The WeWork Arc

Plus! Amazon’s Third-Party Data; The Lucas Critique in Finance; Matching the Huawei Strategy; Froth; Demand and Logistics

I decided to make this issue of The Diff  free. WeWork has been a  fun story for years, and it’s finally gotten a  book-length treatment. The story is still widely misunderstood, but now  it’s been told from start to finish.

In this issue:

The WeWork Arc

WeWork is an ideal company for a business book. Per my general theory of business books, the ideal recipe for a satisfying narrative about business is:

  1. A classic Greek tragedy, where the hero is undone by his own hubris, and
  2. Lots of people with free time to talk to an author, who have a vested interest in telling their side of the story.

WeWork has both. The company’s financial history sounds like an  extended roulette session: every year, the company doubled in size,  until 2019, when it shrank to almost zero. And the story is tied to the  ambition of a single founder, Adam Neumann, whose sales ability and  indifference to risk propelled the company to a $47bn valuation and then  led to its near-collapse.

WeWork got a lot of media coverage, slowly on the way up and then  much more frequently on the way down, and now the story has been told in  the just-published Billion Dollar Loser.

One thing the book’s narrative makes clear is that WeWork was not  just a creation of the venture capital market of the late 2010s. It was  also a creation of the labor and real estate markets of the early 2010s. WeWork’s  founders, Adam Neumann and Miguel McKelvey, started a predecessor  company called Green Desk in early 2008, leasing office space in a  building in Brooklyn and subleasing smaller units. (In a memorable  exchange, Neumann pitched this idea as a way for his landlord to get  some use out of vacant space. The landlord said “You know nothing about  real estate,” and Neumann replied “Your building is empty. What do you know about real estate.”)

If Green Desk was a pure real estate arbitrage, it had the worst  possible timing. Green Desk committed to paying for commercial real  estate at close to the market peak, and would have to resell it into the  softer recessionary market. As it turns out, it was an “arbitrage” the  same way a restaurant arbitrages the price gap between raw ingredients  and a fully-prepared dinner: Green Desk’s customers were thrilled to buy  real estate in the form they actually wanted, rather than signing longer leases for bigger spaces than they could afford. The early  operation was scrappy—a negotiation with Gothamist, an early tenant, was  resolved when Green Desk agreed to buy a table for the office  conference room if Gothamist found chairs. And the company didn’t have  to pay early employees much at all. By 2009, Green Desk was successful  enough that the landlord bought the founders out and decided to expand  the concept himself.

The founders turned around and launched a competitor, WeWork.[1] WeWork had  to pitch landlords and tenants. Tenants were easy—recessions make people  leery of long-term commitments, and layoffs-with-severance are a way to  force-feed startups their seed funding. Landlords were harder to pitch,  because their question was: why can’t we do WeWork ourselves? Miguel  McKelvey said after the fact WeWork didn’t have a particularly good answer to this question, but  apparently Adam Neumann did, because the company was able to sign  leases—and was able to score an early angel investment, at a $45m  valuation, before they’d done gotten first property.

Once WeWork started growing, the pace didn’t slow down. The company  got good at managing both capital needs and tenant expectations; they  found that they could extract rent-free concessionary periods from  landlords based on how long it would take them to set up a new location,  and then finish the setup process faster. While most commercial tenants  don’t like to move into an unfinished building, WeWork’s customers were  ready as soon as there were chairs and WiFi.[2]

In the depressed real estate market of the post-crisis period, WeWork  could at least find landlords who were willing to hear their pitch, and  could also find employees who were willing to work for below-market  salaries. WeWork promised stock options for years before offering them  to employees, for example, which kept their costs low. Meanwhile, WeWork  had started raising funds from venture capitalists. WeWork was  consistently able to push for a higher valuation than comparable real  estate companies by a) pitching itself as something closer to a tech  play (at first an in-person social network, then as the hype cycle  changed, a space-as-a-service company), and b) by growing fast.

