WeWork Separates Buildings and Beer
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Here’s a business model. You start a company. It’s an office real estate company. You buy office buildings. You try to buy good office buildings, fancy ones in attractive areas. Then you configure and remodel the buildings. You try to do a good job of this, making nice offices that people will enjoy working in. You also manage the buildings. Again, you try to do a good job of this, offering high-tech amenities and free beer and a cool vibe that make the buildings attractive to tenants. Then you rent out the offices to tenants. Once again, you try to do a good job of this, building a strong brand so you can charge high rents; also, you let people rent relatively small chunks of the building (and for relatively short periods) to maximize your appeal to tenants.
You try to do all the things well, because they are all things you have to do. Each thing is a potential advantage, something that you can use to try to close a deal with a tenant. “You can get a flexible number of desks in our architecturally distinguished building in a convenient location that you’ll share with other cool creative tenants with whom you can drink free beer at a building happy hour but also the elevators don’t work” is an okay pitch, but the office market is competitive and you’d be better off saying the stuff about the building and the location and the tenants and adding “also we have state-of-the-art technology and you can control the temperature in your office from our app.” The way you distinguish yourself from your competitors is all ways; your goal is to be distinctive in all aspects of your business.
All of this is expensive, so you go out and raise a kajillion dollars from investors. You write a pitch deck for investors, and it has sections like “We Are Good at Buying Office Buildings” and “We Are Good at Designing Offices” and “We Have an App,” and the investors get the pitch deck, and some of them are like “you are good at buying office buildings, here’s money,” and others are like “you do have an app, here’s money,” and if you are in fact good at many of the things you will raise the money and life will be good.
You’ll miss some investors, though. A tech venture capital fund will look at your pitch deck and say “well, you do have an app, which we love, but you are buying buildings, which is a distinctly old-economy thing to do; we don’t invest in real estate except in virtual reality, so we’re passing.” A real estate investor will look at your pitch deck and say “wow you are great at buying office buildings, and your rents are high, but all this stuff about apps is distracting, I’ll pass.” You are doing a bunch of things, and the people who want one of those things might be alienated by the others. Or they might be fine with the other things, but not give them their full value: A real estate investor might invest because of your good buildings, but not at the sort of late-2010s-tech-company valuation that you want.
You might find this inefficient. What if you could get the real estate investors to invest in the real estate part, and the tech investors to invest in the tech part?
Everyone could get exactly the thing that they want, and at a valuation that reflects how much they want it.
This is a pretty well-known strategy, and many real-estate-heavy businesses — retailers, often, but also weirder things like wireless carriers — have adopted it. You take a company that owns buildings and runs stores in them, and you put the buildings into a separate company, and you sell it or spin it out, and now people who invest in buildings can invest in the buildings and people who invest in stores can invest in the stores. (Or same but with cellular towers, etc.) It has tax efficiencies. It doesn’t always go perfectly. The stores-plus-buildings companies are more diversified than the stores-only or buildings-only companies. That is the downside of specialization; you get less cushion from diversification.
WeWork Cos., the office-space unicorn that has somehow unofficially rebranded as “The We Company,” sort of came to this strategy from the opposite direction. It started with the office design and the free beer, but without the buildings: It would rent space in a building from someone else, and do its tech-and-vibes magic, and re-rent the space to tenants at a higher price. This “asset-light,” vibe-heavy approach got WeWork tech-type valuations and tons of money from SoftBank. But now:
Now, after more than a year of planning, WeWork is creating an investment fund that aims to raise billions of dollars to buy stakes in buildings where it will be a major tenant. If all goes according to plan, the fund, called ARK, will start with $2.8 billion, including $1 billion from Canadian real estate investor Ivanhoé Cambridge Inc. WeWork has long said it mostly stuck to leasing space because it believed in being “asset-light.” Now it’s wagering that buildings become more valuable with WeWorks in them, in which case ARK will put more of that added value back in the company’s own pocket.
