Long leases could be WeWork’s undoing
The bear case against WeWork is that its leases are believed to be very long — sources have said typical WeWork leases in London are 15 years to 25 years. Payments on such leases tend to increase in increments over time. The obvious question is what happens in a downturn, when demand for office space declines and rental prices go down? Won't WeWork be stuck in a market where the price of rent falls below the level of its leases?
We take a deep dive through WeWork's financial statements.

When WeWork launched in the UK it ran at a loss, taking in less in rent than it paid out for its leases.

A lot of those losses came from launch costs and fitting out new buildings.

The revenue-profit gap looks small enough that WeWork doesn't have to go far to be profitable.

Whether the company is worth its purported $17 billion valuation remains an open question.

The reception area at WeWork's SoHo-Sheraton House location in London. WeWork

LONDON — WeWork launched in Britain in 2014 and for more than a year ran at a loss, renting out its space for less money in total than it paid to lease the buildings it controlled.

Between October 2014 and the end of 2015, WeWork's finances looked like this, according to copies of its accounts filed with Companies House:

Total revenues: £13.6 million

£13.6 million Leasing costs: £18.3 million

£18.3 million Net loss: £14.4 million

The top and bottom lines suggest that WeWork is renting to its customers for less than what it pays landlords to obtain its offices. But the numbers only show a snapshot in time after WeWork's UK launch, when the company was spending money to get itself set up here, and before some locations were open to paying customers.

The numbers offer a glimpse inside one of the hottest "unicorn" startups on the planet. London is the company's second largest city.

The company was valued at a staggering $17 billion (£13.1 billion) at its last investment round. It is funded as if it were a tech startup even though the core of its business is the provision of physical office space. The curiosity around WeWork's finances are intense: People want to know why a property company is being treated by venture capitalists as if it were a social media app; they want to know if it is possible to make short-term profits on long-term leases; and most of all they wonder whether it can ever meet the sky-high valuation that has been laid upon it.

WeWork begins paying its leases on the day it signs a contract for a new building, yet it cannot accept new "members" as tenants until the building is renovated, a period called the "fit-out." A fit-out typically takes four to six months, and a WeWork location might not reach 90%-plus occupancy until nine months later, multiple sources familiar with WeWork's business, both inside and outside the company, told Business Insider.

On that basis, WeWork's business model shows promise.

The roof area of WeWork in Soho, London. WeWork

Back-of-the-envelope calculations show WeWork's leases could theoretically generate more rent than their costs: In its 14-month launch "year" in Britain, WeWork's revenues were 35% less than the cost of its property leases. Thirty-five percent of 14 months is 5 months — roughly the same time as a typical fit-out. That implies that the rent on a fully occupied WeWork building would break even on its lease before its first full year.

Early loss-making periods are typical for new businesses, as companies hire staff and develop their products before going out to find customers. As such, WeWork's financial numbers look typical for a startup. The company told us it was profitable on its "mature locations" (buildings open for nine months or more). A spokesperson said:

“WeWork is stronger than ever. In 2016, the company doubled its buildings, cities, countries, members and revenue run rate, and tripled gross profit in mature locations."

"In the years 2014 through 2015 (which this filing reflects), WeWork was setting up its business in the UK and investing heavily here. This was a period of intense growth and expansion for the company as we set up our first European locations and operations."

WeWork's London Fields location has a vintage truck for a reception desk. WeWork

Today, WeWork has 2,200 employees, more than 100,000 members, at 140-plus locations in 44 cities worldwide. It has taken $3.69 billion (£2.85 billion) in funding from investors such as Benchmark , Fidelity, Wellington , JP Morgan Chase , Goldman Sachs, and Hony Capital.

The company was last valued at a reported $17 billion.

It is that "$17 billion" unicorn number that has people like Stratechery analyst Ben Thompson asking questions. In 2015, when WeWork was reportedly worth "only" $10 billion (£7.7 billion), Thompson said in an email to his clients:

"It's easy to be skeptical: WeWork is for all intents and purposes engaging in arbitrage. It rents commercial real estate at one price (preferably a low one -- WeWork focuses on new developments where it can be an anchor tenant with its attendant ~10% discount) chops it up, adds a ping pong table and a beer tap, and rents it out at another significantly higher one. Neat trick, except that Regus [a traditional property broker], with 2,500 locations in 110 countries, does pretty much the same thing and has been valued by the public markets as a $3.74 billion company."