WeWork’s model started to break because there’s a tension between its  two competitive advantages. Underpaying employees and overhyping office space is good for margins,  and overselling investors is a good way to fund growth, but after a  while, the only way to grow is to overpay in order to hire employees and  sign leases.[3] And WeWork’s valuation was, for a while, sustained by  its topline growth; it had to sacrifice either access to capital or  margins, and it chose margins. If WeWork’s competitive advantage a CEO  who excelled at sales, this actually made some business sense: the  person who can pitch investors on a million-dollar investment can pitch  different investors on a billion-dollar investment, but the same person  can’t negotiate every lease when the company is opening two new  locations every day.

The simplest explanation of WeWork is that the company ran out of  people to fool: they used money from small investors to raise money from  bigger ones, until they finally tapped out Softbank, the world’s  biggest investor in private tech(-ish) companies. An IPO provides  liquidity, but it’s also the first time short-sellers can participate in  price discovery, which means it’s a tough experience for controversial  companies. (As one member of WeWork’s finance team put it: “The nature  of private markets is that if nine smart investors pass, it only takes  one relatively dumber investor, and suddenly we’re valued at $16bn.”)

But that greater-fool explanation doesn’t quite hold water. WeWork’s  initial capital came from the founders' successful real estate dealings,  and the first outside money came from another real estate investor. And  they raised venture money from some sophisticated counterparties—even  Softbank, which offered them a ridiculous valuation, was careful to  structure the deal so it protected them from some downside risk.

And, strangest of all, the company didn’t go to zero. They fired  Neumann (proximate cause: adverse PR from smoking marijuana on the  company plane while traveling internationally; actual cause: inability  to complete an IPO).[4] They laid off thousands of employees and sold  some assets. And WeWork’s new CEO says it will be profitable in 2021 ($, FT),  the most impressive transition from disaster to smooth landing since  Apollo 13. WeWork’s skill at fundraising turned out to be great for the  early investors, and only a disaster for the last and biggest. Its  talent strategy changed from underpaying at a small scale to overpaying  at a large scale, so the company’s economics when they filed their  prospectus overstated how unprofitable the undelrying business was. And  while a coworking company is a terrible business in the middle of a  pandemic, it’s a great business for a post-pandemic world where, as in  the early 2010s, most companies are cautious about committing to space  and willing to accept unconventional office arrangements. If WeWork  hadn’t already existed, the rise of partially-remote work and the  collapse of commercial real estate prices in big cities would have  necessitated its invention.

The personality traits necessary for quickly building a property  business have a negative correlation with the traits necessary to build  one that doesn’t collapse. Neumann comes across as absolutely magnetic  in the book; my big regret was that there wasn’t a camera crew following  him around from day one. Which raises an interesting point: maybe the  sorts of people who can build a big, rickety real estate empire really  ought to be in the high-margin, recurring revenue-driven business of  reality TV. We already have one case study of this, and Neumann is only  41. He has time to reinvent himself again.

[1] In what’s now an amusing sidenote, the Green Desk sale included a  noncompete: the founders couldn’t operate a coworking space in  Brooklyn, giving them no choice but to try the vaster market of  Manhattan. Just like France reached its imperial peak under a Corsican  emperor and Russia under a Georgian, Manhattan’s office market has hit  its maximum hype thanks to one property speculator from Queens and  another who got his start in Brooklyn. Outsiders may not have higher  average returns, but they have higher variance, so they dominate the  tails of the distribution.

[2] For a while, WeWork’s head of IT was a literal high school student, nicknamed Joey Cables, who dropped out his junior year to focus on WeWork full-time.

[3] This is Paul Graham’s theory of unions,  and also explains the existence of last-minute airfare, oil industry  pay during boom times, and a handful of “strategic” acquisitions when an  old-economy company buys out a pre-product startup. (The last case can  go to even greater extremes; when the acquisition size is a round number,  assume that the startup being acquired is a Veblen Good, and that the company is paying a billion dollars to tell investors “We’ve invested a billion dollars in…”)

[4] While this was big news ($, WSJ) at the time, it wasn’t news to WeWork employees or investors. Billion Dollar Loser  cites multiple instances in which Neumann moved to a new office and  requested the installation of a vent that would allow him to smoke  there.