The fund’s pitch to investors revolves around the relative safety of a real estate play with a large tenant in hand. It also depends on a gut-level faith in WeWork’s vibes. Sylvain Fortier, Ivanhoé Cambridge’s chief investment and innovation officer, says the company’s strength is what he calls a “recipe.” “People actually want to be in the office, actually want to be together. They feel a little bit like home,” Fortier says. “I bet you that sooner rather than later, a WeWork-branded building will be attracting other tenants the same way you will never have a vacant space next to an Apple Store.”
That is from Ellen Huet’s Bloomberg Businessweek Story about We(Work), which includes a certain amount of hand-wringing about conflicts of interest between the real-estate investors and the tech investors. But that is just a tradeoff that you get from specialization. If all the investors in WeWork got an undifferentiated slice of the real estate, the office design, the tech and the vibes, then there would be no conflict of interest, but they might all be unhappier and worse off. Give them what they want, and then do the best you can to referee their conflicts.
We have talked before about this sort of specialization, by the way, but under another name. That other name is “option value.” I wrote recently, about Uber Technologies Inc.’s efforts to sell a stake in its self-driving-car business:
If you have two independent bets, being able to walk away from the one that doesn’t work out and keep the one that does is more valuable than having to take the combination all or nothing. A finance-y way to put this is “a basket of options is worth more than an option on a basket.”
One implication here is that if you have one company that loses $2 billion a year, and you want to sell stock, you should turn it into two companies that each lose $1 billion a year, because the sum of their two values will be higher than the value of the combined company.
If WeWork’s basic business model — leasing space, sprucing it up, subleasing it and throwing parties — is good, but real estate values collapse, ARK will be a bust but won’t drag WeWork down with it. If WeWork’s basic business model is stupid, but it really does find great buildings, then WeWork will be a bust but ARK’s investors will do well.
Two independent, or independent-ish, or independent-enough payoffs should be worth more than one joint payoff, so you can sell them separately for more than you could sell them for together.
There is some debate about whether WeWork is “really” a tech company, or whether it is “really” a real estate company. This strategy lets it be both. It also lets it be, really, a financial-engineering company, one whose model is as much about corporate structure and investor segmentation as it is about technology and buildings.
Anyway that’s the finance part; separately, I should tell you that every paragraph of Huet’s story is insane and you should read it.
The part that made me dizziest is probably the description of WeWork Chief Executive Officer Adam Neumann’s morning-meal nomenclature:
It’s just past 11:30 a.m. when a male assistant in a black baseball cap delivers a shallow gray ceramic bowl with brown grains and a spoon. “I haven’t broken my fast yet,” the 40-year-old CEO says apologetically, instead of using the word “breakfast.”
And there’s this:
Why the name ARK? “There are a lot of explanations,” he says later. “Adam, Rebekah, and Kids — that’s one.” His wife, Rebekah, is a WeWork co-founder; they have five children. He doesn’t contest a more Biblical origin, noting that “Noah’s Ark represents a covenant between God and the people to never destroy the world.”
The following day, a spokesman stresses that Neumann’s first answer was a joke, and offers a third option: “Asset, return, kicker.”
If there is one thing that we’ve learned in the last few years it is that more tech companies should make a covenant never to destroy the world. Google had “don’t be evil” as its motto, for a while, but a motto is not a covenant and it was eventually abandoned. Facebook, well, you know. We talked a while back about how We’s goal is “to encompass all aspects of people’s lives, in both physical and digital worlds,” and that is an absolutely terrifying idea. It would be nice if they really did enter into some sort of binding covenant not to use that all-encompassing power to destroy the world.
And yet more Uber
Huh. Here’s Leslie Picker at CNBC:
Uber’s underwriters, led by Morgan Stanley, were so worried the company’s initial public offering had run into trouble, they deployed a nuclear option ahead of the deal last week, so they could provide extra support for the stock, four people with knowledge of the move said.
This level of support, known as a “naked short,” is a technique that goes above and beyond the traditional help a new offering can get.
In every deal, there’s an overallotment, which allows the underwriters to sell 115% of the available offering to investors, effectively opening a short position. The excess 15% can be purchased by the underwriters in the open market — covering the short position — to support the stock if it goes down. More colloquially, this is known as the “greenshoe.”
