By Bryan Beach
Adam Neumann’s buffoonery has been the gift that keeps on giving… especially for those of us who write about markets for a living.
In the past year or so, the disgraced CEO of office-space peddler WeWork has provided endless questionable moves to critique from the cheap seats.
Delighting in the downfall of Adam Neumann has become passé. The jokes have been made… The mud has been slung… The pithy tweets have been tweeted. But today I’m going to tell you what we can all learn from the WeWork mess and why you should be more like Adam Neumann in this market environment.
Done correctly, the WeWork business model works just fine. The company enters long-term leases for office space, gussies it up, and rents it out on a short-term basis. It’s certainly not innovative, but the model has been proven by various companies over the past few decades.
WeWork spent much of 2018 working on its big initial public offering (“IPO”). Everything about it was unusual, starting with the company’s S-1 – a document filed with the Securities and Exchange Commission prior to going public.
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S-1 documents are typically bland, black-and-white financial snoozers… But Neumann’s wife Rebekah hired the Vanity Fair director of photography to shoot magazine-grade snapshots for WeWork’s S-1. Neumann himself figures prominently in the document – with the word “Adam” appearing 169 times. (To put that in perspective, the wildly popular messaging company Slack recently filed an S-1 that only mentioned its CEO 19 times).
The Wall Street Journal reported that Neumann invited the heads of the New York Stock Exchange and the Nasdaq out to his Hamptons estate and told them that if they wanted the WeWork listing, they would have to ban meat and plastic in their cafeterias.
Neumann’s neurosis wasn’t limited to WeWork… He told friends he would run for “president of the world,” that he wanted to live forever, and had ambitions of being “the world’s first trillionaire.”
WeWork never did go public.
And Neumann-bashing has become a bit of a national pastime. But Neumann is not the only character in the story… There’s also Japanese billionaire Masayoshi Son (often referred to as “Masa”) and a bunch of rich Saudi investors. Masa, importantly, is CEO of Japanese banking colossus SoftBank and also heads the Vision Fund, the world’s largest venture capital fund.
Masa has escaped the WeWork mess with far less media scrutiny than Neumann, who’s often portrayed as an incompetent, greedy, spoiled brat. That may be so… But if Neumann is a spoiled brat, then Masa is the entitled, undisciplined parent.
The WeWork debacle began in 2017. Back then, Neumann was an eccentric entrepreneur looking for funding. Meanwhile, Masa was flush with cash after raising $100 billion for his Vision Fund, more than half of which came from the sovereign funds of Saudi Arabia and Abu Dhabi.
With the money burning a hole in his pocket, Masa set out giving entrepreneurs far more money than they were looking for. Masa figured that if a good business requires $10 million in funding… then it can be a great business if you give it $100 million.
According the Wall Street Journal, “Mr. Neumann has told others that Mr. Son appreciated how he was crazy – but thought that he needed to be crazier.”
Neumann took Masa’s urging to “be crazier” very seriously. Backed by Masa’s money, WeWork’s annual revenues grew from around $400 million to around $3 billion. That sounds great until you read its S-1 and discover that during the first six months of 2019… the company’s operations burned around $1.4 billion on about $1.5 billion in revenue.
The company maintained that its losses were simply a function of investment in growth. WeWork could, Neumann asserted, turn on the profit faucets whenever it wanted. Despite the obvious fact that WeWork was nothing but a real estate company, Neumann insisted his business deserved the valuation of a high-flying tech darling.
As the profits fell, Masa responded by funneling more and more money into the business, at ever-increasing valuations – a $49 billion valuation in January 2019, versus $22 billion and $21 billion in August 2017 and November 2018, respectively.
That’s right, folks. According to Masa, WeWork’s value increased 133% over a two-month period, despite losing cash at an ever-increasing rate.
But here’s the thing. As Masa recklessly threw good money after bad… Adam Neumann was selling shares at almost every opportunity. In nearly every funding round between 2014 and 2018, Neumann sold part of his shares. According to the Wall Street Journal, he also “took out loans of several hundred million dollars backed by WeWork shares,” and then used that cash to buy buildings… which he leased back to WeWork!
Through it all, Neumann maintained his stranglehold on the company. The original S-1 proposed that Neumann’s shares would have 20 times the voting rights as an outsider’s shares, which would have made it impossible to oust the founder. He also initially planned for Rebekah (a yoga instructor) to control the company upon his death, bragging to employees:
WeWork isn’t just controlled (by me) – we’re generationally controlled… It’s important that one day, maybe in 100 years, maybe in 300 years, a great-great-granddaughter of mine will walk into that room and say, “Hey, you don’t know me; I actually control the place. The way you’re acting is not how we built it.”
The lesson is obvious… If you tell a crazy person to act “10 times crazier,” they’re probably going to do it.
Unfortunately for Masa, it turns out potential IPO investors do not consider “craziness” to be a marketable attribute. As details emerged, potential investors were turned away. The board made concessions, like cutting Neumann’s voting superiority and making him disgorge self-dealing profits. But there was still no appetite for publicly traded WeWork shares.
Making matters worse, it was becoming clear that without an IPO or other cash infusion, WeWork would be out of money by Thanksgiving. With no other options, Adam Neumann voted himself out as CEO… and agreed to a more pedestrian three times the voting rights of others. It was either that or shutter the whole business.
Neumann, meanwhile, still controlled the company: He owned around 30% of the shares… each with three times the voting rights of other shareholders. As it turns out, those voting rights were the most valuable part of the entire company.
