Midtown Manhattan, NYC. Photo courtesy of Ajay Suresh.

The unraveling of the coworking company WeWork’s initial public offering (IPO) has been well-covered in the media and blogosphere. Various outlets dissected WeWork’s initial registration statement (S-1) back in August. Then the drama began: Slowly at first, then seemingly all at once.

One element of the story, however, has been poorly covered by the same outlets: WeWork’s implied “$47 billion” valuation.

$47 billion is the price tag purportedly placed on WeWork by its primary investor SoftBank during the company’s last highly successful financing round in January of 2019. This price tag has found itself in countless headlines. It is also completely misleading from a valuation perspective.

Here are three reasons why.

 

Reason #1: SoftBank’s 2019 financing round falls short of  an “established” value.

 

In the valuation field, it is perfectly acceptable to incorporate an implied valuation from a financing transaction into a valuation analysis. When a round of financing is completed – ideally an equity round – the company value can be calculated based on two figures: The value before the round (“pre-money valuation”) plus the amount of money invested in the round.

This is called the “post-money valuation.” The post-money valuation is used by valuation professionals in a commonly used valuation method that we will refer to here as the “Preferred Stock Transaction Method,” which fits under the broader “Market Approach.” Without going into great depth about the nuances of the Preferred Stock Transaction Method, it is sufficient to say that a shorthand version of this was used to arrive at WeWork’s $47 billion valuation after its January 2019 Series H transaction involving SoftBank.

That much is clear. And, quite frankly, that much is acceptable…as a starting point.

The financial press tends to rely heavily on recent private market transactions because they’re accessible, the calculations are simple, and they incorporate market data.

The problem is most outlets start and end right there. A valuation expert would not.

A careful analysis reveals that the face value of WeWork’s Series H transaction is an unreliable indicator. For starters, there are a handful of characteristics of a transaction that a valuation expert would look at to add to or qualify its validity. Two of the most important ones are as follows:

  • The financing round included a new primary investor and, thus, considered to be at arm’s-length
  • The round was robustly-negotiated by sophisticated investors

These are two attributes we point to verbatim in our valuation reports. Considering these attributes sheds a different light on the transaction. SoftBank, for example, didn’t just lead the round with its Vision Fund: it effectively owned the round. SoftBank was the only investor. Given the fact that SoftBank had led prior rounds, this eliminates the presence of a “new primary investor.”

Second, it is not clear the round was “robustly negotiated.” SoftBank is a seasoned investor, to be sure, but the lack of another institutional investor means it was a two-way dialogue – not an auction.

The lack of a new investor – or any other investor not named SoftBank – chips away at the integrity of the pricing. We don’t know whether anyone else kicked the tires on WeWork. We don’t even know that the company was adequately shopped around during this period.

To be sure, this doesn’t undermine the transaction itself; it just limits the conclusions one can draw about the valuation from the transaction. We would hope to receive a bright signal from a robustly-negotiated and more market-driven round. These shortcomings cast a shadow on that signal.

 

Reason #2: Preferred share pricings are not a shortcut to common share values.

 

Further weakening the claim that WeWork was valued at “$47 billion” is the fact that the SoftBank-priced round was for preferred shares – not common. This is a serious oversight. In the event of an IPO, preferred would convert to common, but that does not mean they’re valued the same. In fact, the “preferences” ascribed to preferred shareholders tend to give them considerably more value. This has consistently held true in our team’s early-stage valuation experience.

Without looking at the term sheet for the January 2019 round of financing (a Series H transaction), we are unable analyze the rights and preferences of the preferred shares relative to the common. However, it is true that preferred shares receive priority payout: They are next in line behind debtholders and before common shareholders.

Another term for this hierarchy of seniority is a “liquidation preference.” A liquidation preference means the company’s preferred stockholders receive their investment back first in case the company liquidates.

NEW YORK, NY – MAY 15: Co-Founder and CEO of WeWork Adam Neumann onstage during TechCrunch Disrupt NY 2017 at Pier 36 on May 15, 2017 in New York City. (Photo by Noam Galai/Getty Images for TechCrunch)

The structure followed by most early-stage companies is one that provides a “1x” liquidation preference for preferred holders before any other shareholder gets paid. It could be higher, of course, and a “2x” liquidation preference would mean the preferred shareholders receive two times their money before the others see a dollar. Keep in mind, too, that this typically works in reverse order for preferred rounds: The most recent preferred investors get paid before the prior preferred holders (or sometimes at the same time as them, which is referred to as “pari passu”).

