When is it gonna pop?
The junk-bond market is still in total bubble bloom, simply ignoring the bloodletting in the Treasury market that pushed the 10-year yield to 3%, finally for the first time in over four years. But investors are lusting after higher yields, and companies are taking advantage of them while they still can, which makes sense, particularly if it’s a unicorn with long-term lease obligations out the wazoo, whose net loss – which doubled to nearly $1 billion – is bigger than its revenues.
A company like this needs a lot of cash to burn. After junk-rated Netflix’s lightning-fast “drive-by” bond sale of $1.9 billion on Monday, it’s now junk-rated WeWork’s turn with its own $500 million bond sale that may well be upsized by a large amount in face of ravenous investor demand.
WeWork essentially makes little ones out of big ones. It leases large office spaces on long terms, dolls them up in some creative way, and rents them out in small portions, down to the size of a desk, to companies or individuals needing a quick office setup for shorter periods of time. Many of its customers are themselves startups – on the time-honored circular principle of VC-funded startups feeding VC-funded startups.
The prospectus for the bond offering, obtained by Alphaville and the FT, points out that revenues jumped by 103% in 2017 from a year earlier, to $886 million, and that total expenses jumped 118% to $1.82 billion. Based on this well-established unicorn strategy, the net loss in 2017 jumped by 117% year-over-year to $933 million.
In other words, the more the company grows, the more it loses. But don’t even look at the losses. They don’t matter. It’s just other people’s money. The key metric to watch is something entirely different: “desks.”
WeWork claims that the number of desks has surged from 44,000 on December 1, 2015, to a whopping 251,000 on March 1, 2018. And there’s another metric: desk “occupancy,” which over the same period has increased from 76% in 2016 to 80%.
So there is demand for desks at this price, just like there is demand for Ubers at their price, but these are not survivable prices. Investors have to subsidize them.
WeWork can nevertheless hold out for a little while. It still has about $2 billion in cash left over from the nearly $7 billion it raised from investors over the years. This includes the $4.4 billion that junk-rated SoftBank with its Vision Fund invested last August. That deal pushed WeWork’s “valuation” to $20 billion.
So now it’s time to raise more cash. Among the investment banks recruited to make this work are J.P. Morgan, BofAML, Citi, Deutsche Bank, Goldman Sachs, HSBC, Morgan Stanley, UBS, and Wells Fargo. The talk is $500 million of seven-year unsecured notes at 7.75–8.00%. Strong investor demand could push the total amount of bonds sold much higher, much like Netflix had upped its bond sale on Monday from $1.5 billion to $1.9 billion.
The book for the WeWork bond deal will close on Wednesday, and pricing is also expected during that time, moved up from Thursday, a source told S&P Global’s LCD. S&P rates the bonds themselves four notches into junk (B+) and the company five notches into junk (B).
Fitch, which rates the bonds three notches into junk (BB-), pointed out that WeWork already has existing debt consisting of a $650 million revolving credit facility and $500 million letter of credit reimbursement facility.
WeWork also has $5 billion in lease payments due over the next five years, not including any additional leases it will sign during its global expansion drive:
- 2018: $706 million
- 2019: $984 million
- 2020: $1.1 billion
- 2021: $1.1 billion
- 2022: $1.1 billion
Another $13 billion in lease payments come due in the years after 2022, according to Bloomberg. That’s some real money that a money-losing company must somehow obtain.
These are 10-year or 20-year office leases. They’re a fixed expense that doesn’t decline when business drops off. As such, they pose a special risk: WeWork’s customers rent their space on much shorter terms, even month-to-month. When things get tough, they can just ride off into the sunset after their short-term leases expire, leaving WeWork to sit on expensive and vacant office space with stale craft brew on tap at the lounge.
Startup investors willingly take huge risks. They assume that most of their investments will fail. But they hope that a few mega-winners will make it all worthwhile. With these mega-winners, they hope for an upside that is measured in multiples, such as 10x or more.