WeWork doesn't just make money on renting space, however. It also offers various types of services and "community" benefits. The company gives tenants an app store (in the US), offering more than 100 services such as office software, chat apps like Slack, and car rentals. It is those add-ons plus the underlying rent fees that get WeWork to profitability, the numbers suggest.

Yes, there is ping pong. WeWork

"The reception WeWork has had in the UK has been exceptional and the level of demand in London was apparent immediately, fueling our continued expansion here," a spokesperson told Business Insider.

"In London alone, WeWork has more than doubled the number of locations and members in 2016, and we plan to do so again in 2017. Our UK occupancy is at or above 90% marketwide. We continue to see unprecedented strength and diversity in our global member community, which includes entrepreneurs, SMEs and large corporates. We are proud to have Business Insider as a member company in San Francisco.” (Disclosure: Business Insider is indeed a tenant of WeWork in that city.)

Income Statement

Here is WeWork's income statement, as filed with Companies House, the UK corporate accounting databank:

Companies House

The key numbers are:

Revenue : £11.9 million

: £11.9 million Other operating income : £1.7 million

: £1.7 million Administrative expenses : £3 million

: £3 million Other operating expenses : £25 million

: £25 million Operating loss: £14.3 million

Most of those "operating expenses" are WeWork's leasing costs — £18.3 million — which are broken out elsewhere:

Companies House

The bull case for WeWork is that £13.6 million in total revenue on underlying lease costs of £18.3 million, in just the first 14 months of business, means that WeWork doesn't have to go very far to become profitable and run on its own revenues.

The bear case against WeWork is that its leases are believed to be very long — two sources told us that typical WeWork leases in London are 15 years to 25 years. Payments on such leases tend to increase in increments over time. The obvious question is what happens in a downturn, when demand for office space declines and rental prices go down? Won't WeWork be stuck in a market where the price of rent falls below the level of its leases?

WeWork defenders say that in a recession, larger companies will seek smaller, more flexible working spaces. And laid-off employees will become freelancers and entrepreneurs. They will all need WeWork-type spaces, which rent for the low hundreds of pounds per month. So We Work gets clients on the way up, when demand for office spaces increases, and on the way down, when the demand for smaller, flexible spaces increases.

It is also notable that on top of the £18.3 million in lease costs there were a further £5.5 million in other running costs. Again, high costs are normal for a company launching from scratch. But still — these are the numbers that will have to decline in proportion over time, if WeWork is to live up to its reputation.

Even if you do not believe that WeWork will be immune from the normal boom-bust cycle of capitalism, it is well-funded, via its US parent. Here is a look at the balance sheet of the UK division.

Balance Sheet: Assets

WeWork

Balance Sheet: Liabilities

Companies House

Balance Sheet: Equity

Companies House

The cashflow statement indicates that WeWork is cashflow positive, but mostly because it borrowed £56.4 million from its parent company at launch.

Cashflow statement

Companies House

The company does not break out its cash from operating activities beyond that £15 million top line. But, interestingly, its operating cashflow is greater than the revenue it recognises on its income statement – a healthy sign for a growing business. It usually means the company has the power to delay payments where it owes money and get paid first by its customers. (The income statement is a formal comparison of a company's costs and revenues; the cashflow statement examines the actual movement of money through the company.)

Companies operating in the UK must file their accounts with the government annually, but they have a 12 month grace period to do so — which explains why these numbers are so old. The next set, detailing the 12 months of 2016, are likely to be filed after the end of this year. They will show more like-for-like revenues on locations that have been open long enough to reach 90% occupancy or "maturity."

Of course, as WeWork is still expanding, they will also contain numbers for new buildings where costs are racing ahead of revenues. The key will be to see whether WeWork can improve its profitability as it grows. If it can do so, then there will be fewer doubters for that $17 billion price tag.