But in rare cases, bankers will use a strategy called a “naked short,” which allows underwriters to sell shares in excess of that greenshoe portion and then buy them back in the open market to provide even more firepower in the event there is significant selling pressure.
The greenshoe, which we’ve talked about a bunch recently, is a no-risk way for the underwriters to support the deal: They sell 15% of the IPO short at the deal price, and then buy it back in the open market if the stock goes down (stabilizing the stock and making a profit for themselves), or exercise their option to buy it back from the company at the deal price if the stock goes up. The naked short,
on the other hand, is a fully at-risk way to support the deal: The underwriters sell even more stock short at the deal price, and then buy it back in the open market if the stock goes down or up. If it goes down, they make money. If it goes up, they lose money. If it goes up a lot, they lose a lot of money.
Most IPO stocks go up in their first few days, and many go up quite a lot. Underwriters generally price IPOs for a nice early pop. So naked shorts are fairly uncommon. Underwriters only go naked short on an IPO if they are pretty sure that it is a dud, one of the minority of offerings that will quickly trade below the IPO price.
But it is hard to communicate that. While Morgan Stanley was deciding to go naked short the Uber IPO, it was also putting out happy noises about how much demand there was and about how the deal would be priced conservatively to ensure a nice pop. There is a fine line to walk here: None of those statements seem to have been untrue (surely the underwriters had at least three times as many orders as they had shares, which is actually not that great, and the deal was priced near the low end of the already conservative-seeming range), but the overall implication was that they were confident that the stock would go up. They were not confident that it would go up. In fact, they were so confident that it would go down that they put their own money at risk on that bet. But they didn’t lie to anyone. They were just marketing; the underwriters were doing what they could to make people excited about Uber’s stock, so that those people would want to buy the stock, so that it would go up in the aftermarket. An IPO is a sentiment-driven process, and the underwriters’ optimism or pessimism is contagious; if you want the deal to go well you have to say that it’s going well. Without lying, I mean. The worse it is going, the harder that is to do.
On the other hand:
Some of the bankers tried to console market participants prior to the opening of trading by telling them that there would be additional support from the naked short, said one of the people, who asked not to be named discussing private conversations.
If you’re telling some people “buy as much as you can at $45, this deal is hot,” and telling other people (in “private conversations”) “this deal is a dog but at least we have a naked short,” then that is awkward.
The other awkward thing is of course that the underwriters made money on their naked short; the more the stock went down, the more money they made. (And the bigger their naked short was — the more sure they were that the stock would go down — the more money they made.) This is not the point of the trade; as far as Uber’s underwriters are concerned, the naked short was a noble and self-sacrificing effort, done at considerable risk to themselves, to stabilize the stock and protect the interests of their issuer and investor clients. But, yeah, they made money on it. Depending on how big the naked short was and when they covered it, it’s quite plausible that Uber’s underwriters made more in trading profits than their $106.2 million underwriting fees.
If you were … inclined to be critical … you would characterize this as Uber’s underwriters talking up the stock to their investing clients, telling them that there was lots of demand at $45, and then pricing the deal there, while at the same time quietly betting their own money that the stock would fall immediately. They sold stock to their customers while betting against that stock, and then that bet turned out to be correct and they made many millions of dollars on it. I cannot stress enough that that was not the subjective experience of Uber’s bankers, who undoubtedly — for their own careers, for their relationships with investors and issuers, for their reputations as skilled bankers — wanted this deal to go differently. But it kind of is what happened, oops. At least they got the money.
If there is a big systemically important bank, and it doesn’t have enough capital, and it needs to raise capital to reassure the market and prevent a panicked run on the bank (and every other bank), and market conditions are so dire that it is hard for it to raise capital and a failed effort would be disastrous, is it okay for it to raise capital fraudulently? For instance, you could sell stock to someone while secretly lending them the money to buy it, or while giving them a big secret fee, announcing to the market that you’ve raised fresh independent capital when that isn’t quite true. Was that a bad thing you did (because it is fraud), or a good thing (because it saved your bank, and maybe the global financial system, from a self-fulfilling panic)?