Investors in junk bonds of such cash-burning unicorns take only slightly less risk than late-stage equity investors, but have zero upside. All they get is the yield for however long the company manages to pay the coupon, and if they’re lucky, they get their money back when the bonds mature. That’s the best-case scenario. There is no upside.
But these days, with the junk bond bubble still red-hot, a yield of 7.75% sounds like a great deal, no matter what the risks, the cash burn, and the losses, especially if the only metric that really counts – desks – has quintupled over the past two years.
Wow, that was fast and huge. This junk-bond market is in peak-bubble mode. Read… Junk-rated Netflix Borrows $1.9 Bn, Most Ever, in “Drive-By” Bond Issue, to Burn $3-$4 Bn in 2018, Debt Soars to $8.4 billion
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WeWork bought out Naked Hub in China for an undisclosed amount. Some reports put the deal 400mil USD. I looked into the cost of Naked Hub and for 300 USD/month you can have access to the lounge with open seating and free craft beer. The Naked Hub building I was looking into was just refurbished by them; beautiful building. https://www.nakedhub.com/en/hub/loushanguan-lu
Naked Hub has a lot of nice properties actually. I wonder if Naked Hub was also showing a loss and WeWork said, no worries, we will give you 400mil
How can anyone* even survive the consumption of 300 USD/month craft beer?
There must be more to the Naked Hub membership deal that compels people to spend the 300 USD/month than the “free” beer.
*)
Churchill and Hemingway getting away with it in style won’t save my liver!
I think it’s the influence of the movie “The Big Short” with images of colossal business deals being closed around coffee tables in lobbies. $300 gets you access to a coffee table in the business district for a month. $450 gets you a desk, etc.
It makes way more sense for a small startup with a few employees. Think just above the garage level(if they even have a garage) Instead of paying for a full office they can just have a few private rooms. Much cheaper for expanding to a new area too. My sisters company used one of these for their temps when they had a large project, 6 months later they cut the office and the 30 temps moved on, with a 5 year lease that project would never have been doable. As a loss leader the single desks could get the small companies in when they are one person.
So let me get this straight, they rent out desk space, maybe even cubicle space? To employees who we surmise will in the near future contract out as office help to corporate Am., XYZ, and provide their own office space? These are the same people who used to work at home and telecommute? The reason why you choose this instead of the home office is? Maybe a better internet connect – ah recalls the day trading centers in the 90’s with a dedicated T line – and other resources (beer) and maybe an office products kiosk and shipping in the lobby. And it has to be an business expense, right? So what’s happening to the workplace?
Yours Truly actually is a member of a coworking space. The big selling point for these places is collaboration. As in, you have other people to talk to and bounce ideas off of.
In other words, you aren’t isolated in your home office with no one to interact with except the goldfish or the neighbors’ barking dogs.
The big downside to this space is its location, downtown Tucson. You have to pay to park and that’s a deal-breaker in a city with so many offices with free parking. A lot of people have left here for that very reason.
Is it a business expense? You bet your sweet bippy it is. I write it off as a business expense on my tax return, and I don’t know anyone around here who doesn’t.
I thought I might have been incorrect but I checked with the Turbo Tax and:
“Commuting expenses between your home and main workplace are never deductible, even if your workplace is far away or you conduct business or haul work supplies during your commute. (A few states allow you to deduct certain commuter related expenses, but that has to be done on your state return.)
However, if you travel to and from a temporary work location (where your assignment is expected to last no more than 1 year) outside your metropolitan area, you can claim commuting expenses. You can also claim commuting expenses to and from a temporary work site, regardless of location, as long as your main workplace is elsewhere.
You’re also allowed to deduct commuting expenses between multiple job sites during the same day. For example, if you go directly from your day job to your evening job, you can deduct the commute between those 2 job sites. But if you first go home and then leave to go to your second job, that can’t be deducted.
Qualifying travel expenses for employees are reported on Form 2106 and are subject to the 2% rule.”
I just remembered this because when I worked as a Consultant, I could charge my miles to a customer’s site if it was the only place I went to for the day…so I always “swung by the office” wink, wink.
