Fundamentals. They are an extremely important analysis for any investor or trader. At MatrixChart Systems, we are huge advocates for fundamentals. After all, before you park your hard earned money in a stock, you should want to find out if that company has been making good profits, and if there are significant growth opportunities in the foreseeable future. Ignoring fundamentals because of laziness or ignorance is usually costly.
What has this got to do with greater fool theory? Well, sometimes if you’re not careful, or perhaps get too taken in by a certain rhetoric, you could fall prey to being the greater fool, and buy something that has no fundamental value, at a ridiculous price.
What is Greater Fool Theory?
Greater Fool Theory essentially says that is possible to make money by buying something regardless of its fundamental value or if it is clearly overvalued, because there will usually be someone (a greater fool) who is willing to pay a higher price. This applies not just in the stock market, but in any market, from automobiles to real estate, limited edition toys, and Cryptocurrencies especially. As long as there is another buyer out there willing to pay more, you can make money.
Morality aside, almost nobody turns away a greater fool, because if they did, then they would be the one stuck with something that they overpaid for, and will have to stomach the loss.
Take real estate for example, if you sink $600,000 into a property, and later find out its worth only $550,000 after a few months, you would begin to feel a little uneasy. But what if suddenly, due to a government announcement that you know will not make much impact in the long-term, manages to convince other speculative buyers who have short-term views to rush in, and a buyer now offers you $1 Million for your property? Would you say no? Of course not, that sudden short-term boost that has caused possibly uninformed or greedy speculative buyers to rush in, is your chance to exit this investment with a 66% gain, instead of an 8.3% loss.
Now of course, there are plenty of other ways in which the price of something can be boosted. Take for example a ridiculous valuation of a start-up, based only on rapidly growing revenues founded on hype and marketing but with no stable fundamentals, and yet plans to IPO.
WeWork’s IPO – An Exit Strategy For Initial Investors
Remember, when you want to cash out of something that you bought, you need to find a willing buyer, and preferably at a price point that is higher than what you paid. For start-ups, after the founders and key investors have built the company as best as they can, they might consider an exit strategy that involves growth, or to just exit completely. If they were to exit completely, then they would look to get acquired by a larger company that buys them out totally so they can collect the cash and walk away. However, an exit strategy that involves growth, is an IPO (Initial Public Offering), as the early backers and founders can cash out a sizeable amount of shares for phenomenal returns, but still retain some of their holdings with the intention of seeing how much further they can grow the company. Let’s take a look at WeWork in this regard.
For WeWork, it has become fairly obvious that their big investors, like Softbank, are looking to use the IPO to exit with huge returns by offloading their investments to ordinary retail investors who will hopefully be greater fools. Softbank has sunk a significant amount of money into WeWork, and owns close to 30% of the company at this point. Having invested at a valuation of $47 Billion in January 2019, Softbank clearly overpaid. And now, given their total investment in WeWork, Softbank cannot suddenly appear to walk away anymore. Softbank is “too far down the rabbit hole” so to speak. If Softbank were to walk away now and show their lack of faith, nobody is going to touch WeWork even with a stick, and WeWork will certainly file for bankruptcy.
When WeWork filed for IPO, they had to make the necessary filings with the SEC, and this also opened up the company’s books, after which WeWork had to shelve its plans for their IPO. Namely because public capital markets set off the alarm bells after properly scrutinising all of WeWork’s filings. All is not as it seems.
The Business Model for WeWork = WontWork
WeWork is in the business of providing co-working spaces. It doesn’t matter how fancy or high-tech those spaces are, it is still office space. And to put it simply, they have long-term liabilities and short-term revenues. All this points to WeWork’s business model being fatally flawed. WeWork locks in long-term leases with landlords of properties and this loads WeWork with long-term lease obligations along with debt from all the expensive renovations and technology that they want to put in place to make themselves a cut above the rest.
However on the revenue side of things, WeWork operates on giving sub-leases to very short-term tenants who can come and go with as little as 1 months’ notice.
To put things in perspective with numbers, WeWork’s property lease obligations are almost at a staggering $50 Billion and have an average period of 15 years. When looking at their tenants, WeWork’s committed and contracted tenant base works out to only about $4 Billion with an average period of 15 months. If that sounds insanely risky, that’s because it is.
Committing to a fixed stream of debt and lease obligations while having an unstable and risky revenue stream has never worked out well. Look no further than Hyflux in Singapore for a similar example.
To add to their woes, WeWork reportedly only has about $2.5 Billion in cash currently, and in the first 6 months of 2019, has already burnt through $1.5 Billion. At that rate, WeWork will be out of cash by around May 2020 if nothing changes.
Further compounding their problems are the fact that ex-CEO and founder Adam Neumann has had some questionable dealings with the company and has in fact already cashed out $700 Million personally, apart from also owning some of the properties that WeWork leases. Next would be the fact that WeWork doesn’t really offer anything special other than hype and marketing. Competitor IWG is in the same space with similar capacity and is actually profitable, but IWG is valued at approximately $3.7 Billion, more than 10 times less. And lastly, what’s stopping some of the landlords themselves from converting their own properties into co-working spaces on their own?
A Lesson In Fundamentals
What we have here then, is a lesson in fundamentals and prudence. WeWork received huge backlash for even thinking about an IPO given their spiralling losses and that they’ve been mostly cash negative long before the IPO filing. But the truth is Uber and Lyft could be lumped into that same category, and yet those 2 unicorns have made it to the IPO stage and have since fallen far below their IPO price. Yet another recent unicorn that made it to IPO and sunk is Peloton, with a ridiculous valuation that when based on forecasted revenues, really doesn’t make any sense, and yet, Peloton cleared the IPO hurdle.
Just because a company is allowed to IPO, doesn’t automatically make it a great company. Some companies start off great, like Microsoft, and some companies take a fair amount of time to become great, like Apple. But those companies listed in a different era, when times were different. Either way, you should only ever consider investing in the company when the signs for greatness finally appear. If those signs appear at IPO, fantastic, and if they don’t, just stay out. Always remember that patience is a virtue.
Conclusion – Caveat Emptor (Buyer Beware)
To wrap up, beware of all the hype surrounding these unicorns. Clearly, the venture capitalists and early investors are more than happy to push through ridiculous valuations based on rapidly growing revenues with no fundamentals. Early backers and VC firms stand to make huge returns if a start-up can make it to an IPO, as an IPO means that there is variability and “wiggle room” for them to inflate and anchor the price of the stock when it is sold to retail investors. These early backers will reap fantastic gains selling their holdings to greater fools like uninformed investors, reckless retail investors who fall for the hype and marketing, or greedy investors who want to gamble and try their luck.
Don’t be the greater fool, do your homework on the stock, and trust in the fundamentals you have researched for yourself.
To quote the greatest showman, P.T. Barnum, “There’s A Sucker Born Every Minute”, don’t let yourself be one of them.