WeWork Is Foundering While Softbank Struggles With Its Bailout
Softbank’s tender offer for WeWork shares is underway, but recent developments and other troubling factors suggest all may not be well with WeWork’s rescue plan.
Bloomberg reported Softbank Group (9984 JP) finally has launched its $3 billion tender offer for WeWork shares, according to sources privy to the deal, confirming a Reuters report on Sunday.
All is not as rosy as this would imply, however, since the offer doesn't expire until April 1st next year.
This is an inordinately long time to win approval from a comparatively small group of equity investors SoftBank and WeWork's board have been talking with since well before the company accepted Softbank's rescue package October 22th.
Indications are that Softbank's bailout for WeWork is not as settled as it seemed, with key factors like funding for the tender offer to even the tender amount reportedly still under discussion.
Softbank's banks and investors continue to voice serious concerns about the billions of dollars it will take to salvage WeWork as well as Softbank's apparent conflicts of interest.
It doesn't help that WeWork selectively revealed recently that it was producing massive and accelerating losses during the third quarter even as it was peddling its failed IPO and fighting the SEC's objections about missing and misleading disclosures, including bogus performance metrics (as I warned in The Tide Is Out and WeWork Bondholders Are Naked, 10/7/19).
On Its Way, Sort Of
Terms of WeWork's rescue plan announced back in October called for Softbank to tender for up to $3 billion in stock from founders, investors, and employees.
Timing is critical since Softbank will not move forward with $3.3 billion in vital cash funding from new bonds until after the tender closes. However, as weeks passed in silence, I suspected the plan has hit some snags.
My concerns were confirmed over the past week, starting with a report that Softbank is trying to borrow $2.8 billion to help it fund the tender--and it's bankers may say no.
While Softbank could seemingly fund this round with cash on hand, it's concerning that it chose not to and that its banks believe the risk is too high--understandable given how fast WeWork will likely burn through it.
The banks were already concerned about Softbank pumping another $9.5 billion into WeWork after nearly $10 billion invested so far had plunged by at least 85% to $7 billion (down by 94% versus my estimate of $3 billion as of 10/7/19, which I now consider generous even for the going concern).
Indeed, the egregious $1.7 billion buyout promised to ex-CEO Adam Neumann, a sore point of contention for Softbank's banks and investors as well as WeWork's employees, exceeds the $1.5 billion emergency cash infusion Softbank wired to WeWork when it accepted Softbank's bid.
Softbank's investors also have complained about its $6.5 billion loss for the September quarter, it's worst in 38 years, mostly on the sickening hit from WeWork. SoftBank and its $100 billion Vision Fund wrote down their WeWork stakes by $4.7 billion and $3.5 billion, respectively. Vision Fund reported a stunning $9 billion loss for the quarter, its first ever, which also included losses at Uber plus 20 other investments.
Softbank's largest investors have voiced objections about its massive WeWork rescue plan as well as its freewheeling investment strategy and potential conflicts of interest; e.g. loaning $20 billion to its top executives to invest in Vision Fund.
No surprise then that Softbank may reduce the size of its tender offer for WeWork shares versus the $3 billion planned. WeWork is a black hole where billions of dollars have evaporated at an increasing clip every quarter for years.
Even Softbank's 5-year turnaround plan doesn't project it will be cashflow positive before 2023--tracking my estimates Softbank May Blink First (WeWork Bondholders Hope) 10/14/19.
These concerns help explain the inordinate delay in launching the tender offer.
Another was WeWork's alarming third-quarter performance.
It's Only Money
WeWork released a tragically limited summary to bondholders on November 13th which reported the third-quarter loss at $1.25 billion, 1.3x revenue reported at $934 million (up 94%).
This was nearly 2x the second-quarter loss of $640 million (.9x revenue) and nearly 3x worse versus the $497 million loss (1x revenue) for the third quarter last year.
The unvarnished loss was even worse. Tiny print in the footnote revealed the reported loss was boosted by a "$457 million gain from change in fair value of related party financial instruments."
Excluding this convenient and unexplained gain, WeWork lost $1.71 billion (1.8x revenue)—nearly as large as the $1.93 billion loss (1.1x revenue) reported for all of 2018.
Balance sheet and cash flow statements weren't provided, but I suspect severe cash consumption was partially offset by further borrowing (e.g. limited credit facility availability plus new leases signed) which only worsened WeWork's precarious financial condition.
Reported cash fell to just $2 billion versus $2.4 billion as of June 30th, which likely still included at least $1 billion in padding from joint venture-owned cash and customer deposits--cash it can’t actually spend as I tracked in June results (see Gravity Works As WeWork Doesn't; Now Plan B, 9/17/19).
