now, revenue growth is what matters for these IPO companies. And these companies should IPO now while they can because these conditions won’t last forever.
The company which could have changed the dynamic is WeWork. It has been hounded by a series of negative stories regarding conflicts of interest, high cash burn rates, and poor corporate governance. But, for me, it's the business model that makes WeWork questionable.
Having a business based almost exclusively on short-term revenue agreements while locking yourself into long-term loan liabilities is a recipe for a liquidity crisis. It's what's called a duration mismatch. And so, the British bank Northern Rock comes to mind when I think of WeWork. In the Noughties, it was growing gangbusters via this duration mismatch route. Northern Rock was so dependent on the short-term funding market for liquidity that, when that market seized up in 2007, it ran aground, forcing the Bank of England to arrange a bailout.
As I put it in May:
The same will happen to WeWork when the economy turns down, as their short-term contracts are canceled en masse. Let’s see how the company’s finances hold up. Personally, I expect WeWork to go to zero. This is one company on which I am definitely bearish.
The toxic brew here is two-fold. It's about the duration mismatch and it's also about growth. I am not enamoured of WeWork's business model relying on short-term leases when most real estate companies have leases of a variety of lengths. But, that could be manageable were it not growing so quickly, running up huge losses and depleting its cash reserves. The duration mismatch and the huge growth makes WeWork uniquely vulnerable as it did Northern Rock a dozen years ago. It's a model that's destined to fail when the economy turns down.
The Private Market Crash
Now, back in May, I expected WeWork to have almost no problems getting an IPO off the ground, so frothy were market conditions. But as the yield curve has inverted and angst about global growth has increased, financial conditions have tightened.
WeWork may never go public. And if it doesn't, the implications could be far-reaching. We have seen a slew of companies raise private money from "patient investors" who are looking for alternative places to put their wealth in the aftermath of the Great Financial Crisis. The thinking has been that this market is insulated from the volatility of public markets because it is defined by long-term money because of its relative illiquidity.
We need to re-assess that assumption in the face of the massive hit to valuation that WeWork took. If private market investors are exposed to deep losses, their behavior might change. And to the degree they realize that an IPO is not the endgame. But instead, large losses may well be, this could impair the ability of loss-making companies to get additional funding rounds. Once that happens, we will see these companies cut back on investment, lay off workers and husband cash.
Think of WeWork as the canary in the coal mine. I expect more spectacular flameouts like this to come. And then, we'll just have to see how the private market's liquidity holds up.