WeInflate, WeMalinvest, WeWork | AIER
The bankruptcy filing of WeWork Inc. on November 6, 2023 came with neither a whimper nor a bang, but with a laconic shrug. Although the company has been around for 13 years, it has been defined more by successive flirtations with demise and unseemly corporate revelations than by innovative ideas for the second half of its life. Few were surprised when the latest, and possibly not the final, chapter arrived.
While some stories are better told starting at the end, the WeWork story is best told from the beginning: It started as a company that rents desks. That’s it. Yes, it has been described as an enterprise providing “flexible co-working spaces” with the value adds of “collaboration” and “community.” Over the years it has variously billed itself as a real estate company and a high-tech firm. It has dabbled in online events, run a design agency, owned a smartphone authentication startup, acquired an online facilities management platform, and stretched the We brand beyond recognition (WeLive, WeGrow, Rise by We, and others). At the root of all, though — buried deep under a morass of corporate mysticism, questionable business dealings, and most of all a penchant for squandering money at a Biblically diluvian rate — is a business of renting desks.
One can easily see how the sharing model employed by Uber, AirBNB, Turo, TaskRabbit, Spinlister, and other such firms would’ve found its way into the commercial real estate business. Yet subleasing as a business was not pioneered by WeWork. Large urban office buildings are frequently not fully occupied during traditional business hours. And rarely are there office spaces small enough to both accommodate and justify the expense of one or two individuals, or for only a day or two per week, or other permutations thereof. And this is where economic calculation begins: If some smart person could figure out how to treat commercial space like a four-dimensional game of Tetris, cleverly fitting different occupancy needs of spaces and times together in ways that traditional building managers can’t or won’t, they might not only serve an unmet need, but eke out a profit in the process.
But landlords aren’t terribly interested in putting wild-eyed intermediaries between themselves and their earnings. So an entrepreneur interested in offering unique, customizable office spaces has to first rent out space, usually several floors or an entire building, only then dividing it into the unusual units for which there may be a market. While eventually WeWork did purchase and operate its own buildings, its basic business is that of a sublessor: renting space to rent back out at a slight premium with perks to enhance the marketability of spaces. Some of those amenities were subtle, like dartboards or Ping Pong tables. Others seemed out-of-place in a business context, like beer on tap and hammocks. A few, like administrative support, phone systems, and printers undoubtedly added value.
While there are many challenges to running that kind of business, several are immediately evident. First, margins are likely to be small — even before spending on inducements. Also, providing maximum permutability to would-be renters of various sizes and terms requires taking long-term leases. And it goes without saying that in order to make significant revenue and profits, the business — again, fundamentally, renting desks — would have to be scaled enormously. More floors, in more buildings, in more cities, with tireless marketing, sales, and development support.
If, sometime in 2019, you’d asked a major, international sublessor what the major threats to their business were, they’d probably have said a terror attack or serious recession. But both of those things have happened, and while they dampened economic growth, they weren’t long-lasting. Plus, international diversification provides a hedge, of sorts, to that kind of shock. What few, if any, would have guessed is that a pandemic would break out. Far fewer would have guessed that governments around the world, with few exceptions, would respond to a pandemic by ordering widespread business shutdowns, restrictions on in-person meetings, and other heedlessly destructive policies. And who, even when the word COVID became part of the 24-hour news cycle throughout 2020 and 2021, would have anticipated that the relaxation of non-pharmaceutical interventions would not be met by a surge back into office spaces, but by a vastly broader acceptance of remote work?
In the future, the many idiosyncrasies of founder Adam Neumann are likely to figure prominently in WeWork retellings. The explanation for the bankruptcy that is likely to prevail, however, is that WeWork was felled by COVID precautions. In fact, WeWork was conceived of and established during the Federal Reserve’s post-2008 collapse zero interest rate policy (ZIRP), at a time when credit was cheap and plentiful. And just as the company was facing calamity, historically expansive monetary and fiscal policy measures gave the long-ailing WeWork a reprieve before it ultimately succumbed to long-looming financial vulnerabilities.
Austrian Business Cycle Theory
It sometimes puzzles observers that scores of sound businesses humming along would suddenly collapse in large bunches as economic conditions begin to deteriorate. Or relatedly, that firms which are unprofitable can at times limp along for years on end. The Austrian Business Cycle Theory (ABCT) offers an explanation for these phenomena, by focusing upon the relationship between central bank policies, interest rates, and the allocation of resources within an economy.
