WeWork’s Mounting Losses Send Softbank Scrambling For Alternative Financing
WeWork’s dangerously empty pockets after an even worse Q4, why SoftBank can’t buy back stock, and how far it might go rather than go down with WeWork.
Softbank Group (9984 JP; 9434 JP) announced Wednesday it took out a 2-3 year margin loan against its own shares for JPY 500 billion ($4.5 billion).
This follows Tuesday's news that SoftBank has pumped another $2.5 billion into Vision Fund since Octoberto help offset stunning losses mostly due to disastrous investments in beleaguered The We Company (WeWork) (WE US) (see WeWork Is Foundering While SoftBank Struggles With Its Bailout, 11/27, 2019).
SoftBank also has failed after months of negotiations since October to convince its banks to loan it $3 billion it needs to fund its outstanding tender offer for WeWork shares, confirming my concerns that even the inordinately long period to complete the tender by April 1st may not be long enough.
Indeed, it took more than two months for WeWork to convince Goldman Sachs Group (GS US) to close a new Letter of Credit facility last week—even with SoftBank forced to sign on as a co-borrower (see WeWork Still Failing Expensively; SoftBank Struggling to Foot the Bill, 12/30/19).
No doubt the banks working with WeWork and SoftBank remain alarmed that WeWork continues to light cash on fire as soon as it gets it, as indicated by sparse details in SoftBank's third-quarter earnings report released the day after WeWork's facility was finally closed.
If so, this likely means SoftBank will not buy back stock any time soon no matter how much pressure it's getting from activist investor Elliot Management—because it can't.
Picking Through What's Left
As I have warned in several reports, notably in The Tide Is Out and WeWork Bondholders Are Naked (10/7/19), investors lost their best chance at getting fairly reliable financial information on WeWork when its IPO went down in flames last fall.
As I noted then, "WeWork is only required by its bond indenture to provide financial reports to holders or "prospective holders" of its bonds. Reported financial information need only be "essentially" complete to the extent it was provided in the bond prospectus and does not have to be certified by WeWork senior officers as correct and true."
Remember bondholders had received a year of WeWork's "essentially" complete financial statements before its IPO filing last August. Yet it took public scrutiny of its problematic S-1 filing, incomplete and misleading as it was, to reveal WeWork's massive and escalating losses from its severely flawed business model and its alarmingly fragile and effectively insolvent financial condition (see Gravity Works As WeWork Doesn't; Now Plan B, 9/17/19).
With WeWork in even more peril than ever, and no fourth-quarter financial statements likely to materialize for public review, we are left to pick out what we can from SoftBank's third-quarter results as of December 31st.
Revenue Weaker Versus WeWork Projections; Losses Even Worse
WeWork's projection as of the third quarter was run-rate annual revenue at $4.2 billion, up from $3.3 billion as of the second quarter, and $4.3 billion in revenue backlog of "committed contractual agreements."
I remained skeptical, sticking with my initial 2019 revenue estimate published in September (Gravity Works As WeWork Doesn't; Now Plan B) for roughly $3.3 billion for the year with little if any improvement for 2020.
This implied less than $940 million in revenue for the fourth quarter, little changed versus the third quarter.
I also expected a worse net loss versus the stunning $1.3 billion loss reported in the third quarter, which actually was a $1.7 billion loss excluding a convenient gain in "Fair Value of Related Party Financial Instruments."
As I noted in WeWork Is Foundering While SoftBank Struggles With Its Bailout, 11/27/19:
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.
Sure enough, real estate company CBRE reported last month that WeWork signed only four leases in the fourth quarter—down 93% versus last year.
SoftBank confirmed that WeWork already had lost more than $1 billion by October 30th, when its takeover agreement was finalized. Given how badly the quarter sunk over the subsequent two months it's reasonable to assume losses doubled and perhaps tripled for the full quarter.
WeWork guidance confirmed my other projections, as shown with this slide provided to SoftBank and tagged in the teeny tiny footnotes as "Not projections; these are goals" to make sure we don't get our hopes up too high.
