The Profitless Prosperity Sector Will Collapse...



Posted by Ed 5 mths ago
Near the culmination of all great stock market bubbles, at least one of that cycle’s supposed luminaries suffers an epic collapse because of fraud. As a result, fresh capital is restricted from that sector when it is needed most, leading to further crisis and a winnowing out of the sector as competitors cannot raise additional capital.

Remember; suckers are always willing to finance bad businesses, but fraud means you immediately sell. It is this fear of endemic fraud tarnishing a whole sector, not economics, that finally ends a bubble.

Following Enron; capital was restricted from pipelines and energy trading. The collapses of WorldCom and Qwest led to a slow-down in fiber-optic buildouts. After the collapses of Ivar Kreuger and Samuel Insull, there was a multi-decade decline in conglomerates and holding companies. Following the collapse of Lehman Brothers, there was a multi-year dearth in underwriting archaic structured products and I’m sure the collapse of Madoff led to a decline in Ponzi investing.

There are always second order effects in the sectors where these companies were previously shining lights—along with a lot of carnage. As a rule; if the biggest players were cheating a lot, even the honest guys were cheating a little. With Tesla (TSLAQ – USA) beginning its death rattle it’s worth considering what will happen to the rest of the Profitless Prosperity Sector.

Ever since Amazon (AMZN – USA) came to dominate internet retailing; there has been a mantra that profits are irrelevant (in the short to medium term) if you can rapidly gain market share. In certain sectors with massive addressable markets, this may be true, but how many billion-dollar dog-walking apps does the world need? How many supposedly ‘disruptive’ industries are simply taking a current industry, adding a bit of marketing flair, maybe an app to the front end and then massively subsidizing users to gain market share, generating explosive revenue growth along the way. If you give a product away for dramatically less than your cost, of course people will migrate to your product.

Is WeWork truly revolutionary? Or has it taken market share in shared space, by added a kegerator and dramatically undercutting incumbents using shareholder capital? WeWork is supposed to lose roughly as much as its revenue this year. This isn’t a brand-new startup; it’s already 9 years old and operating at a huge scale. Should it be losing as much as its revenue? If WeWork priced space with the need for a mid-single digit return on un-leveraged capital (in-line with competitors in the property sector), would they still gain market share? What if their current cost structure isn’t even price competitive with established players like Regus? Think about that for a bit.

Even clear category winners like Uber and Lyft, which have revolutionized an industry, are forever competing with each other in a pure commodity industry; backed by shareholders willing to lose billions a year. If shareholders forced them to earn an acceptable return on the billions in capital invested, would pricing be attractive enough to keep users engaged? If you applied a sensible multiple on that cash flow, would they be worth anywhere near current private market valuations? I can go on ad infinitum—there are thousands of these businesses that grow revenues and losses at astronomical rates yet continue to attract growth capital.

Amazon was the rare outlier to lose money for years while rapidly growing revenues before eventually inflecting towards profitability. Most copycat companies have no chance of ever becoming profitable—their businesses simply aren’t structured in a way that makes this possible. Even the winners trade at insane valuations. Yet, they have all somehow convinced investors to keep funding them because they are the “Amazons” of their respective sectors.

Without fresh cash, many of these businesses will collapse—quite rapidly. That is because they aren’t businesses—they are market share grabs in highly competitive industries with few barriers to entry. Adding an ampersand to the logo and selling a product for a loss isn’t viable if you cannot find someone to fund it. More importantly, after a decade of Profitless Prosperity, investors have a false sense of confidence. When the bubble unwinds, it will be fast and vicious as there is no natural buyer of a money losing business that’s run out of capital. It took half a decade to create the internet bubble yet it all vaporized in a few months. This bubble will also collapse at a similar rate.

While most of these Profitless Prosperity companies never came public, plenty are listed on global stock markets. Look through your portfolio. If something cannot survive without fresh equity capital, if a valuation is justified by unlimited growth funded by future equity capital, if a company has yet to inflect into profitability, it’s time to re-assess your investment.

The collapse and subsequent revelations from Tesla will shock investors to the core. While many think of Tesla as simply overvalued, many more know that there are skeletons in there that will stun people. As we have learned from similar collapses, if the industry leader is doing something illegal, you can count on its competitors also playing around the edges of legality and morality.