ABCT designates the start of booms with a period of credit expansion by a central bank, which typically involves lowering interest rates and increasing the money supply. This expansion leads to a decrease in market interest rates, making borrowing cheaper and more attractive to businesses and investors. As a result of the lower interest rates, businesses and investors increase their borrowing and investment activities. This leads to an economic boom characterized by increased spending, investment in long-term projects, and a general sense of optimism in the economy.
Artificially low interest rates (rates set by policy, rather than set by market forces in lending markets) send misleading signals to entrepreneurs and investors. These low rates suggest that resources are more abundant than they actually are, and that the time preference for consumption, versus saving and investment, has changed. Entrepreneurs and businesses respond to the distorted interest rate signals by making investments in long-term and capital-intensive projects that may not be economically viable in the long run. They may engage in speculative ventures and allocate resources inefficiently. Owing to bountiful credit at negligible cost, business concepts which, in normal periods at market-determined rates, may never have gotten off the ground are not only established but gain initial traction.
The credit expansion can lead to the creation of asset bubbles in various sectors. These bubbles are unsustainable because they are driven by the artificial credit expansion rather than genuine economic fundamentals. Eventually, the unsustainable nature of the boom becomes evident. The central bank may start to raise interest rates or reduce monetary stimulus, leading to a contraction in credit and a shift in market sentiment. This triggers the “bust” phase. Malinvestments made during the boom become apparent. Businesses may find that their long-term projects are no longer profitable, leading to bankruptcies, layoffs, and a revaluation of asset prices.
The Federal Reserve began its first round of quantitative easing (QE1) in late 2008 in response to the global financial crisis. It was followed by QE2, which ran from November 2010 to September 2012 and QE3, which ended in October 2014. WeWork’s establishment in March 2010 places its corporate birth late within the first, most-expansionary phase of the post-2008-crisis monetary policy regimes.
When interest rates are driven to rock-bottom prices as a matter of policy, investors begin to seek higher-risk projects and vehicles to produce meaningful returns. This phenomenon is known as the “reach for yield,” which has been seen time and time again throughout boom and bust cycles. It may induce individual investors preparing for retirement to abandon investment grade bonds and stock indices in favor of riskier securities. And it may drive venture capital firms already in the business of taking on speculative ventures to ratchet up their exposure to uncertain and questionable ventures. This has been shown from one speculative bubble to the next.
The WeWork Saga
As mentioned previously, WeWork has done one thing consistently since its founding: lose money. A $15 million investment in 2010 which valued the company at $45 million leapt to a $16 billion valuation by 2016. By that time, the firm was already struggling, missing several financial targets and laying off a substantial number of its employees. By mid-2017 the firm was valued at $20 billion, boosted by high-profile investments from the Softbank Vision Fund among others. Throughout this period, WeWork embarked upon an acquisition spree, purchasing high-profile buildings, international spaces, competitors, and several businesses (some particularly unusual). The valuation of the company reached roughly $42 billion by the end of 2018, even as it lost over $2 billion throughout the year.
The peak of WeWork’s valuation was $47 billion in January 2019. At that point, an initial public offering of stock was considered, and in August 2019 a Form S-1 was filed with the United States Securities and Exchange Commission (SEC).
(It is instructive at this point to note that an initial public offering, while sometimes depicted as a magnanimous opportunity for retail investors, is in fact an exit strategy for founders and early-stage investors. Although most companies continue to generate positive returns after going public, IPOs are undertaken when the general consensus among insiders is that the explosive period of initial growth is over, nearly so, or that public equity valuations are high enough that they should be taken advantage of.)
The filing revealed WeWork to be incurring massive losses, with questionable governance arrangements and dubious prospects. Of particular note was the disclosure that the company had incurred $47 billion in future lease obligations with only $4 billion in lease commitments. A number of questionable financial metrics within the filing additionally raised concerns regarding the proper depiction of the firm’s financial health. The effect of these revelations, as well as doubts regarding the fitness of Neumann to serve as the CEO of a public company, led to the IPO being withdrawn in September 2019. Within this time period, the company’s valuation plummeted from nearly $50 billion to an estimated $10 billion.
