I met with someone yesterday who has an office at WeWork and was pleased to see the relaxed atmosphere, posters advertising Meditation Hour, and beer on tap. (It was morning so I couldn’t have any beer.) That visit reminded me that I wanted to look at their prospectus and check out issues relating to their valuation as it had been under attack recently. Lo and behold, yesterday happened to be the day that WeWork delayed their IPO. After looking at their prospectus, I understand why.
In total, the company has raised $5.6 billion of equity and has revenue last year of $1.8 billion. That’s a ratio of 3.1 times which isn’t far above the ratio of 2.3 times for software industry IPOs over the last six years. (Check out our recent report on IPOs for data.) The problem is that WeWork isn’t a software company but it looks like they tried to value themselves like one.
The average software company going public has a gross margin (Gross Profit/Revenue) of 65% whereas WeWork has one of 16%. (Bear with me here, I’m about to get even more boring.) That means the Capital to Gross Margin ratio is 18.7 times, way more that that of the software industry’s recent IPO ratio of 2.59 times.
WeWork has a great growth rate, 105% in the last year which puts them well above software industry IPOs of 55% over the last six years. They were initially looking for a valuation of about $47 billion and this would imply a revenue multiple of about 26 times. Even this would be high compared with Shopify’s which was worth a revenue multiple of 20 times for an equivalent growth rate.
The problem is that you can’t use a revenue multiple similar to software companies when the gross margin is so low. WeWork is a high cost operation so a better way to look at it would be to look at a Gross Margin Multiple. Software industry IPOs over the last six years averaged revenue multiples of 8 times. This would be equivalent to a Gross Margin Multiple of 12.3 times. WeWork was looking for a Gross Margin Multiple of 157 times.
Even if you factor in their high growth rate, they might have deserved a gross margin multiple of 30 times. This would have valued the company at under $10 billion. They had already reduced expectations to a valuation of $20 billion. The problem was that with a valuation of below $10 billion, it was less than half their valuation at the beginning of the year. Someone was about to get a haircut.
Overall, I think they are in a great market with a very needed product that users love. There may be a problem though with unit economics. The average software company is losing 60% of revenue or 100% or so of gross margin. WeWork is losing 89% of revenue which is not out of line. What is out of line is losing 536% of gross margin. Overall, something has got to change in their business model as these numbers do not point to a company that can ever make money and whose valuation was justifiably questioned.