Turning back to the Giga-Fraud; investors are finally realizing that selling cars at a loss and hoping to make it up in volume isn’t a viable business. Adding an EV to a traditional chassis isn’t as revolutionary as hoped (it’s slightly more complicated than adding anti-lock brakes and power steering). However, Tesla (TSLA – USA) is the clear thought leader in the Profitless Prosperity Sector where revenue growth is all that matters and profitability can be ignored indefinitely.

When investors lose over $60 billion in Tesla equity value and learn that their bonds are severely impaired, they will stop investing in other money losing start-ups. The collapse of Tesla will be the catalyst for the rest of the Profitless Prosperity Sector to unwind.

Q3/2018 was the high water mark for Tesla’s supposed “profitability.” Q4/2018 will be the high water mark for deliveries. Both metrics will begin to comp negative in Q1/2019. It’s all downhill from here…

Trade carefully.


Ed 5 mths ago
Softbank Slashes WeWork Investment Plans Amid "Need For More Caution"

With WeWork's USD bonds (10.5%) yielding more than Argentina's USD bonds (9.71%), it is perhaps no wonder that Softbank - the massive Japanese tech firm, formerly willing to invest in anything with a pulse to get yen out of Japan - has dramatically slashed its investment plans in WeWork this year.

Ed 5 mths ago

Ed 5 mths ago
I’m wondering if We Work (or the We Company as it now grandly calls itself), is likely to be the car crash that causes the almighty pile up in the Unicorn/Tech Market we’ve so long expected? The spark that ignites the conflagration to restore valuation common sense?

I didn’t have time yesterday morning to launch into an analysis of the Softbank/We Work farago, but a number of readers came back with similar concerns.

In case you missed it: We Work was expecting a $16 bln capital injection from Softbank’s Visionfund, but after the Middle East Sovereign Wealth Funds (who fund Visionfund) pointed out there is nothing Tech about funding a property rental business, Softbank had to scale back the investment to $2 bln, causing massive internal loss of face, and a scrabbling around to present a story pretending it doesn’t matter or change anything.

Part of the response was the name shift from We Work to We Company to clarify just what a life-style modern tech company We Work (sorry We Company) really is…. You can put lipstick on a pig.

Softbank must be very disappointed. By, today’s convoluted millennial wisdom: the more a company loses, the more it must be worth! On that basis We Work should and must be a screaming buy! $16 bln to buy out other shareholders, fund the company to lose yet more money and give a $50 bln valuation.. what’s not to like?

There is logic to the madness of Unicorn valuations.

Stocks ratcheting up massive losses while exhibiting zero earnings growth can be massively valuable – especially if they are creating new markets and a variation of a monopoly position for themselves. That’s about the only reason I stick with Tesla – even though every single one of my neurons screams something like – it’s a crap car, it can’t make enough of them, Musk is hatstand…. But the reality may be Tesla has probably cracked the electric car. Or how about Amazon – among the most valuable companies in the world because it recognised and seized e-commerce. I could on.. Facebook…

Others, I am not so sure off. Netflix is a case in point – it moved video rental into streaming and created a whole new way to watch TV. But it’s massively vulnerable to completion – and Disney is the one I watch. Sure Netflix is making great content… but its burning through money to garner subscribers to get them to watch their programmes, while Disney leads with its Great Content attracting subscribers in. Simples…

But We Work is something else completely. It’s nothing new. It’s not innovative. But, it is very good at what it does - renting office space. I’ve been in We Work offices – and they’re fine. She-who-is-Mrs-Blain loves them. A chum who is CFO of a Tech firm swears by them – she sticks all her staff in them. But, she’s also quite happy to use a Regus office for board meetings. In fact she prefers to. Everyone is aware We Work has smashed the previous short-term office rental paradigm - a market of 3-4 firms. It leases property long term, does them up to make them attractive to the kind of workforce likely to use them – millenials, start-ups, gig-workers, consultancies, etc.

The rest of the We Company stuff is pure-bunkum – schools and residential living might be aspirational, but it’s a complete distraction. I can’t imagine a more meaningless life – everything from your home, to friends, holidays and kids, circling round your workspace.. How did we manage before We Work figured you might have a pint with co-workers.. (Maybe I get SoftBank to fund me $20 bin for my new social-dynamic inter-reactions experience-centre:

The bottom line is We Work rents property long-term and rents it out short term. End of. And very dangerous.

