🎢Weeeeeeeeeeeeeee🎢

⚡️Update: WeWork⚡️

This was us covering the hourly news diarrhea that came out about WeWork in the last 48 hours alone:

Which, we suppose, is better than how the company’s equity and existing noteholders must be managing:

Or the fine bankers over at JPMorgan Chase ($JPM) who are tasked with finding capital markets suckers…uh…investors…who’d be so kind as extend this steaming pile a lifeline:

So, sifting through the constant headlines, where are we at?

At most, WeWork has the capacity to issue a little more than $1 billion in secured debt and $2.56 billion of unsecured debt: @XtractResearch This is substantially less than some of the estimates floating out there regarding potential loan commitments.

— Lisa Abramowicz (@lisaabramowicz1) October 14, 2019

Okay, right. The hot mess of a liquidity profile and limited amount of debt capacity to get a deal done.  Nothing to see here. All good.

Reminder: it is widely believed that WeWork will run out of cash by the end of the year without a new deal in place. Axios reports:

The company reported $2.4 billion of cash at the end of June, with a first-half net loss of $904 million. At that pace, it should have been able to survive at least through the middle of 2020. But I'm told that it significantly increased spend in Q3, partially due to the lumpy nature of real estate cap-ex, believing it would be absorbed by $9 billion in proceeds from the IPO and concurrent debt deal. One source says that there's probably enough money to get through Thanksgiving, but not to Christmas.

Riiiiiight. So here are the options:

• A Softbank Group new equity and debt bailout pursuant to which they get control of WeWork and napalm Masa’s former boy, Adam Neumann, in the process. This would reportedly be an aggregate $3b package “to get through the next year” — repeat, TO GET THROUGH THE NEXT YEAR — with the equity component coming significantly cheaper than the previous self-imposed $47b valuation (at a $10b valuation); or

• JPM arranges some hodge-podge debt package and tests the market’s never-ceasing thirst for yield, baby, yield. The early reports were that the financing package would be $3b, comprised of $1 billion of 9-11% secured debt, $2b of unsecured PIK notes yielding 15% (1/3 cash pay, 2/3 PIK), and letter of credit availability. Wait, 15%?! How does a company with no liquidity even pay that? That’s why the PIK component is so critical: it would simply add 2/3 of the interest due to the principal of the debt. Said another way, the debt would compound annually and creep past $2.5b in two years. Per Bloomberg, “The $2 billion of proposed unsecured debt may carry an additional sweetener for investors: equity warrants designed so that investors could boost their return to around 30% if the company gets to a $20 billion valuation, according to the person who described the structure.” Because debt won’t dilute equity like Softbank’s equity-heavy proposal would, WeWork insiders (read: Neumann) apparently prefer the JPM approach. Regardless of what insiders prefer, however, is whether the market will be receptive to what one investor dubbed, per Bloomberg, “substantial career risk.”

We’re old enough to remember when WeWork’s notes rebounded a mere five days ago for reasons that were wildly inexplicable to us then and even more so now.

So, to summarize, who are the big winners? IWG/Regus ($IWGFF)(long?). We’re pretty sure they’re loving what’s happening here; we have to imagine that the inbound calls have to be on the upswing. Also, the restructuring professionals. Whether you’re Weil Gotshal & Manges LLP (Softbank), Houlihan Lokey ($HLI)(Softbank), or Perella Weinberg Partners (WeWork’s Board of Directors), you’re incurring more billables/fees than you expected to mere days weeks ago. Somehow, some way, the restructuring pros always seem to come out ahead. And, finally, Goldman Sachs ($GS). Because there’s nothing more Goldman-y than them selling their prop stock right out from under a proposed IPO.

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💨WeWork (Long Death Spirals & Cascading Effects)💨

The Co-Working Giant Spirals Amidst Liquidity Crunch Sparking Landlord and CMBS Worries

Our WeWork space currently has no running water. I knew WeWork had a liquidity problem, but this is ridiculous!!!!!!!!!!

— matt weinberger (@gamoid) October 7, 2019

Alison Griswold’s Oversharing newsletter has been all over the WeWork mess and this recent missive includes a solid and stunning collection of links-all-things-WeWork. Things could get even worse if a financing doesn’t get done. Like, soon. Per The Financial Times:

WeWork’s bankers are scrambling to complete a new debt financing package as soon as next week to buy time to restructure after the company’s failed initial public offering left it running short of cash at a faster rate than expected.