From this we can see:
WeWork is not even targeting $1 billion in quarterly revenue until sometime later this year. This means fourth-quarter revenue likely fell well short of $1 billion, as I projected, with 2020 revenue tracking well below $4 billion.
Forget about profits for the foreseeable future. Even WeWork's creatively (dubiously) defined EBITDA may not turn positive for two years. Already sky-high leverage will remain off the charts for years as a result, particularly after WeWork adds at least another $3.3 billion in debt as part of SoftBank's bailout on top of $47 billion in long term leases it can't afford.
Wait three years, or more, to see liberally define free cash flow turn positive, and 4-5 years for free cash flow to hit $1 billion.
Achieving WeWork's "goals"—not projections—will take at least two years longer than SoftBank initially indicated for WeWork to stabilize.
It's also going to be even more expensive than SoftBank probably expected to keep WeWork afloat until then, and that's not covered by WeWork's 5-year plan.
WeWork wildly overstated even its near-term cash position.
For starters, WeWork didn't actually have $2 billion in effective available cash reported as of September 30th. The chart shows that $629 million was cash restricted to back its credit facility which it can't spend. Another $600 million was owned by its variable interest entities (VIEs) and it also carried at least $500 million in membership deposits which customers paid for leasehold improvements WeWork must perform. This left just $272 million in cash WeWork could actually spend in the fourth quarter.
The trouble is, as I projected last September (and affirmed in WeWork Bondholders Brace for SoftBank's Rescue Plan—In Silence, 10/29/19), WeWork has been consuming $2-3 billion in cash per quarter. This explained why WeWork would run out of cash before the end of November.
Hence the urgency to get a bailout deal from SoftBank, and especially the emergency cash infusion of $1.5 billion wired in right after the terms were signed on October 22nd.
This did not take WeWork's pro forma cash to $6.9 billion, despite what is indicated in the chart above.
The $3.3 billion won't arrive until April, or later, depending on when SoftBank completes the tender for WeWork stock.
Another $100 million from SoftBank went to WeWork Japan—again, not available to WeWork parent.
Given my estimate for WeWork's voracious cash consumption, I had projected it was likely to run out of cash by yearend.
Looks like it did.
WeWork ended the year with $1.2 billion reported in cash, indicating at least $2.3 billion was consumed. Subtracting at least $700 million owned by VIEs as of September 30th and at least $500 million in membership deposits wiped out the entire $1.2 billion balance as not actually available for WeWork to spend.
Huh? WeWork is left with spending other people's money to keep the lights on? What's going on with SoftBank and its carefully crafted bailout?
SoftBank Hits Snags
With so much attention on WeWork's slow-moving train wreck, SoftBank's troubles to fund its rescue plan came were unexpected.
I first noticed it was taking a weirdly long time for SoftBank to initiate its tender for WeWork stock—the next step in the rescue plan that held up $3.3 billion in WeWork's obviously vital funding.
The surprise came late in November, a month after SoftBank agreed to take over WeWork, when Bloomberg revealed that SoftBank was seeking a $2.8 billion loan to fund the tender.
The next day Financial Times reported the banks would likely say no.
By December it was clear that SoftBank's financing plans for the tender were in trouble, and apparently it didn't have sufficient cash to complete the tender otherwise. Reuter’s reported that SoftBank’s negotiations with its already wary banks were stalled because it has hit its loan limit.
Meanwhile, WeWork was not able to get a new credit facility until December when Goldman Sachs finally committed to a $1.75 billion Letter of Credit facility, but only after SoftBank signed on as a co-borrower.
This no doubt created even more trouble between SoftBank and its banks, which already were concerned about their exposure to SoftBank as well as its excessive exposure to WeWork.
This explains why it took two months to get Goldman to close WeWork's new letter of credit facility which doesn't actually loan a penny to WeWork but reportedly freed up $800 million in cash restricted as collateral by its previous credit line.