There isn’t anything remarkable, innovative or fundamental about renting office space. If the world is entering recession, then the first parts of the economy likely to be shaken out are… consultants, start-ups, and SMEs. It reminds me of a German Bank I used to cover in the 1990s – they told me they borrowed long and lent short and were happy to take the risk because the Bundesbank was right next door and therefore they could predict interest rates perfectly. They collapsed and went under.
The question to ask is how We Work’s CEO, Adam Neumann, pulled it all together? Marketing is a talent. Tell people what they want to believe and they will believe it. Finding the right partner even more so.

Softbank founder Masayoshi Son was the perfect mark. He and Neumann cooked up the valuations between themselves. He bought into the flaky We Work white-board Venn diagram concentric circles encompassing Work Space, Health, Sport, Friends, Etc… Somewhere he might have missed is the point we do these things anyway.. and the core of We Work was Property, Property, Property.
Nothing Tech about it.

How did he fall for it? I’m sure he was mightily impressed that Neumann was sporting a broken finger earlier this week – broken while surfing 15 ft waves in Hawaii with a top pro surfer. Wow. Aspiration lifestyle, and you can get it all, with free beer on a Friday, at We Work. I bet Son would love to do the same.

At which point its worth bearing in mind how We Work is also vulnerable to changing fashion. At the moment millennials like shabby post industrial-chic. The plus is it looks distressed today, and will still be distressed in 10-years time as We Work’s leases come up. However, the reason the Millennials’ bosses rent a board room from Regus is because they have to impress the baby boomers who still control the purse strings. (And bear in mind, Regus’s parent IWG makes money.) Toscafund has been steadily increasing its stake in IWC, even as Regus starts to do stuff We Work does, like allowing yoga pants in the office.. But, they do it profitably..

Who knows if We Work will be another “Wake up and smell the Coffee” moment… In this strange, curious and difficult to understand modern world, everything is not what it seems. There is actually value in losses to build position. There is corporate evolution, and the “Art of War” is as relevant today as ever. But, you can’t put lipstick on a property gamble and call it a Tech paradigm shift…

Out of time, and have a great weekend.

Bill Blain Shard Capital

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Ed 5 mths ago
WeWork CEO Exposed For Buying Buildings And Leasing Space To His Own Company

Given that Neumann has already played the 'pivot' card (though presumably he could pull an MbS and unveil his "plan" to build a shining new "WeCity" in the middle of the desert), we wonder how he plans to distract from the latest damaging report, published Wednesday by the Wall Street Journal, which uncovered that many of the buildings WeWork is leasing for office space are owned in part by Neumann himself, presenting what most investors should immediately recognize as a flagrant conflict of interest.

A WeWork spokesman said that this arrangement had been disclosed to investors and reviewed by the company's board, and WSJ reported that Neumann's ownership had been flagged in a prospectus circulated to buyers of the company's debt.

In a prospectus related to a debt offering last year, WeWork said it had leases with multiple properties owned in part by Mr. Neumann. It also said WeWork paid more than $12 million in rent to buildings “partially owned by officers” of WeWork between 2016 and 2017, and future payments total more than $110 million over the life of the leases. The specific properties weren’t listed.

But many investors in the privately-held company. which Neumann controls, told WSJ that they were 'concerned' about the arrangement.

Mr. Neumann has made millions of dollars by leasing multiple properties in which he has an ownership stake back to WeWork, one of the country’s most valuable startups. Multiple investors of the privately held company said the arrangement concerned them as a potential conflict of interest in which the CEO could benefit on rents or other terms with the company.

A WeWork spokesman said all related-party deals are reviewed and approved by the board or an independent committee and disclosed to investors. Mr. Neumann declined to comment through a spokesman.

WeWork, which was recently valued at $47 billion by investor SoftBank Group Corp. , signs long-term leases for office space with landlords, then subleases the space on a short-term basis to companies. Mr. Neumann, the 39-year-old executive who founded WeWork in 2010, is WeWork’s largest individual shareholder and has voting control over the company.

And their concern is understandable. After all, while Neumann has presumably been making a killing on the long-term leases that the company signs, WeWork - sorry, "We Company" - bond holders are taking a bath...

...and his company remains staggeringly unprofitable.

Though, as we've learned time and time again, in the world of tech (a label that WeWork has some how glomed on to despite its focus on the comparatively drab business of renting office space), unprofitable companies earn absurd valuations every day (just look at Tesla). SoftBank just invested $2 billion at a valuation of $47 billion (though the Japanese hyper-VC fund had initially planned an investment ten times that size).