Out of options, and desperate to save his investment, in the final week of October, Masa committed nearly $10 billion of SoftBank/Vision Fund’s capital to clean up the mess that he created. $1.7 billion of this went to Neumann directly.
In exchange for the payday, Neumann agreed to give up his “super-voting control” shares. He’ll just be another shareholder… and will no longer control the business he started. The $1.7 billion was essentially a payment for Neumann to sit down, shut up, and go away. Without it, Neumann and his controlling stake would continue to haunt Masa and his investment.
The dust has settled, and Neumann remains a popular whipping boy in various media outlets… the terms “crook” and “fraud” get thrown around a lot.
Always a contrarian, I am tempted to defend Neumann a little bit…
Neumann consolidated as much power as possible for himself, and his investors were OK with that. He then acted with extreme self-interest, defended his business model using shoddy unaudited numbers that were obviously ludicrous, and generally behaved like an entitled brat. None of those behaviors are, in and of themselves, illegal.
And even if Neumann’s windfall were the result of some kind of nefarious heist, this fraud happens to have the least-sympathetic group of victims ever assembled. Neumann’s main victims are the egocentric Japanese billionaire who enabled the whole charade and the sovereign wealth funds of a couple of countries with questionable international reputations.
WeWork’s employees are often portrayed as victims… After all, they didn’t make off with a $1.7 billion golden parachute. They got nothing. But, to quote Bloomberg’s Matt Levine:
They worked at a money furnace that lost almost $2 billion a year and destroyed $40 billion in market value in a few months, why should they get equity upside?
Meanwhile, Masa’s SoftBank and Vision Fund have paid nearly $20 billion in cash to own 80% of WeWork, which is now valued somewhere between $5 billion and $8 billion. That’s a truly horrendous return on investment. Masa’s investors are down at least 70% so far.
So where does this leave us? For investors, there are three key lessons…
First, you should always keep an eye on who controls a company’s voting rights… especially when investing in startups.
If you’re mad that Neumann got $1.7 billion for selling his voting rights, blame the investors who allowed him to accumulate those voting rights in the first place. Any investor – especially Masa – could have pushed back on Neumann’s controlling shares before they ponied up cash to invest. They didn’t, and they paid dearly for that error.
Neumann set up a ridiculously aggressive ownership structure that no sane person should ever have agreed to. Yet early investors agreed to it anyway. The public markets, as it turns out, did not agree to the terms. So the early investors had to pay him off to remove the terms. Is that fraud? Of course not. It’s greedy negotiating on one end, and incompetent deal-making on the other.
Before investing in a business, make sure you understand who really controls it.
The next lesson is great news… Sometimes the market can recognize junk when it sees it.
As recently as April, the WeWork IPO was a foregone conclusion. Plenty of shaky businesses had already gone public. There was no reason to doubt that the market would suddenly reject the madness. The only question was how much money the offering would raise.
And we’ve learned that the market is indeed capable of rejecting valuation fallacies. Everyone was shocked…
This is a huge win for passive investors. Long-time market followers and bankers are noting that, for the first time ever, the market’s gatekeepers have said “no” to an IPO that stood to generate hundreds of millions in fees for investment bankers.
The final lesson is more controversial. We can all learn a thing or two from Adam Neumann.
Neumann’s words suggest he’s a foolhardy windbag, but his personal financial statements reveal the financial acumen of a guy who knows a bubble when he sees one.
It takes more than an egomaniac cheerleader to inflate a bubble… It takes billions of dollars in capital. Since 2017, the capital that inflated the WeWork bubble has primarily come from one man – Masayoshi Son.
Now, the bubble has burst. Masa is left holding a bag full of garbage that nobody wants to buy. But Neumann has six houses, stakes in other startups, commercial real estate investments, and still owns 20% of WeWork. You can call Neumann a foolhardy windbag… But you can’t call him stupid.
Neumann was wrong in so many ways. His business model didn’t work. He believed Masa’s ill-conceived hype. He misjudged the market’s willingness to put up with his control-freak tendencies. But as his behavior became more erratic, his rhetoric became more outlandish, and his ego became impossible to manage… he just kept clipping profits.
There’s a lesson here. If you’re bullish on an investment that keeps going up… maybe you should “pull a Neumann” and continue to clip profits along the way. After all, your bullish stance may be wrong.
Here’s what that means for you… …
We’re 10 years into a raging bull market. All long-term market participants are sitting on huge gains. Is there more to come?
Heading into 2020, I think there’s a great chance that the market remains strong.
My optimism could be misplaced… A correction could be imminent. The market could be headed for a full-blown collapse (though I doubt it).
As I weigh these options, I find myself thinking of Neumann – He was wrong… He was always optimistic about WeWork’s prospects, but he took profits along the way. For a value investor like me, Neumann is an odd market exemplar. But here we are…
As the calendar turns to 2020, you should take a hard look at your portfolio’s winners and ask some tough questions. Has the easy money been made? Is it possible that the current price reflects undue optimism? If you still like a company whose shares are up substantially, does it make sense to sell a partial position? And, perhaps the most important question: If I’m not selling today, at what price would it make sense to sell this stock?
The WeWork debacle was epic… Business schools will be talking about it for years. Neumann will go down as the biggest financial bozo of 2019. To some extent, that’s deserved. I’ve laughed at Adam along with the rest of you.
But I submit that Masa, not Neumann, was the real bozo.
And so, as you head into 2020, giddy from riding a 10-year market move… it’s time to look at your portfolio and ask yourself: Would I rather be a Neumann or a Masa?