Finally, because the failure rate in early-stage companies is high (upwards of 75% or 80% depending on the study) the potential outcomes favor the shareholders with a liquidation preference. If the company ends up being worth significantly less than what investors expected – like WeWork – then the preferred shareholders are likely to capture all of the value before common sees any proceeds in an unsuccessful exit event. This, too, would mean preferred should be valued higher than common.

For these reasons, using the pricing of a preferred share transaction – like SoftBank’s Series H – we would be ascribing much more value to WeWork’s common shares than is warranted. The dollar difference in a valuation setting is not minor, either. It is often the case that an appropriately performed valuation of a private company’s common stock is less than half the value of most recently raised preferred stock.

To ascribe a value to a company’s common shares based on the price paid by a preferred investor – as the media tends to do – is a shaky practice in valuation.

 

Reason #3: Masa Son and SoftBank appear to be strategic investors when compared to traditional institutional investors. Strategic investors tend to pay a premium.

 

The last reason we view this valuation with skepticism is because of the nature of the investor involved. There is ample evidence that SoftBank plays a more strategic role in the investment in and development of WeWork than we would otherwise expect from a purely financial investor. This has implications for the valuation.

For background, strategic investors are interested in different aspects of a company for investment than financial buyers. One key difference stands out:

  • Strategic buyers are interested in how a company fits into their own long-term business plans with intentions of themselves contributing to greater realized value because of this overlapping fit and vision.
  • Financial buyers are interested in buying companies purely for financial returns; they typically have no interest in synergies and are more often aiming for diversification within their portfolio.
Photo courtesy of Nobuyuki Hayashi.

In the context of WeWork, which type of buyer was SoftBank? On paper, a financial one – institutional investors typically are. In reality, more of a strategic one. There are a few key reasons why:

Beyond the sheer dollar amount, the unique aspect of SoftBank and its $100 billion Vision Fund is the influence of the company’s chairman, Masayoshi Son. Masa Son is no ordinary investor. Despite the size of his fund, it is reported he is intimately familiar with and sits down with every founder he invests in. He was particularly close with WeWork’s CEO Adam Neumann. He was Neumann’s “biggest champion” as CNBC put it. He didn’t scoff at Neumann’s “crazy” ambitions; he one-upped them.

This dovetails with another trademark of the Korean-Japanese billionaire: He is a fast-moving visionary.

To the first point, Masa Son is eager to catalyze breakneck growth in the startups connected to SoftBank by providing cash infusions at an unprecedented rate. Hence the rapid growth and size of his funds.

Second, he aims to integrate technology across all industries – even the most challenging ones like bricks-and-mortar real estate. In turn, every startup he invests in fits into a vision, and WeWork happens to sit at the top of the heap of an industry Masa Son has become fanatical about: real estate.

FastCompany called his vision for global real estate his “Obsession No. 1” in this lengthy profile of Masa Son and his fund. He views real estate as fractured and he is looking to consolidate assets and streamline everything related to buying, selling, and managing properties through technology. WeWork is at the center of both of his key objectives in this industry.

All of this begs the questions for WeWork and SoftBank: What is their real relationship? What is the end-game? If SoftBank looks at WeWork as more of a strategic investment, would it be willing to pay more?

We’re primarily concerned with the last question. And the answer is a resounding “Yes.”

Strategic buyers pay more for companies.

Why? Because they expect synergies and benefits to accrue to their organizations for years to come. Financial buyers would primarily look at ROI. Strategic buyers contemplate paybacks that are less quantifiable.

How high are these premiums? In our practice, we analyze strategic premiums through the lens of control premiums (or market participant acquisition premiums) across industries and often see 20% to 50% as a typical range with premiums reaching above 100% in some circumstances.

SoftBank, which placed $10 billion in WeWork over the course of several years, most likely paid a premium. While it could be challenging to quantify, this premium is nonetheless another dent in the armor of the oft-cited $47 billion valuation.

 

The Bottom Line

 

WeWork’s January 2019 transaction is the most frequently cited indication of value. It’s the highest valuation quoted for the company. Unfortunately, it’s also unreliable.

A thoughtful appraiser would look at the merits of the transaction, the differences between share classes, and the characteristics of the investors leading the rounds. In addition, reporters would do well to mention the shortcomings of relying on a transaction with a single buyer.

This would better inform all investors and founders. In the wake of WeWork’s IPO debacle, this is something everyone can get behind.

 

In the market for a valuation or second opinion? We’d love to help. Shoot us a note at info@redwoodvaluation.com and we’ll be in touch.