Wework not working?

When Saudi Arabia and Abu Dhabi successfully dissuaded the SoftBank Vision Fund from buying a majority stake in WeWork for $16 billion, CEO Adam Neumann lobbed a Trump-style smoke bomb at the news cycle by subsequently announcing that the company was changing its name to “The We Company” in recognition of its expanded vision – which involves not just short-term office space rentals spiced up with the exposed brick, shabby-chic flavor popular with millennial’s, but cooperative living space, a coding academy and, inexplicably enough…a “We” bank?

Given that Neumann has already played the ‘pivot’ card (though presumably he could pull an MbS and unveil his “plan” to build a shining new “WeCity” in the middle of the desert), we wonder how he plans to distract from the latest damaging report, published Wednesday by the Wall Street Journal, which uncovered that many of the buildings WeWork is leasing for office space are owned in part by Neumann himself, presenting what most investors should immediately recognize as a flagrant conflict of interest.

A WeWork spokesman said that this arrangement had been disclosed to investors and reviewed by the company’s board, and WSJ reported that Neumann’s ownership had been flagged in a prospectus circulated to buyers of the company’s debt.

In a prospectus related to a debt offering last year, WeWork said it had leases with multiple properties owned in part by Mr. Neumann. It also said WeWork paid more than $12 million in rent to buildings “partially owned by officers” of WeWork between 2016 and 2017, and future payments total more than $110 million over the life of the leases. The specific properties weren’t listed.

But many investors in the privately-held company. which Neumann controls, told WSJ that they were ‘concerned’ about the arrangement.

Mr. Neumann has made millions of dollars by leasing multiple properties in which he has an ownership stake back to WeWork, one of the country’s most valuable startups. Multiple investors of the privately held company said the arrangement concerned them as a potential conflict of interest in which the CEO could benefit on rents or other terms with the company.

A WeWork spokesman said all related-party deals are reviewed and approved by the board or an independent committee and disclosed to investors. Mr. Neumann declined to comment through a spokesman.

WeWork, which was recently valued at $47 billion by investor SoftBank Group Corp. , signs long-term leases for office space with landlords, then subleases the space on a short-term basis to companies. Mr. Neumann, the 39-year-old executive who founded WeWork in 2010, is WeWork’s largest individual shareholder and has voting control over the company.

And their concern is understandable. After all, while Neumann has presumably been making a killing on the long-term leases that the company signs, WeWork – sorry, “We Company” – bond holders are taking a bath…

Though, as we’ve learned time and time again, in the world of tech (a label that WeWork has some how glomed on to despite its focus on the comparatively drab business of renting office space), unprofitable companies earn absurd valuations every day (just look at Tesla). SoftBank just invested $2 billion at a valuation of $47 billion (though the Japanese hyper-VC fund had initially planned an investment ten times that size).

But as if the presence of this conflict of interest wasn’t enough of a red flag, one detail reported lower down in the WSJ story is even more alarming. According to WSJ, Neumann had tried to purchase stakes in buildings leasing to WeWork before gaining full control over the company in 2014, but he was stymied by the board.

In at least one instance before he secured full control over the company, Mr. Neumann wasn’t able to complete a similar deal. When WeWork was negotiating a lease on a Chicago building in 2013, he tried to buy a stake of up to 5% in the building – 210-220 N. Green St. – as part of the deal, people familiar with the negotiation said. WeWork’s board raised concerns about the deal, citing a potential conflict of interest, and WeWork paid for the stake instead, one of the people said.

The next year, Mr. Neumann effectively gained control over the company. As part of an investment round for WeWork in 2014, he was granted Class B shares that gave him 10 votes per share, and now he has more than 65% of the overall share vote, according to WeWork corporate filings.

Mr. Neumann has since bought up several properties through investor groups and leased some of them to WeWork.

After unmitigated power was secured, Neumann moved ahead with the deals. In a nutshell, this should tell investors everything they need to know about the WeWork board’s ability to effectively monitor the company’s CEO.

But if they needed more reason for skepticism, corporate governance experts quoted by WSJ said WeWork’s arrangement with Neumann wouldn’t pass muster if the company was publicly traded.

Corporate governance experts say Mr. Neumann’s ownership of buildings he leases to WeWork is unusual for a large company. Corporations typically bar executives from similar arrangements, given that companies risk paying too much in rent or leasing buildings they ordinarily wouldn’t, they said.

“In a public company, that would be considered highly controversial,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “Usually human beings tend to think of themselves over the company itself when they’re on the other side of the transaction.”

And indeed, some of the property deals that Neumann has been involved in seem suspiciously tailored to profit off Neumann’s relationship with WeWork.

In New York, the deal at 88 University came together in 2015 after Mr. Neumann partnered with fashion designer Elie Tahari to buy the building for $70 million. The pair planned a renovation that included an overhaul of at least one of the elevators, said a person involved with the deal.

The owners subleased the building to WeWork. In turn, WeWork struck a deal with IBM, which needed space quickly and moved there in spring 2017. Mr. Neumann’s interest in the building was revealed last year by real-estate publication the Real Deal.

And some of WeWork’s biggest tenants have complained about conditions at the building – like a malfunctioning elevator that has forced employees to take the stairs – but Neumann worked out a favorable lease with WeWork delegating responsibility for building maintenance on a building that he owns to his company (and, by extension, its bond holders).

Soon after IBM arrived, one of the two elevators was out while the other was frequently breaking, causing lengthy waits and long slogs up the building’s narrow stairs.

IBM executives, frustrated about their working conditions, complained to WeWork about the broken elevators, said people familiar with the matter. While landlords typically are responsible for elevators, WeWork had signed a so-called triple-net lease with Messrs. Tahari and Neumann, in which WeWork was responsible for fixing issues like elevators. As part of that deal, the landlord set aside funds to WeWork to pay for such renovations, a WeWork spokesman said.

An IBM spokeswoman declined to comment.

The building’s value, meanwhile, has gone up, and the owners have been able to borrow more money by refinancing the property’s debt. Late last year, Messrs. Neumann and Tahari took out a $77.5 million loan, according to loan adviser Meridian Capital Group, $7.5 million more than the prior loan to buy the building.

If WeWork relied on a slightly more stable business model, maybe it would be easier for investors to overlook these conflicts. But the fact is, as we’ve explained before, WeWork’s business model relies on signing long-term leases then turning around and signing up clients who only commit for the short term. This predisposes the company for a massive revenue dislocation when a downturn hits (which it almost certainly will in the near future).

Though the amount of money Neumann has already extracted from WeWork isn’t publicly known, he has reportedly told friends that he has earned hundreds of millions of dollars from sales of WeWork stock.

But fundamentally, the conflict begs the question: What would Neumann the landlord do if Neumann the tenant can’t make rent? Would he make a claim against his own company if its teetering on the edge of bankruptcy, or move to evict? These are questions that all WeWork bond holders should be asking.

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