But as if the presence of this conflict of interest wasn't enough of a red flag, one detail reported lower down in the WSJ story is even more alarming. According to WSJ, Neumann had tried to purchase stakes in buildings leasing to WeWork before gaining full control over the company in 2014, but he was stymied by the board.

In at least one instance before he secured full control over the company, Mr. Neumann wasn’t able to complete a similar deal. When WeWork was negotiating a lease on a Chicago building in 2013, he tried to buy a stake of up to 5% in the building - 210-220 N. Green St. - as part of the deal, people familiar with the negotiation said. WeWork’s board raised concerns about the deal, citing a potential conflict of interest, and WeWork paid for the stake instead, one of the people said.

The next year, Mr. Neumann effectively gained control over the company. As part of an investment round for WeWork in 2014, he was granted Class B shares that gave him 10 votes per share, and now he has more than 65% of the overall share vote, according to WeWork corporate filings.

Mr. Neumann has since bought up several properties through investor groups and leased some of them to WeWork.

After unmitigated power was secured, Neumann moved ahead with the deals. In a nutshell, this should tell investors everything they need to know about the WeWork board's ability to effectively monitor the company's CEO.

But if they needed more reason for skepticism, corporate governance experts quoted by WSJ said WeWork's arrangement with Neumann wouldn't pass muster if the company was publicly traded.

Corporate governance experts say Mr. Neumann’s ownership of buildings he leases to WeWork is unusual for a large company. Corporations typically bar executives from similar arrangements, given that companies risk paying too much in rent or leasing buildings they ordinarily wouldn’t, they said.

"In a public company, that would be considered highly controversial," said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "Usually human beings tend to think of themselves over the company itself when they’re on the other side of the transaction."

And indeed, some of the property deals that Neumann has been involved in seem suspiciously tailored to profit off Neumann's relationship with WeWork.

In New York, the deal at 88 University came together in 2015 after Mr. Neumann partnered with fashion designer Elie Tahari to buy the building for $70 million. The pair planned a renovation that included an overhaul of at least one of the elevators, said a person involved with the deal.

The owners subleased the building to WeWork. In turn, WeWork struck a deal with IBM, which needed space quickly and moved there in spring 2017. Mr. Neumann’s interest in the building was revealed last year by real-estate publication the Real Deal.

And some of WeWork's biggest tenants have complained about conditions at the building - like a malfunctioning elevator that has forced employees to take the stairs - but Neumann worked out a favorable lease with WeWork delegating responsibility for building maintenance on a building that he owns to his company (and, by extension, its bond holders).

Soon after IBM arrived, one of the two elevators was out while the other was frequently breaking, causing lengthy waits and long slogs up the building’s narrow stairs.

IBM executives, frustrated about their working conditions, complained to WeWork about the broken elevators, said people familiar with the matter. While landlords typically are responsible for elevators, WeWork had signed a so-called triple-net lease with Messrs. Tahari and Neumann, in which WeWork was responsible for fixing issues like elevators. As part of that deal, the landlord set aside funds to WeWork to pay for such renovations, a WeWork spokesman said.

An IBM spokeswoman declined to comment.

The building’s value, meanwhile, has gone up, and the owners have been able to borrow more money by refinancing the property’s debt. Late last year, Messrs. Neumann and Tahari took out a $77.5 million loan, according to loan adviser Meridian Capital Group, $7.5 million more than the prior loan to buy the building.

If WeWork relied on a slightly more stable business model, maybe it would be easier for investors to overlook these conflicts. But the fact is, as we've explained before, WeWork's business model relies on signing long-term leases then turning around and signing up clients who only commit for the short term. This predisposes the company for a massive revenue dislocation when a downturn hits (which it almost certainly will in the near future).

Though the amount of money Neumann has already extracted from WeWork isn't publicly known, he has reportedly told friends that he has earned hundreds of millions of dollars from sales of WeWork stock.

But fundamentally, the conflict begs the question: What would Neumann the landlord do if Neumann the tenant can't make rent? Would he make a claim against his own company if its teetering on the edge of bankruptcy, or move to evict? These are questions that all WeWork bond holders should be asking.

Ed 5 mths ago
WeWork’s CEO Makes Millions as Landlord to WeWork

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