Two people briefed on the fundraising efforts said the office company’s cash crunch was so acute that it had to raise new financing no later than the end of November. Fitch Ratings downgraded WeWork’s credit rating last week to CCC+, warning that the lossmaking company’s liquidity position was “precarious”.

Fitch estimates WeWork’s current funding arrangements might only carry it through another four to eight quarters unless it rapidly reduced the rate at which it has been burning cash.

Interest payments are, of course, small potatoes relative to massive lease obligations but WeWork has $702mm of 7.875% unsecured notes with biannual interest payments. Its next payment is due 11/1/19. That would be a $27.9m nut. The timing couldn’t possibly be worse.

This barrage of bad news has the haters drooling:

In other words, nearly 10% of the outstanding unsecured bonds are short. Man, the vibe around this thing isn’t exactly Kibbutz-like.

If you wondered why WeWork $WE was still contemplating an IPO at a 2/3rds discount to the last round, now you know:

They're broke pic.twitter.com/K7be4LsKJ3

— Donut Shorts (@DonutShorts) October 11, 2019

Some other bits here: (i) JPMorgan Chase & Co. ($JPM) is trying to get other banks to participate in the “emergency financing package” but the-always-winning-to-the-point-of-the-game-seeming-rigged Goldman Sachs Group Inc. ($GS) is currently not in talks to participate, effectively walking away from an earlier IPO-based commitment to the company; and (ii) Softbank may sink more money into this pit but is renegotiating the price of its earlier issued shares in the process (read: this is leverage baby).

If you’re wondering why a senior lender might be hesitating to join JPM in a syndicated senior secured loan, the issue may very well be this: secured by what, exactly? In terms of assets, the company has roughly $15b in leases (which, obviously, have an offsetting liability, and the quality of which will be variable and in need of examination) and $7b of property and equipment, i.e., desks, chairs, barista equipment, yogababble, etc. Given all of the beer swilling and hooking up that occurs at these places, equipment has a questionable lifespan and, by extension, value.

Compounding matters is the fact that enterprise tenants — a key component to WeWork’s go-forward viability — appear to be balking. Per The Information:

“We were looking at doing a couple deals [with WeWork], and thinking about it quite differently now. Are they going to invest in the market?” said Robert Teed, vice president of real estate and workplace for ServiceNow, a publicly traded cloud computing company that puts some of its employees in WeWork spaces. “It’s making us stop and think. It’s awfully noisy. Will they do what they say they’re gonna do?”

And, so, people are beginning to fear what happens if…uh…as?…WeWork falls. Here is a Wall Street Journal article about the President of the Federal Reserve Bank of Boston’s concerns about WeWork, co-working and CRE. It seems his concerns may not be misplaced: cracks are beginning to form in Boston’s commercial real estate market, generally. Here is a Financial Times piece about WeWork halting new lease agreements, a move that “will rattle commercial property owners across the globe who rented to WeWork, which often upgraded the spaces so the group could re-let the buildings to its own customers.” This change in pace will “cut[] out a significant source of demand in large urban property markets where it operates.” Landlords are battening down the hatches. Per Financial Times:

Two landlords of large WeWork sites in London, who asked not to be named, said they would not sign new leases for the foreseeable future and were making contingency plans for their existing WeWork offices in the event of a restructuring.

“It would not be prudent for us to do anything [new] with them until we see how the new management will operate,” one landlord said.

The magnitude of this cannot be overstated. WeWork accounts for over 7mm square feet of office space in New York City alone — making it the largest tenant in the Big Apple. Its $47b in lease obligations is well-documented — including $2.3b in obligations due in 2020 — but to put that in perspective, that figure puts WeWork in third in terms of lease commitments IN THE WORLD.

So, the first question is, “what happens to the existing money-losing properties if WeWork cannot sure up liquidity?”

Back to the FT:

Alex Snyder, assistant portfolio manager at CenterSquare Investment Management in Philadelphia, said: “WeWork has structured many of its leases so that they can simply collapse the special purpose entity it’s trapped in and walk away. This vacancy pressure on the market [would] be painful.”

This ⬆️ is a nuance that a lot of the media — quick to push a sensationalist bankruptcy narrative — seems to miss. The company is set up like a REIT with each individual property non-recourse to the parent. If properties fail, WeWork will just “mic drop” the keys and walk away, leaving landlords with large spaces to fill. What happens then is anyone’s guess. Another co-working space takes over? 🤔

Which gets us to the second question, “if WeWork is no longer expanding, who will fill CRE supply?” These charts ought to give you a sense of the magnitude of WeWork’s reach ⬇️. With this halting, landlords will need to start looking elsewhere.

