Company discloses $1 billion losses in bond offering

Wall Street’s biggest houses just hawked $702 million in junk bonds for WeWork. The junk pays 7.875 percent interest and is due in 7 years. With 10-year treasuries hovering almost a full 5 percent less, this offering sounded better to the bond-buying public than happy hour at Denny’s, especially if they read the part about WeWork valuing itself at $20 billion. In fact, the bond buyers clamored for so much more that WeWork, which had initially planned to steal only $500 million, said what the hell and increased its haul by 40 percent.

A private company, WeWork was legally required to pull back the curtain as part of the bond offering, revealing it lost $934 million last year, that it now leases 14 million square feet of office space, that it has 220,000 “members” (formerly known as subtenants), that it needs 60 percent occupancy to break even on its rental obligations (at the moment, $5 billion accrues through 2022 and another $13 billion after that) and that it is diversifying away from its long-time business model—leasing long and then subleasing short to pony-tailed entrepreneurs—by buying and managing some properties and by subleasing large blocks of space to Fortune 500 companies. So much has already been written about the company’s finances that this single observation may suffice: If, instead of merely subleasing 14 million feet, WeWork owned 14 million feet of office buildings at a valuation of say $500 a foot, the company would be worth $7 billion or roughly 1/3rd of its self-touted value. And that $7 billion valuation would presuppose owning all of those buildings free and clear of debt.

He’s selling that $20 billion valuation to a lot of smart, rich guys

For those in the office leasing business, one other fact leapt off the bond disclosure page: WeWork neither signs nor guarantees its own leases; rather, for each lease it signs, it creates a single purpose entity with very limited capitalization; i.e. its leases carry almost no financial exposure to the parent company. These entities are known as SPE’s (“Screwing Probably Expected”).

Before we get to the forthright Adam Neumann, founder and CEO of WeWork, a slight digression may be useful. Some years ago, we were negotiating a retail lease with a Russian immigrant, another forthright man. After agreeing upon minimum rent, the topic of percentage rent arose. “Percentage rent? What is this,” Alexi asked.

“It’s simple: It’s the extra rent you would pay us if your clothing store sales are greater than we jointly anticipate. We’re setting your rent at $60,000 a year because we both expect you to do $1 million in sales. If you do $2 million, you pay us more rent.”

As unsophisticated as he was in American retail, the Russian was yet a shrewd businessman. He pondered this issue for a long moment and then said, “John, tell me: Why you want to force me to keep two sets of books?”

Recognizing a lost cause, we signed the lease without this provision and all went well with his tenancy until it didn’t. The candidly dishonest Alexi lived down to his word and screwed us, but only when he absolutely had to.

Back to Adam Neumann. Take another look at his picture: the guy is a rock star’s rock star—he’s the best-looking CEO in the country. And, by all reports, he’s absolutely mesmerizing. He has to be. He’s selling that $20 billion valuation to a lot of smart, rich guys by declaring, according to the New York Times, that his isn’t a real estate company, but “a state of consciousness.” Jimmy Buffett could sell that line, Warren Buffett couldn’t. You might just ask yourself this: What do rock stars do to their biggest fans, the ones who beg to get on the bus?

Like our Alexi, Neumann has made no secret about his business ethics, about what he intends to do to landlords holding his worthless SPE-backed leases. One top San Francisco broker put it this way, “WeWork’s openly been saying for years that if the market tanks, it’ll renegotiate every lease it has.”

It may be that WeWork will shiv its landlords only when it becomes truly desperate, but with $18 billion in short and medium-term debt and losses running nearly a billion a year, desperation may arrive sooner than anticipated. This, by the way, is where WeWork’s pivot to the Fortune 500 is going to bite harder than a third grader in a schoolyard fight. Sublease 100,000 feet to 400 dinky entrepreneurs and start-ups and chances are some will prove to be cockroaches that survive the next downturn—the space may stay half-leased. Sublease that same 100,000 feet to General Motors or Microsoft, companies with better—and more conservative—economic forecasting models than you’ve ever dreamed of, and they will go dark before your feet hit the floor.

If WeWork tumbles, its landlords will be the first to go down, but if it gets bad enough, its junk bondholders may be reminded that rock stars are no strangers to the ménage à trois.