Slim here: I don’t deduct commuting expenses. I deduct the cost of my desk rental at the coworking space.
Hope this clears things up!
I imagine a goodly portion of these toxic junk bonds have found their way into CDO’s compliments of the usual shady character’s listed in the article.
We remember credit default obligation deals, don’t we? These were the derivatives that brought the economy to it’s knees in 08 – 09.
Well guess what? In 2015 several large Wall street banks began selling billions in something called a “bespoke tranche opportunity”. A foul smelling pile of dung by any other name is still a pile of dung. Because these BTO’s are nothing but CDO’s in disguise.
It gets even better if you’re depending on, or about to depend on, a pension to support you in retirement. Global pensions have increasingly turned to exotic financial instruments in search of yield, because of ultra low interest rates. When the big crunch occurs and it will, just a matter of time, these stinking piles of dung will be unmasked for what they really are. Worthless along with pensions.
Get out your checkbooks, taxpayers. The Wall Street-Federal Reserve Looting Syndicate and its Congressional errand boys are going to be screwing you over yet again.
All *I* can say is that, if one strolls over to ISDA (https://www.isda.org) and look a their statistics, one sees that the “notional value” of all of the worlds global pot of OTC derivatives has been increasing even through 2008 (last check something like 60x global BNP, a conservative leverage by any standards :).
Presumably the OTC-market is where most of the central bank money went and someone like the ECB will be the eventual backstoppers of all that “value”. This is basically what they decided to do in 2008, make OTC into real money by allowing it to be placed as collateral for EUR loans.
Which means that nothing from 2008 was cleaned up or even unwound (If I had this facility at my disposal, I’d spin up my laser printer and print some more “value” right there and then too).
The next crash will be a doozy! It will be visible all the way from Alpha Centauri too. I don’t worry about it too much. ‘Tis Nothing one can do.
hey Wolf,
Since we’re on the topic of, “When Will it Pop”?
Do you fulfil requests?
If we’re searching for clues. Could this be worth investigating?
Late last year Ken Fisher named a few provisions from MiFid rule of causing 2 trillion of liquidity to evaporate out of the market. They were implemented in 2007 months before the crash and continued draining liquidity out of the banks until they were removed in mid 2009.
Source: https://www.youtube.com/watch?v=GAmAk1LNvJA&t=322s&list=PL24JSJxb-8yQALh4teBxr8c4lQhQyNQE3
Skip 5min in.
I mention this because on jan 3rd 2018 the new MiFid II regulations were introduced. Due to slow digestion many requirements were extended by six months leading to this summer.
Basics overview: https://www.youtube.com/watch?v=fRKspKgzoq4
Bloomberg coverage: https://www.youtube.com/watch?v=oOzqd_-hyqY
If Ken’s assumption was true. Then maybe unintended government overreach/regulation might have kicked the shoe off the economy rather then it spontaneously falling off.
I could be venturing into tin-hat territory, but when a multi-billionaire gives his opinion, maybe its worth something, if its genuine.
Would love to hear your opinion.
The economy is doing fine, compared to how it was doing over the past few years. Deflating asset bubbles are a risk to the real economy only if they deflate all together all at once and credit freezes up. Regulation isn’t going to cause that kind of all-at-once asset bubble burst. Regulation couldn’t even prevent these asset bubbles from building. So “over-regulation” is not high on my worry list — though it’s high on my aggravation list, being a business owner myself :-]
“Deflating asset bubbles are a risk to the real economy only if they deflate all together all at once and credit freezes up.”
Should the “and” not be an “or”???
A credit freeze will stop a bull run in its tracks, instantly, and turn a stable or minor correction Market, into a crash, just as fast.
It was the inter-bank credit freeze in Europe (prompted by the greek state frauds) that turned an internal US correction, into the 2008 GFC.
Yes, but I think the sequence was this: the deflation of residential and commercial real estate prices, and some other things, caused the confidence in the banking system to wobble (inter-bank lending freezes), which then caused some big players to collapse, which caused overall credit (even for industrial companies) to freeze up.
agreed.