To add an another layer to this, all of this has people concerned about CMBS exposure. Trepp recently issued a report on this issue. They conclude:

WeWork is certainly a growing exposure for the CMBS market; one that concerns people. The volume of WeWork loans in CMBS, post 2010, is approaching 1% of the entire CMBS market and about 4% of loans backed by offices, so that exposure is meaningful.

The biggest issue is not the pulling of the IPO per se, but the broader concerns about the firm’s viability. The worst-case scenario would be that the firm continues to burn through cash and can no longer support all of its lease obligations. If that were followed by a period of non-payment of rent by WeWork, but physical occupancy and current payments by the firm’s sub-lessees, that would make for some interesting work for landlords and special servicers. Stay tuned.

Wolf Richter — someone who has a reputation for alarmist takes — adds:

These “special servicers” may already be licking their chops. When a CMBS loan defaults, or sometimes even when the building loses a critical tenant but the loan hasn’t defaulted yet, servicing gets switched from the master servicer to a special servicer, as laid out in the pooling and servicing agreement (PSA). The special servicer’s role is to figure out if the borrower can become current via a loan modification or a debt workout. Under many PSAs, special servicers have the right to purchase the building at a discount if the very same special servicer decides the loan cannot be brought current. So, yeah — this might get interesting.

And there are additional complications. WeWork is so large in some markets that a reduction in leasing demand from WeWork, or an outright unwinding of its leases, would put downward pressure on rents and prices in those markets, making it that much more difficult to sort through the fallout in the market from problems at WeWork.

Stay tuned indeed.

*****

More on WeWork: here is a provocative thread about WeWork’s effect on the venture system and what its failure presages for other unicorns in growth-at-alls-costs-even-if-the-business-model-is-faulty mode; here is the WSJ and here is Bloomberg’s Matt Levine, respectively, discussing the personal loans to Adam Neumann; and here is a pointed must-read Harvard Business School study discussing the company’s business model. We particularly enjoyed this bit:

Fundamentally, WeWork engages in “rent arbitrage” by signing long term leases, generally 15 years, at one rate and subleasing the space to SMEs and Enterprise members at with shorter durations. While the cost per desk is lower for the member, the aggregate rent WeWork receives is higher for the space due to the density.

The practice obviously creates a duration mismatch which leaves WeWork, or the special purpose vehicle that entered into the lease, exposed to market fluctuations in the event of a downturn. The short duration of the subleases leaves WeWork exposed to the risk that tenants might abandon the space on short notice leaving WeWork liable for the master lease obligation. They are also exposed to the credit risk of the SME subleasees.

WeWork does not believe a market downturn will impair their business. To the contrary, WeWork maintains that as businesses contract, they will be attracted to WeWork’s business model as it will offer SMEs and larger Enterprises the needed flexibility and lower cost structure per employee during a recession. Indeed, Neumann highlights that the Company was founded during the Great Recession and attracted tenants. Time will only tell if this will be accurate, but it is worth noting that their main competitor, Regus, now IWG, went bankrupt during the Great Recession. (emphasis added)

BURN.

Automotive (Short the B2B Business Model)

More Signs of Upcoming Auto-Related Distress

Assuming Uber Technologies Inc. can survive its latest self-imposed issues, e.g., an unreported data breach, increased regulatory scrutiny, skittish investors in Softbank and Benchmark Capital, etc.,, it appears to be positioning itself and the automobile industry towards a brand new business model. This week Uber announced its (non-binding) agreement to purchase 24k sport utility vehicles from Volvo Cars to seed a fleet of autonomous cars. Deployment date: 2019. Yes, 2019. Anyway, in addition to the obvious and previously discussed implications for labor, this move might have bigger ramifications: a forced pivot of the automotive business model in the direction of the airline model.

What do we mean by that? Assuming a great many things (including Uber's ability to successfully deploy its sensors and software with Volvo's hardware, regulatory hurdles, etc.), this could be another blow to the model of individual car ownership, the B2C formula deployed by the OEMs for years. Hyperbole? Maybe, but if people stop buying cars (and borrow money to do so), auto companies will see significant revenue effects. And they'd have to sell more to fleet operators, i.e., Uber, Lyft, etc., much like Boeing ($BA) and Airbus ($AIR) sell to Delta ($DAL), United Airlines ($UA), etc. This could mean fewer cars on the road, all told. Which, as we've previously discussed here and here, could lead to increased pain in the auto supply chain. 

Elsewhere in auto, the Faraday Future dumpster fire is turning into a full-fledged conflagration and looks like a ripe candidate to be voluntaried into bankruptcy.