The results confirmed my concerns about why WeWork’s banks were so spooked they refused to extend further credit after the IPO fell apart as well as how egregious are the company’s public disclosures and financial reporting (see The Tide Is Out and WeWork Bondholders Are Naked, 10/7/19).
Indeed, The Wall Street Journal reported WeWork was fighting to retain its deliberately misleading and grossly inadequate disclosures despite strong and continuing objections from the SEC even as the IPO was unraveling and ultimately withdrawn the last day of the quarter.
As I told the New York Times, WeWork knew the quarter would be bad when and after it launched its IPO midway through the quarter on August 14th.
Yet it continued to peddle its IPO without publishing warning guidance of material importance to prospective investors about its rapid escalation in losses and alarming cash consumption at levels that rendered the company unsustainable.
This is same stunt WeWork pulled in April 2018 when it sold its unregistered bonds, as I warned back in September in Gravity Works As WeWork Doesn't; Now Plan B.
It Gets Worse
I had estimated cash consumption at $2-3 billion per quarter (affirmed in WeWork Bondholders Brace for Softbank's Rescue Plan--In Silence, 10/29/19), which explains how WeWork was set to run out of cash before the end of November.
This also implies WeWork may burn through by yearend actually available cash on hand as of September 30th, likely less than $1 billion, plus most if not all the $1.5 billion emergency cash Softbank injected October 22nd when its offer was accepted.
My expectations for the fourth quarter and next year greatly discount reported strong growth in revenue in the third quarter, which was fueled by increased memberships and locations plus improved performance at maturing locations which offset faltering occupancy rates.
These results barely reflected the evolving failure of WeWork's IPO, which was withdrawn September 30th, much less its drastically changed prospects.
Revelations of the company's profoundly weak operations and precarious financial condition no doubt added further pressure to operations by spooking customers as well as WeWork's landlords--both existing as well as prospective.
Moreover, management has moved quickly in recent weeks to slow new deals, toss out others, and otherwise significantly curb market expansion and coverage as well as put underperforming businesses up for sale.
This could rapidly slow if not reverse revenue growth for several quarters, while costs will spike even higher as a percentage of revenue even before we count the sharp increase in cash spent on severance, closing and downsizing locations, and exiting agreements. (The pace of necessary layoffs has been impaired because WeWork reportedly can't afford severance payments.)
I also have estimated that cutting even $1 billion in direct and overhead costs per quarter won't be enough to offset WeWork's largest and least flexible expense: rent on its $47 billion in long-term leases, which may take a restructuring to whittle down to a manageable level.
As a result, I expect the fourth quarter will be a dumpster fire with little if any improvement through at least the first half of next year, if not the full year.
After the Fall
WeWork's astonishing crash into reality took only weeks, leaving a smoldering heap worth $40 billion less than advertised with a critically flawed and nearly bankrupt business model that may not recover for years, if ever.
The longer WeWork takes to settle, the farther it falls. The unexplained delay and uncertainty to get its rescue plan funded lower WeWork's value even more.
Whether and how WeWork can be saved will test Softbank's resolve. CEO Masayoshi Son has indicated such bailouts won't continue, but he has said this before. The more billions of dollars WeWork chews up, and the more Softbank pumps back in, the more Softbank's bankers and investors are repelled. This also has put Vision Fund and Vision Fund II at risk.
A lot can happen between now and April 1st, when the tender offer is set to expire, and chances are WeWork's results will be worse, not better than expected.
If so, I suspect WeWork may need another substantial cash infusion early in the first quarter, less than two months from now and at least three months before $3.3 billion in new bonds are issued which could fund WeWork through perhaps another quarter or two at best.
Given the negative prevailing winds, it's becoming less certain Softbank will elect to accelerate that funding versus pursuing an expedient restructuring and/or bankruptcy.
Prices on WeWork's bonds seem to have nowhere to go but lower as the company's prospects and meager asset value--on which they have no claims--melt away.
WeWork 7.875% senior notes lost another 13 points to 71.6 (15.9% ytw/1425 bps) since my last report, and are down more than 31 points since I initiated coverage with "Sell" in Gravity Works As WeWork Doesn't; Now Plan B, 9/17/19. WeWork remains severely distressed and it's not yet clear the company can remain viable. Existing bonds face the further risk of WeWork's pending note offerings which will envelop them in a mountain of debt without providing a convincing path for the company's recovery.
Moreover, WeWork's severe cash consumption and foundering business prospects increase chances that Softbank may elect to restructure the company in bankruptcy, potentially rendering the bonds nearly worthless at 5-10 cents on the dollar likely paid in new equity. Upside potential on the bonds remains limited at best outside of brief, misguided rallies while downside risk could be 60 points or so given the most extreme outlook. Maintain “Sell.”
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