However I still believe without (the discovery of) the greek frauds the US event, could have remained a US event.
greece turned it global. As it locked Europe (Inter-bank lending) solid, for week’s.
European banking has still not fully recovered from that event. Yes spain, italy, france ,Cyprus, Portugal, and ireland, all had undercapitalised banks, so none of them could afford the losses caused by their exposure to the greek frauds.
Look at all those broken club med banks today, then look at how much they lost in the haircuts imposed on them over greece.
Yes they were sick before greece, for so many of them after that, it was and is, simply, when they die, due to the effects of the greek disease.
Cyprus had the biggest on % exposure to greece, of all, so it was used as a testing ground for bail in when its greek exposure, finally caught up with it.
As spain and italy have repeatedly shown, how aggressive and prompt the EU/ECB is on bailins, also depends on, Who you are.
7 year bonds with 2.5 years of runway at the current rate of cash burn. Sounds good to me :)
Any info on how the leases are structured? Maybe the agreed-upon future lease rates are capped in such that WeWork’s profitability will improve?
My other thought was that maybe if they’re buying buildings (they mention switching to an ownership model), expenses will be incurred upfront, distorting the financial picture.
Last year they bought the building on Fifth Avenue in NYC where Lord & Taylor’s flagship store is located.
The department store will shrink and lease the bottom three floors (I think) and WeWork has the rest.
If they buy a building, it wouldn’t be an “expense” but an investment in an “asset.” So it wouldn’t show up as an expense at first, though the building itself (not the value of the land) would be depreciated over time, and the depreciation expense would show up on a quarterly basis.
Even if this would be the case, it would be bad. Buying real estate financed with bonds yielding 8% is not going to make money.
Is gonna pop when “junkies” like Netflix taking on more junk debt goes bad.
And yes I am calling them junkies because they need junk debt like an addict needs their next fix but junk debt is also killing them.
We tend to look to the oligopoly and monopoly players as exerting a nefarious influence on governments as they refuse to enforce anti-trust laws. However, we may be looking at the wrong set of players. Not to let the Microsofts and Googles of the world off the hook, but it looks to me that the whole financial system is designed around creating monopolies so that the investor class can be made whole when all competitors are driven out of business or bought up and the survivors can start churning out monopoly profits and paying off on the investor class’s largess. The only trick that may be left up corporate capitalism’s sleeve is the blowing of bubbles that lead to crashes that cull the market and leave oligopolies or monopolies in their wake. Since competition leads to a falling rate of profit (Marx was right about that, and the evidence is in Adam Smith if anyone cares to read him) the only way to maintain guaranteed profitability is to severely limit the number of producers in any market while pushing globalization in order to increase the number of consumers.
“… the only way to maintain guaranteed profitability is to severely limit the number of producers in any market while pushing globalization in order to increase the number of consumers.”
Don’t forget the class war aspect of “guaranteed profitability.” A major part of globalization is labor arbitrage/seeking the cheapest, most easily-exploited labor markets (the B-school euphemism for which is “labor flexibility”) and for those industries where production can’t be sent overseas, there’s union-busting, pension raiding, privatization and wealth extraction via the usual private equity model.
Big Government likes Big Business and that leads to Big Fraud
who is buying this stuff-calpers?
Yes. They’re counting on an average annual return of 7% into perpetuity. So they have to buy high-risk junk bonds that return 8% before they default. It would be funny if it weren’t so tragic.
Actually I think Calpers has gotten more conservative. If its Illinois, maybe a different story they have no choice but to bet the rent money. If rates keep going higher (the Fed PROMISED ME they would) then this will all come out in the wash, and if the Fed suddenly pulls back, (market thinks so) the buyers of high yield are still good, and the sellers just keep floating new issues and the Fed buys their paper using QE. I don’t know what can go wrong.
One of the banks said a sustained break of 3.05% on the 10 yr. would pop this bubble. The Fed’s financial repression has created an American underclass, marginal middle class and moneyed individuals chasing zombie companies. I honestly don’t want the assets that the moneyed interests are chasing; I just want this yoke of central planning lifted from my neck.