In November, SoftBank Group disclosed a $9.2 billion loss in the value of its investments in WeWork, which amounted to approximately 90 percent of the $10.3 billion that SoftBank had previously invested in WeWork over the preceding years. Less than two weeks later, WeWork announced workforce reductions of roughly 20 percent of its global headcount. The firm was already struggling mightily before the pandemic struck.
With the onset of the pandemic came several rounds of massively expansionary monetary policy programs, as well as fiscal stimuli policies, on a global scale. A stock market crash in March 2020 — the first since 1987 — accompanied by several rounds of stimulus checks, rock-bottom interest rates, and collective ennui, drove investors into markets ranging from equities to cryptocurrencies and beyond. The coordinated short squeezes of a handful of distressed equity issues was emblematic of the effects of the massive credit boom.
Throughout 2020, WeWork liquidated some of its Chinese assets and engaged in several more rounds of layoffs. It also renegotiated certain lease agreements and deferments at many locations. Cheap money and seemingly insatiable risk appetites throughout the year led to a surge in Special Purpose Acquisition Company (SPAC) deals, which:
are also commonly referred to as blank check companies … [T]hrough a SPAC transaction, a private company can become a publicly traded company with more certainty as to pricing and control over deal terms as compared to traditional initial public offerings, or IPOs … Unlike an operating company that becomes public through a traditional IPO, however, a SPAC is a shell company when it becomes public. This means that it does not have an underlying operating business and does not have assets other than cash and limited investments, including the proceeds from the IPO.
Fed Funds rate (red), WeWork stock price (black, w/first trading date green horizontal line)
(Source: Bloomberg Finance, LP)
Less than six months later, in March 2022, the Federal Reserve began its most-aggressive contractionary policy campaign in four decades to arrest the surge of inflation in the United States. With higher interest rates and the contraction of the balance sheet, the size of the US money stock began contracting for the first time in decades. As the flow of credit slowed and became more expensive, the prospects of many SPACs dimmed, with their stock prices following.
After going public, WeWork’s stock price and valuation declined steadily. By August 2023 the share price hit $0.14 cents, down 99 percent in 22 months. WeWork bonds traded at a deeply distressed 10 cents to the dollar. Once valued at $47 billion, the company’s valuation had fallen to $300 million. To maintain the minimum $1 bid price required to remain listed on the New York Stock Exchange, the company undertook a 1:40 reverse split. And despite a debt restructuring, shedding superfluous assets, and the renegotiation of virtually all of its remaining global leases, WeWork filed for bankruptcy on Monday, November 6th, with $15 billion in assets, $18 billion in debt, and at a reverse split stock price of 84 cents valued at $60 million. Softbank’s total losses in WeWork are calculated at over $14 billion.
Since 2008, some eleven years have seen policy rates set at one percent or less. In that time period, the year-over-year expansion of different monetary aggregates has varied greatly. From March 2020 to July 2022, the M2 money supply increased by almost $6 trillion, and has since been contracting at the fastest rate in decades.
Companies founded in easy money periods will tend to be the most vulnerable. Many firms will survive the credit crunch, but few will emerge unscathed. WeWork is only among the most prominent of countless firms which were carried aloft by expansionary policies, now feeling the effects of the severe contractionary reversal (see also Peloton, Beyond Meat, Zoom, Didi Global, and others).
Stock prices of Peloton (blue), Beyond Meat (green), Zoom (purple), and Didi Global ADR (red), M1 Money Supply Index (black dash), and M2 Money Supply M2 Index (black dots), 2020 – present
(Source: Bloomberg Finance, LP)
The liquidation of malinvestment is painful and takes time. There will be more layoffs, more breached contracts, and more fire sales. There is a chance that, greatly scaled down and highly focused, WeWork can emerge from bankruptcy and find some measure of commercial success. Or its assets may be acquired by other entrepreneurs and put to work profitably. One cannot and should not fault business visionaries for attempting to scale a niche, low-margin business into a global empire. Nor are they to be blamed for taking advantage of investor interest, expansive credit offers, or unconventional sources of financing. The cause ultimately lies not with them, and much less with a virus, but with the monetary interventionism that made both the attempt and the ensuing wreckage possible.