Well, not exactly. Only last week did WeWork clarify (see the fine print on the chart shown above) that the $800 million in restricted cash "is expected to be released in the coming months."
So now, two months after WeWork was effectively out of available cash, with no available credit for cash, it's potentially burning through another $2 billion which it can only offset with letters of credit to back up promises to pay up later. It must wait another two months to get the next meaningful cash infusion via its SoftBank rescue plan, and it doesn't expect to be self-funding for at least 2-3 years.
Meanwhile, SoftBank has other mounting problems not helped by its disastrous WeWork money pit.
How Much Farther Will SoftBank Go To Save WeWork?
SoftBank reported another round of disappointing results last week for its December quarter with operating profit plunging 99% y/y to just $24 million, again mostly due to WeWork losses.
This followed the $6.5 billion loss for the September quarter, it's worst in 38 years. SoftBank also reduced WeWork's equity value by another $500 million—now $5.2 billion written off so far—to $7.3 billion, which still seems ambitious.
I lowered my initial estimate of $5-7.5 billion to $3 billion back in October,and then only as a going concern. After the third quarter it was even more obvious that WeWork is insolvent and could be for years given its broken business model supported by nominal tangible asset value at best versus at least $25 billion in long-term debt and leases—so far.
Even if most of its expensive leases can be renegotiated, which isn't likely, its existing debt and equity are likely worth zero in a bankruptcy recapitalization or liquidation scenario.
How many more billions in cash support will SoftBank throw at WeWork to keep it afloat when it's already down by more than half on its drastically overpriced investment?
I suspect the magic final number might be $3.3 billion, which is the last round of committed financing SoftBank is due to provide WeWork after it completes its tender offer for up to $3 billion in WeWork equity which it still hasn't funded.
This implies $5-6 billion in financing SoftBank needs to arrange, which is only partially met with proceeds of its margin loan, but still likely doable by the end of April.
After that, I think WeWork will be on its own to sink or swim. SoftBank just installed bankruptcy and turnaround veteran Sandeep Mathrani as WeWork's new CEO.
Mathrani plans to bring in a new CFO and other top execs in a clean sweep of WeWork's management, which is what I recommended last fall (see WeWork Board and SoftBank Battle CEO For Control, 9/22/19).
This doesn't guarantee Mathrani will avoid steering WeWork into a recapitalization, even bankruptcy, and SoftBank signaled last week by letting Brandless fail that it's willing to let that happen.
SoftBank has enough on its plate for the foreseeable future trying to sooth its skittish banks which consider it too stretched to support a $3 billion loan to fund its WeWork tender, and why it was driven to get a margin loan backed by its own shares instead. It's on the hook as co-borrower of WeWork's $1.75 billion LoC facility. SoftBank also is trying to salvage its sputtering Vision Fund II offering, which it is funding after losing most of its potential investors. This may explain why SoftBank is unwilling and perhaps discouraged by its banks to whittle down its winning stakes in Alibaba Group (BABA US) and Sprint Corp (S US) to raise cash.
So it's no surprise that SoftBank is not interested in spending $10-20 billion on buying back stock. That might appease activist investor Elliott Management which recently acquired a 3% stake, but SoftBank would have to weaken its balance sheet further to fund it since it's tapped out from feeding billions in cash to WeWork, Vision Fund, and Vision Fund II.
And it's only February.
Risk for WeWork bonds remains acute, but they are up 6 points since my last report to 88.8 (10.8% ytw; 935 bps). This belies the company's dismal results for the fourth quarter and likely 2020, plus the persisting risk of a comprehensive capital restructuring or even bankruptcy unless the company can renegotiate tens of billions locked up in expensive long-term leases WeWork can't afford. Not to mention the prospect of being eclipsed by $3.3 billion in new debt with higher (albeit likely still inadequate) coupons and issue sizes which will afford them comparatively better trading liquidity versus existing bonds—such as it is for unregistered bonds from an appalling weak issuer. Maintain “Sell.”
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