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Wolf, the bubble has already busted, you are just looking on the wrong “chart”. I propose a book, “Detroit: An American Autopsy”. If you draw a line in the middle between wallstreet and Detroit you will understand why this stock market is still alive. Because the USA has decided to use every once of the system (legislature, politics, subsidies, radio, tv, internet, FED, Treasury, etc.) to perpetuate the illusion of a functioning economy. And everything and everyone else is just collateral damage.
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My point being: the system value has , for a very long time, not reflected the true state of the nation, it’s people, and it’s economy.
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A comment off topic…
And if you say the system is rigged they will say:”Look, that guy made it, why can’t you? He/She doesn’t complain. You just don’t work hard enough, or you are not smart enough…” They will step on you until your spirit gives in and you accept that it’s your fault. And I have asked successful people how they got where they are today. They all but one said more or less : “A very imaginative set of unusual circumstances with no real path, riddled with obstacles, hard work, good friends and good fortune”.
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The system is the people. And they are broken. Hopefully not beyond repair.
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WeWork is one company where Galloway the formerly Great and now merely Rich got his prediction wrong. From : Revisiting 2017 Predictions (12-2017)
“Prediction: WeWork loses 75%+ of its value from peak ($16B) and becomes poster child of unicorn mania.
Wrong. Firm is doing a bunch of innovative things that have extended the halcyon.”
Thus no sign of tech firm implosions thus far. The JNK market is placidly rolling over a tiny bit amid the return to increased volatility. Dollar is bouncing off a series of lows, and the Hedgeye Macro Show today forecasts no drama in the Fixed Rate Mortgage market for a year and continued improvement in New Home Sales and continued supply constraints in existing home sales, thus pushing the Case Shiller numbers up and to the right.
In summary, no drama in tech. Drama (as per Hedgeye) in industrials where input costs (oil, commodities, and labor costs) are rising. Second half could show some strains.
For more on the tech phenomenon where profitability is not a problem, see the lecture from last year, youtube: Scott Galloway: Growth Is the New Profitability
The drama for WeWork, Tesla, Uber etc. — cash-burning money-losing companies — will start when investors refuse to fund their losses, in other words when these companies can no longer raise cheap capital to burn. That hasn’t happened yet. Far from it. Investors are still eager to throw their money at these companies. That was the point of the article.
I think something is going on in the markets: I got contacted by these fine folks – http://wellington-capital-group.com – about a very special situation, just for you only, in something I might actually be interested in (IT-security business) if I was in the market.
The salesperson was very good and quite persuasive, except I have had a similar training and I know the patterns used.
They spent relatively a lot of effort on persuading “little me”, a total of 2 hours of international calls and several glossy brochures, indeed mailed on physical paper from Japan as I asked.
Some AI must have left a good impression of me with someone – or someone amongst the market critters are getting a bit stressed and going out on the fringes of people who invest in stocks.
I have only ever got cold-called on investments right before something went tits-up, four times:
Hafnia Holding (DK, 1980’s – straight-up bank scam), Some holiday I “won” in some timeshare right before the UK property market dived in the 1980’s, Borrowing against my home to invest in pension savings in 2006 (the standard bank scam in the 00’ies DK) and now this.
It is an Omen!
That’s good one. I’ll put that on my list omens :-]
Fajensen – I’d love a job selling rich suckers their sucker-bait. I’m good on the phone and speak an uncommonly “pure” American English, about the only thing carried over from when my family was middle or upper-middle class, before the economy ate us. I’m good on the phone too, having worked doing surveys and volunteered for Arnold’s campaign.
But, gotta know the right person to get a job like that. Maybe if I pony up $300 a month to hang out in a place that serves craft beers and has a T1 line …
Why would and allegedly. Japanese based company, with such good English.
Use a city name that is not that common (Outside NZ where it is the capital) and NZ and AU coins in its promo photos.
This thing without further research, trips my “Dodger/Scammer” antenna.
Seems like a nice business for good times. Its one of those services I’d love to use, but wouldn’t particularly want to own.