And, finally, we noted back in February that 3D-printing could have a big impact on a number of industries. Now, apparently, 3D printing is projected to have a spike in activity in 2018. Businesses sourcing it most? Manufacturing, telecom, defense, and, of course, auto. To point, Divergent 3D just raised $65mm Series B financing round to build its car frame business. Curious.

The (Hard) Business of Eating

Long VC Subsidies & Facebook's Copying Skills

Generally speaking, there are four categories in the dining space. First, there are the QSRs (quick service restaurants). Your run-of-the-mill fast food spots fall into this space. For the most part, these guys are doing okay: McDonald's ($MCD) and Wendy's ($WEN), for instance, have both seen great stock performance in the TTM. Second, there's the fast casual space. Competition here is fast and furious covering all manner of ethnicities and varieties. Chipotle ($CMG) and Panera Bread are probably the two best known representatives of this category. The former has gotten SMOKED and the latter got taken private. Generally speaking, there'll be some shakeout here, but the category as a whole has been holding its own. Third, there's the fine dining space. This is a tough space to play in but there are clear cut winners and losers (Le Cirque, see below): not a lot of chains fall in to this category. And, finally, there is the casual dining category. Here is where there's been a ton of shakeout. This past week, for instance, Ruby Tuesday Inc. ($RT) - the ubiquitous casual dining restaurant loosely associated with bad New Jersey strip malls - got bailed out...uh, taken private by NRD Capital at a fraction of its once $30/share price. (There was some assumed debt, too, to be fair). Moreover, Romano's Macaroni Grill filed for chapter 11 bankruptcy. In RMG's bankruptcy papers, the company's Chief Restructuring Officer said the following, "The Debtors’ operations and financial performance have been adversely affected by a number of economic factors, but perhaps most notably by an overall downturn for the casual dining industry. The preferences of such customers have shifted to cheaper, faster alternatives. On the other end of the spectrum, there is a trend among younger customers to spend their disposable income at non-chain “experience-driven” restaurants, even if slightly more expensive." No. Bueno. See below for a more in-depth (and slightly repetitive summary) of this particular bankruptcy filing. 

Unfortunately, the restaurant world received some other (slightly under-the-radar) bad news this past week: UberEATS, Uber's food delivery service, reportedly generated 10% of the company's total global bookings in Q2 - which, extrapolated, equates to $3b in gross sales for the year. That's a lot of food delivery to a lot of people sitting at home doing the "Netflix-and-chill" thing instead of the eat-microwaved-mozzarella-sticks-at-the-local-Ruby-Tuesday-thing. Of course, this is attributable to Softbank and other venture capitalists who are subsidizing this money-losing endeavor: UberEATS is unprofitable in 75% of the cities it services. On the other hand, do you know what IS profitable? Facebook ($FB). Yeah, Facebook is profitable. And Facebook is going after this space too; it released its plans to get into the online food ordering business earlier this week. And many suspect that this may be a precursor to a foray into food delivery as well. Why? Perhaps Mark Zuckerberg saw Cowen's prediction that US food delivery would grow 79% in the next several years. Delivery or not, anything that helps make online food ordering easier and more mainstream is an obvious headwind to the casual dining spots. Given that this area is already troubled and many casual dining spots have already fallen victim to bankruptcy, there don't seem to be many indications of a near-term reversal of fortune. Headwinds for the casual dining space correlate to tailwinds for restructuring professionals. Sick? Yeah. Sad? Sure. But true. 

Busted Tech

Speaking of tech, Quixey, a "pioneer" of deep mobile search, announced in an epically hubristic blog post that it is shutting down and exploring strategic options (read: IP sale in bankruptcy, most likely). It has $31mm of venture debt and $134mm of venture capital from the likes of Alibaba and Softbank scattered on the cap table. On the topic of venture debt, choice quote from Fred Wilson taken from here: "I have lived [the venture debt] story several times in my career and we are seeing this play out again in the market." Sure sounds like it. We've surveyed a number of restructuring professionals and there seems to be very little attention given to busted tech. Well, maybe other than from us. Why? No debt, we're told. Really? No debt? See, e.g., Violin Memory, Answers.com, Aspect Software. And, now also, some Soundcloud news - a company we have previously identified as a potential bankruptcy candidate. The company appears to have secured an additional $70mm of venture debt (additive to the $30mm previously raised from Tennenbaum Capital Partners) from the likes of Ares Capital, among others. Something tells us that Houlihan Lokey isn't in the business of making nonsensical and useless acquisitions. Interested in this subject? Email us.