Shedding extra light on how ‘we work’ as investors
How to reach a plausible valuation of a ‘unicorn’ business is a topic we have consistently addressed, here on The Value Perspective, but WeWork sheds added light on our thinking and our investment process
When market historians come to analyse the widespread fixation with so-called ‘unicorn’ stocks in the second decade of the 21st Century, will 30 September 2019 be judged a pivotal date?
Value investors may strive not to impose any kind of narrative on financial events but even they might be forgiven for seeing the day WeWork – once the US’s most valuable private company but now the subject of a $9.5bn (£7.4bn) rescue by largest shareholder Softbank – formally withdrew its plans for an initial public offering (IPO) as a potentially watershed moment.
In investment terms, a ‘unicorn’ is an unlisted start-up business that has reached a paper valuation of at least $1bn – a figure dwarfed by the $47bn at which WeWork’s management, only a matter of weeks ago, had hoped the office space company would be valued when it floated.
How can you plausibly value a ‘unicorn’ business? is a question we have consistently posed, here on The Value Perspective, but WeWork sheds added light on our thinking.
Over the summer months, the WeWork floatation was the subject of increasing coverage by financial commentators and, while we have always approached IPOs with caution, it would have been remiss not to take a closer look at the numbers underpinning the business.
Regular visitors to The Value Perspective will know there are seven key questions we ask of every single company we consider as a potential investment.
Set out in full below, they address the different aspects of any business we believe need to be checked and double-checked before we decide to part with any of our investors’ money. And when it came to our analysis of WeWork, we used our same valuation method, which led us to flag up potential risk areas, both on the company’s balance sheet – essentially its debt position – and off it too.
Our seven ‘Red’ questions
* Has anything been missed off from the company’s enterprise value?
* Have profits – that is, the company’s net operating profit after tax – been misrepresented?
* Is the company’s past a good guide to its future?
* Do the company’s profits turn into cash?
* Is the company’s balance sheet good enough?
* Is the business itself good enough?
* Are there other risks to consider?
Source: The Value Perspective
On the balance sheet side, for example, our analysis showed the company had some $24bn in total commitments – for the most part operating leases for different periods but also some conventional debt.
To offer some context here, this was a business whose IPO prospectus had indicated some $2.6bn of revenues generated over the 12 months to 30 June 2019 – not to mention operating losses in excess of $2bn.
That by itself would represent a significant red flag for us, here on The Value Perspective – but there were plenty of corporate governance question marks too.
Many of these – co-founder and former CEO Adam Neumann’s position as both landlord and tenant, the role of his wife and “strategic thought partner” Rebekah in the business and the so-called “supervoting” shares – have received extensive coverage across the financial media.
Among the many potential answers to our seventh red question – “Are there other risks to consider?” – was WeWork’s extraordinarily complex and convoluted structure, which is nicely addressed (and in far more detail than we have space for here) in one of Aswath Damodaran’s ‘Musings on Markets’ blogs, dated 9 September 2019 and entitled Runaway Story or Meltdown in Motion? The Unravelling of the WeWork IPO.
The leasing machine
Beginning with the observation that WeWork is “a fascinating insight into corporate narratives, how and why they acquire credibility (and value) and how quickly they can lose them, if markets lose faith”, Damodaran goes on to consider what he calls the company’s “leasing machine” before addressing its “complex holding structure and share classes with different voting rights”.
Reproducing a diagram from the WeWork prospectus that looks a bit like Henry VIII’s family tree, Damodaran jokes that the company’s owners and bankers have managed to create more complexity in a couple of years than most companies can create in decades.
Some of this complexity, he suggests, may be down to tax reasons, some to protect the company from “the downside of its own lease-fuelled growth”.
“A great deal of the complexity, though,” he concludes, “has to do with the founder(s) desire for control and potential conflicts of interests, and investors will have to take that into account when valuing/pricing the company.”
Of course, complexity is just one of many elements we take into consideration when valuing a business, which is why it is so important to have a framework to help us do so consistently.
Our ‘Seven red questions’ checklist – and the red flags they can raise over potential investments – is an integral part of this.
As we also concluded in One investment edge is good but four are better, if you have a process that can, on a consistent basis, help you to weed out companies that deserve to be cheap and only pick the ones that are temporarily so – that can rebound – then, here at The Value Perspective, we believe you can have an edge over your competition.
Any references to securities are for illustrative purposes only and not a recommendation to buy and/or sell. This information is not an offer, solicitation or recommendation to buy or sell any financial instrument or to adopt any investment strategy.
Juan Torres Rodriguez
Research Analyst, Equity Value
I joined Schroders in January 2017 as a member of the Global Value Investment team. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet I was a member of the Customs Solution Group at HOLT Credit Suisse.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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