We have talked about this question recently, and it seems to have come up a lot during and after the financial crisis. I think the obvious, though unsatisfying, answer is “it’s a bad thing from the perspective of a fraud regulator, and a good thing from the perspective of a bank stability regulator.”
So here you go:
The Bank of England warned prosecutors that a criminal charge against Barclays could present an existential threat to the lender, showing that regulators still worry about large banks being “too big to jail.”
According to people familiar with the matter, in 2017, Sam Woods, the BoE’s top banking supervisor, told David Green, the then-director of the Serious Fraud Office, that there could be unpredictable consequences if there were charges against Barclays over crisis-era payments to Qatar.
I like this sort of thing. The fraud regulators should care about fraud, and the bank supervisors should care about bank stability, and they should argue about it. Diversity of opinions is good!
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If there was a large contingent of office-design-focused investors, you could separate that part out too, but in the real world you are probably going to end up lumping that part in with the tech or the real estate.
Again, the flip side is that both sets of investors have less diversification; WeWork’s profits won’t carry ARK through a real-estate downturn, and vice versa. I linked in the text to an August 2018 article titled “As Sears Withers, Its Former Stores Fuel a New Fortune”: Sears Holdings Inc. sold many of its stores to a real-estate spinoff called Seritage; Sears went bankrupt while Seritage did fine. From the point of view of Seritage investors, this is how it was supposed to work: They got a pure-play real estate investment that was relatively insulated from bad retailing decisions at Sears. From the point of view of Sears investors, some of that insulation might have been nice.
Here is a good post from Byrne Hobart last month on this sort of optionality in company valuations.
A fun additional point is that, pre-ARK, WeWork leases some buildings from founder Adam Neumann, creating even more obvious conflicts of interest. But Neumann will solve those conflicts of interest by selling those buildings to ARK! Creating different conflicts of interest! But “he emphasizes that he’ll be selling his controversial property stakes to ARK for the same price he paid. He also says this will mean a huge sacrifice for him personally.” And: “I’m a great real estate buyer, so if I bought for $100, it’s probably worth $300. I’ll still sell it for $100.”
It is called a “naked short.” This is unrelated to the illegal practice of selling stock short without being able to borrow the underlying shares, which is also called “naked shorting.” Sorry. Just one of those things. The naked short is described on page 285 of Uber’s prospectus. That language is standard; it says that the underwriters “may also sell shares in excess of the over-allotment option, creating a naked short position,”and that “a naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market after pricing that could adversely affect investors who purchase in this offering.” Every IPO prospectus says that; they don’t say whether the underwriters *will* do a naked short.
By the way, there is one little bit of incoherence in the whole idea of stabilizing and greenshoes and naked shorts. The point of these transactions is to create extra *demand* for the stock: The underwriting banks are short some number of shares, and will buy those shares back, so there’ll be an extra bid to buy the stock. But of course those transactions also create (the same amount of) extra *supply* *of the stock: Uber’s bankers sold the 180 million shares in the IPO, and then 27 million greenshoe shares, and then some number of naked short shares—“The exact size of the naked short could not be learned, but it is expected to have been ‘fairly small,’” reports Picker—and then bought back the 27 million greenshoe shares and the naked short shares. But by *selling* those extra shares in the first place, they created extra selling pressure too. The usual explanation here is that some (hopefully largeish) fraction of the shares sold in an IPO will go to long-term investors who won’t flip them; if you sell 27 million greenshoe shares, 15 million of them (or whatever) will go to long-term holders and only 12 million will come into the market on the first day, so your 27 million-share short creates more demand than supply. But in the case of Uber it does seem like the marginal buyers in the IPO unloaded their stocks right quick, so it’s not obvious how much the greenshoe or naked short helped.
I did the hypothetical math yesterday for just the greenshoe; the naked short adds to that linearly, but also makes it less likely that the underwriters covered their entire short position at relatively high prices on Friday afternoon, and more likely that they did some much more profitable buying later.
With the important caveat that if everyone knows that the bank stability regulator lets this kind of thing go on, then it will stop working. A banking system *needs an overall reputation for honesty and transparency, even if the odd individual bit of dishonesty and obfuscation can be good for stability.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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