Today, I’m going to discuss the ongoing WeWork disaster and its impact on the pre-IPO investing world.
In August, WeWork filed its IPO paperwork (S-1). Its last funding round had been at a $47 billion valuation. The only investor in that round was Japan’s SoftBank, and the round took place in January 2019.
WeWork has since pulled its IPO because it became apparent that there’s absolutely no interest at even a $10 billion to $15 billion valuation.
In my view, WeWork is probably headed for bankruptcy. The company lost $700 million in the first quarter. In 2018, it lost $1.9 billion on $1.8 billion of revenue.
SoftBank is the key player in all of this. The investment giant has put more than $10 billion into WeWork. At some point, SoftBank probably realized there were going to be serious problems if WeWork listed at $47 billion, but SoftBank ignored the warning signs and convinced itself that it could sell WeWork to the public. It had no such luck, fortunately for retail investors.
I think what happened here is that SoftBank basically stuck its head in the sand. It kept investing to keep its huge investment in WeWork afloat. It hoped to avoid having to deal with the fallout of a major failed bet. Now the bill is coming due.
Changes will come because of the WeWork situation, but that doesn’t change my bullish view on private markets in the least bit.
Effects on Private Markets
So how does all of this affect pre-IPO investing? In my view, it doesn’t affect our strategy very much, if at all. I’ve already mentioned that I recommend avoiding the giant private companies and instead going after the up-and-coming ones worth $500 million to $3 billion. That should help avoid the majority of WeWork-like problems.
It’s also prudent to steer clear of companies that are losing gobs of money, like WeWork. I suspect this “maximum growth at all costs” practice has peaked, and private companies will mostly be belt-tightening from here on out.
I’m not worried about this scaring investors away from private markets. There are too few assets out there with the potential to outperform everything else. Bonds yield almost nothing already, and stocks are expensive by almost every measure. Disruptive software-enabled startups will continue to be a major bright spot in the U.S. and global economies.
One good thing that may come of this mess is that companies should start going public earlier. The public markets are a much better way to gauge the value of a company than highly subjective private markets (especially when a single investor is setting the price, like SoftBank did with WeWork).
One of my favorite venture capitalists, Fred Wilson, wrote a great piece on this subject titled “The Great Public Market Reckoning.” I highly recommend reading the entire piece, but here’s an excerpt.
Public market investors can buy and sell stocks every day based on what is attractive to them and what is not. If they feel like they missed out on something, they can get into it immediately.
For this reason, valuations in the private markets, particularly the late-stage private markets, can sometimes be irrational. Public market valuations, certainly after a stock has traded for a material amount of time and lockups have come off, are much more rational.
For the last five or six years, I have been writing here that I very much want to see the wave of highly valued and highly heralded companies that were started in the last decade come public. I have wanted to see how these companies trade because it will help us in the private markets better understand how to finance and value businesses.
And now we are seeing that.
And what we are seeing, for the most part, is that margins matter. Both gross margins and operating margins.
Wilson points out that some software companies deserve a premium valuation because their profit margins are incredibly high. Zoom, for example, has an 81% gross margin! That’s incredible. As a company, Zoom probably deserves a healthy premium on price.
But the Ubers and WeWorks of the world aren’t truly software businesses. Their gross margins are much lower. The problem is that private markets have been valuing them like they’re high-margin software companies.
Going public earlier in the process would solve most of these problems. Public markets are great at sniffing out b.s.
Hopefully we’ll begin to see some “hot” private companies go public earlier in the process. I think it would create more sustainable companies and benefit everyone involved.
No matter what happens, there will always be amazing private deals to be found at both the early and later stages. I continue to believe we should focus on the earlier end of the pre-IPO spectrum. Personally, I’m most interested in companies valued between $500 million and $3 billion.
That’s it for this week. If you have questions, comments or suggestions, please email us at mailbag@earlyinvesting.com.