To The Moon

Summary

• WeWork's inclusion of a "going concern" statement in their 10-Q filing caused a sharp drop in their stock price after the close on August 8.

• This ASU No. 2014-15 (subtopic 205-40) "going concern" statement by management is not the same as a going concern statement by auditors in an annual report.

• WeWork plans to reduce costs, increase revenue, control expenses, and seek additional capital to alleviate the going concern issue.

• WeWork will run out of cash by early next year if they continue to burn cash at the same rate as in 2Q.

Justin Sullivan/Getty Images News

As expected, WeWork $WeWork(WE)$ included a "going concern" statement in their 10-Q filed after the close on August 8, which caused a major drop in the stock during after-hours trading. I think that many traders are confused about what this statement actually means. There has already been massive dilution of WE stock as the number of Class A shares outstanding has increased to 2,110,280,756 as of August 7 from 711,363,722 Class A shares outstanding on March 20, 2023. Shareholders voted to approve a reverse stock split range of 1 for 10 to 1 for 40 in order to remain listed. WE stock has plunged 88% since my December 2022 sell recommendation article and I continue to rate WE a sell.

Data by YCharts

Going Concern Statement in Latest 10-Q

Their 10-Q included a statement by management:

As a result of our losses and our projected cash needs, which have been impacted by the recent increases in member churn, combined with our current liquidity level, substantial doubt exists about the Company's ability to continue as a going concern".

Some seemed confused about this statement. It is NOT the same type of statement made in annual reports by auditors. This is different. A "going concern' statement in an annual audit is, in my opinion, much more serious. It is a relatively new ASU No. 2014-15 (subtopic 205-40) accounting requirement. Sears Holdings was the first major company to issue this warning in their 10-Q for 1Q 2017, which caused their stock to plunge. There are really two parts to this. First, management is required to explain the factors that caused them to include the going concern statement. Second, management is required to state what they are doing/going to alleviate this issue.

To alleviate this going concern issue they stated that over the next twelve months they plan on:

*Reducing rent and tenancy costs via restructuring actions and negotiation of more favorable lease terms.

*Increasing revenue by reducing member churn and increasing new sales.

*Controlling expenses and limiting capital expenditures.

*Seeking additional capital via issuance of debt or equity securities or asset sales.

The problem, in my opinion, is that nothing stated above is really anything new. It is just the "same old, same old" that got them into this serious problem.

While investors should not panic over this new statement, they should be concerned, especially because there most likely will be some indirect negative impact on their operations. Vendors and landlords might become stricter in their terms when dealing with WeWork. I expected the going concern statement, but some may wonder why SoftBank $Softbank Group Corp(SFTBY)$, which controls WeWork, did not do more to avoid requiring management to file that statement in their 10-Q because the statement itself most likely will make it even more difficult to get new customers. The biggest negative could be the publicity about the going concern statement might make potential customers reluctant to consider WeWork office spaces because they worry there is increased likelihood that they will eventually file for bankruptcy. There are complexities in the U.S. Bankruptcy code, such as rejecting contracts and leases under section 365, that could impact their decision process.

Why They Had to Include the Going Concern Statement

WeWork included the going concern statement because of their continued terrible results as can be seen by the income statement and quarterly results below. They keep burning cash. During the 2Q they burned $246 million cash from operations. According to their press release as of June 30 they had $680 million in total liquidity, including $205 million cash. If they continue to burn cash at that same rate, they will be completely out of cash early next year. If the economy weakens in the next few months, they might be out of cash before the end of the year.

Income Statement

sec.gov

(Note: the per-share numbers use average number of shares outstanding and not the current number.)

Quarterly Results 2023, 2022, and 2021

sec.gov

They have been struggling for years to get their operations cash flow positive. I think there are two major issues. The spread per square foot from revenue compared to lease payments WeWork pays to their landlords is just too small and their occupancy rates are stuck below profitability. These two ideas are not original - they have been discussed "ad nauseum". The reality is that their business model does not work, especially when capital is no longer free - OK, almost free. Recent higher interest rates completely destroy the potential to be cash-flow positive. It is important to remember these terrible cash-flow numbers don't really reflect the impact of carrying a large amount of debt because much of their debt is PIK so there is no cash interest paid - only additional debt. Their latest $175 million borrowing has a 15% PIK interest rate, for example.

How to Alleviate the Problems

For starters, they are already in the process of a management shake-up. Their CEO resigned in May and three new board members have been added to the board according to their recent press release. (Some of my friends asserted today that they are changing the captain and senior crew after the Titanic already hit the iceberg.)

Earlier this year, there were major exchange offers that changed their balance sheet. The impact can be seen by the long-term debt statement below.

Long-Term Debt

sec.gov

(Note: the numbers do not include the latest $175 million 15% PIK notes)

These prior debt restructurings also resulted in a massive increase in the number of shares to 2,110,280,756 as of August 7 compared to 711,363,722 Class A shares outstanding on March 20, 2023. While this created massive dilution for WE shareholders at least it kept WeWork out of bankruptcy court. I think that a major reason why SoftBank was willing to accept equity for some of their debt was that they realized that there was a very serious risk that their debt could be recharacterized as "equity interest" under section 105(a) in a Ch.11 bankruptcy process so they might as well improve the balance sheet and take the equity. I covered this issue in more detail in my December 2022 article.

As can be seen in the table below, the fair value as of June 30 for their various issues is significantly below the carrying value. This implies that to issue new debt to raise needed cash to cover their likely negative cash-flow will be very difficult - if not impossible by traditional credit market deals.

Comparing Carrying Value of Debt to Fair Value

sec.gov

If they eventually do a major reverse stock split, which shareholders approved a range of 1 for 10 to 1 for 40, WE stock price should then increase to allow them to remain listed. My own suggestion would have them issue stock rights to current WE shareholders to buy a significant number of new shares at a modest discount to the then current WE price. While this will cause even more dilution, it could raise enough cash to cover a few months of negative cash flow. Since they are already authorized to issue 4,874,958,334 Class A common stock compared to 2,110,280,756 currently outstanding there would be no "AMC problem".

The most likely path will be SoftBank will continue to loan them money and buy additional stock/warrants. Eventually, I still expect a Ch.11 bankruptcy filing that would wipe out debt and allow for rejection of some of their unprofitable leases under section 365. The problem, in my opinion, is that in order for the court to confirm a Ch.11 reorganization plan under section 1129 "the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan". Even after wiping out debt and interest payments plus rejecting some unprofitable leases, I don't see WeWork having a viable business model that would allow them to generate positive cash flow in order for them to stay in business.

Conclusion

While an ASU No. 2014-15 (subtopic 205-40) "going concern" statement by management in a 10-Q is an "orange flag" for WeWork investors, it is not the same as a "going concern" statement by auditors in an annual report. If WeWork does not get their cash-flow and business model in order by next year, I expect that their auditors will include a "going concern" statement - assuming WeWork is not already in bankruptcy court.

SoftBank has tried a number of balance sheet restructurings that has kept WeWork out of Ch.11 bankruptcy. It is not enough if the actual business model does not and is most likely will not work in the near future. They burn too much cash and don't seem capable of fixing this critical problem. I continue to rate WE stock a sell and I expect my next article will be about their Ch.11 bankruptcy filing.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Source: Seeking Alpha