They lock in their expenses for the long term, and then expose themselves 100% to the business cycle for their revenues. In fact, the normal business cycle wasn’t exciting enough – they had to expose themselves to the venture funding cycle.
It’s like scheduling the detonation of the business for the next downturn. One would think the VC would know better, but maybe the memory of the last downturn has faded by now.
This is extremely upsetting. The thought that pensions are buying junk debt that will require a pension bailout by the U.S. taxpayer when things turn sour. It’s a win-win for executive criminals, and a lose-lose for taxpayers. This is simply outrageous. Trust is our system is broken because the people who are expected to exercise fiduciary responsibility have become short-sighted. Pure incompetence.
Promises about future payouts win elections and don’t cost a thing. In the end, many pensioners will see a reduced payout as each additional pension bailout will be met with increased resistance/anger from voters.
This issue is fundamentally duration mismatch between A) fund managers
and politician’s careers and B) the life of a pension fund, as well as the fact that you simply can’t guarantee investment returns. What a stupid system.
It looks like theres some ambiguity regarding who will be responsible if Wework breaks its long term leases during an economic downturn:
https://www.bizjournals.com/sanfrancisco/blog/real-estate/2016/08/wework-coworking-leasing-office-financials-sf-cre.html
“According to sources, WeWork typically uses single-purpose entities, registered as limited liability corporations, to sign its leases with landlords. Deals usually range from 10 to 15 years, in part because landlords want a long-enough duration to justify WeWork’s extensive interior renovations, which the company meticulously designs itself. WeWork, the parent company, only guarantees the leases for a portion of the full duration, said sources. After the guarantee period is over, the landlord has a deal with the single-purpose entity, rather than WeWork. That means WeWork could theoretically close an individual location, without the parent company being legally liable for a broken lease, although it is possible a landlord could still seek to sue the parent company in such a scenario.”
Just another example of a zombie company which would not exist in a normalized rate environment.
Seems to me whatever actual “success” it’s having securing customers is simply due to its below-cost product offerings. With investors willing to subsidize its losses to such a degree, it makes no sense for any of the established CRE companies to enter this space. That is probably the only thing keeping it alive. The barriers to entry aren’t that high. If the big RE companies wanted in on the action I don’t think it’d take much for them to put up similar set ups. Plus, the concept itself isn’t all that novel, Regus for example has been doing something similar for decades, although perhaps not going down to the “desk” level.
The coworking business model is pretty simple: You have some commercial real estate. And you sub-lease it.
It isn’t rocket science.
But it appears they can not make it work and they still lose money on it.
Gotta be the the dumbest of the dumb to lose that kind of money in a booming RE market.
They can’t make it work for the plain and simple reason that there’s a lot of turnover in coworking spaces. You sell that office space or desk this month, and then your lessee is gone next month. Multiply that by dozens of offices or desks and you can see that there’s a real sales and marketing challenge.
Wake up.
The company is loosing money, the people operating it, are coining it, BIG TIME.
They do desk level in UK. I’m not sure who was first to do desk level though
https://www.regus.co.uk/coworking-space
Not yet. Because the crypto-bond has not been issued yet. When the crypto companies start issuing bonds, it’s the beginning of the end.
Update:
WeWork has completed the bond sale. As expected, it sold more than the $500 million talked about. It ended up selling $702 million of these 7-year notes at a yield of 7.875% — right in the middle of the range indicated yesterday.
I know this comment will put me in tin foil hat land but maybe just maybe the fed wants to break things so all of their private equity buddies can swoop in and buy things for 10 to 40 cents on the dollar. That’s what they did in 2008-9. Blackstone bought over 1000 houses in Atlanta for 40 cents on the dollar and then rented them back to the same folks who lost them due to Greenscam raising the Federal funds rate from 1% to 5%
Not really Your comment actually puts you in the “enlightened” category
ZH has a shout out to WolfStreet just now:
https://www.zerohedge.com/news/2018-05-01/wecrash
“And Wolf Richter broke down all the details of the farcical bond issue last week…”