Further reading: I enjoyed Billion Dollar Loser, and recommend it as a great retelling of the WeWork story. I previously wrote about WeWork’s IPO prospectus here, and its aftermath here. And I wrote about Softbank and the “Capital Moat” strategy earlier.


Amazon’s Third-Party Data

Amazon has a rapidly-growing advertising business because of the  company’s vast collection of first-party purchase data. Amazon knows  what you bought, what you browsed for first, how long you spent on  reviews—as long as that activity occurred on Amazon. To see  what’s going on in the rest of the retail economy, though, they need to  get data from users. Amazon is doing this through a shopper panel app, which gives users gift cards when they upload photos of receipts from non-Amazon purchases.  There are a handful of independent companies that sell data on this,  too, but the economics of doing it in-house are similar to those that  affect alternative data  in finance: it’s easier to amortize costs over multiple users, but a  single user captures more upside, and has more control over exactly what  data is collected.

The Lucas Critique in Finance

Cynically, published research on systematic investing strategies falls into roughly three categories:

  1. Results based on spurious correlations that never worked.
  2. Strategies that produce excess return, but only by taking additional risk, and
  3. Strategies that used to produce excess risk-adjusted returns, until somebody published them.

In a fun example of point #3, some papers a few years ago discovered  that executives' language on conference calls could predict future  returns. As a result:

Managers are emphasizing positivity and avoiding words or  phrases known to be perceived by machines as negative. So it’s out with  things like “claimants” and “cease” and in with the likes of  “innovator” and “improving.”

One could take this a step further, and identify which CEOs  studiously avoid using the entire set of harmful words while using as  many of the good ones as possible. Hyper-compliance with a rule implies a  desire to game it. It’s a bit similar to the old joke that American  communist organizations in the 50s knew which of their members were undercover FBI  agents, because they were the only ones who paid their dues on time.

Matching the Huawei Strategy

Last week, I mentioned a piece about how Huawei closes deals: even when the company itself isn’t getting subsidized, its customers are getting below-market loans to buy Huawei equipment. The US is trying the same approach,  offering to lend Brazilian telecoms money to buy non-Huawei gear. An  interesting feature of US/China competition is that both countries are  trying to use their vast financial systems as a tool to get other  countries into their respective orbits. China has a scale and  coordination advantage, since its financial system is immense, its  savings rate is high, and banks ultimately answer to the state. The US’s  advantage is a sophisticated financial system; less firepower, but better aim.


Many market moves are notable because of what they imply about  reality, but sometimes we get a natural experiment in how markets react  to fiction. At a conference yesterday, short seller Jim Chanos said  he’d “go long any of the space companies that have gone public because  we know that space is infinite. There’s no price too high to pay.” In  text, this looks like a plausible quote, but in context it’s  obviously a joke—Chanos is a short-selling specialist, and a notably  cynical one at that. But text is viral, and his quote was repeated  online, causing shares of Virgin Galactic (ticker: SPCE) to briefly rise 7%.

This is telling, because it reveals what optimistic investors want  to believe: that growth and a large addressable market are all that  matters, and that the experts are refusing to acknowledge the obvious.

Demand and Logistics

In a normal recession, one of the forces that keeps the economy from  contracting too much is the stability of government jobs. Government  employees can get laid off in a recession, but their work is usually  less sensitive to temporary economic ebbs and flows. That’s not  happening this year: local government employment is down almost as much  as overall employment, and the Oregon Office of Economic Analysis has a good post on why:

The bulk of the layoffs [in education] are tied to  student workers, recreational centers, dorms, student unions, and the  like… Besides education, the public sector does a lot of things.  Employment here is down largely due to zoos, convention centers,  recreation facilities, public pools, libraries and the like being  limited during the pandemic. The losses in public administration are  relatively small to date.

This is a reminder that the Covid recession is not like a normal  recession; the shortfall in demand is partly driven by the fact that  some kinds of demand simply won’t exist, at any income level, until the  disease is not a risk. That implies a different policy mix than usual.  Normally, a recession is a time to kickstart the economy to get people  working again, but this round, policy needs to focus on making what The Economist calls “The 90% Economy” a harmless as possible, while waiting for the opportunity to get back to 100%.