Market Thinking

making sense of the narrative

When the bigger fool……is you

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In our current upside down world of investment, where bonds are bought for capital gain and equities for income, and where an obsession with low volatility has driven a dangerous rush by institutional investors into ‘alternatives’, such as Private Equity, Private Credit, Direct lending and Real Estate, we find risk averse institutional investors acting as largely unsecured bankers to tech dream-sellers with the aim of selling out to other ‘bigger fool’ investors in public markets – only to find that these bigger fools no longer exist. Since they are in fact, themselves.

While most observers probably regard the WeWork debacle as a long overdue hit to the hubris of the Silicon Valley and consider the losses that main backers SoftBank are undoubtedly going to have to book as yet another example of ‘when genius failed’, we should not ignore the fact that there are some significant potential risks out IRL (in Real Life as they say in the Valley) due to the very nature of WeWork itself and the fact that while presented as a tech Unicorn, it was and remains basically a leasing business. A leveraged, property Leasing business, with a serious duration mismatch.

What most real world investors recognised from the very beginning was that behind all the Silicon Valley hype, WeWork is basically a property service company seeking to arbitrage the higher rent paid by short term tenancies with the lower leases available to long term renters. Essentially a not very high quality cyclical business presented as the next Amazon, When the IPO filing went in, it showed that WeWork has $47bn of long term lease liabilities but only $4bn of committed rental assets, which means a lot of landlords are going to be facing a reset. Moreover, it has been revealed that WeWork is the major tenant behind around $3.3bn of Commercial Mortgaged Backed Securities, most of which will doubtless be owned by pension funds and insurance companies, the irony being that the very risk aversion that drove them to buy the bonds is making them stay away from the IPO that is supposed to maintain the leveraged bubble.

So here we have a company that had raised around $12bn in equity and loans with $47bn of lease commitments and, no doubt coincidentally, a $47bn (“I just made it up”) valuation, from ambitious Investment Bankers, aiming to raise around $3bn from an IPO in order to unlock a further $6bn in loans. The fact that these Tech Unicorns don’t actually make any money no longer seems to bother the IBs, assuming somehow that the ‘dumb money’ (which is unfortunately how many regard institutional investors) would just suck it up. The founder has secured hundreds of millions in loans against his stock no doubt from bankers taking a similar view that a bigger fool would turn up to bail them out despite the fact that for every dollar WeWork spent, they lost two. Selling dollars for fifty cents is a great business model so long as you can persuade people to give you free money and value you on turnover rather than profits. After all, who needs collateral or a viable business model when you have the IPO market?

The crash of 2000 was based on the same notion of a bigger fool in the equity market while the crash of 2008 was based on the notion that illiquid assets were a safe haven for large amounts of institutional savings simply on account of having low volatility. Currently we look to be revisiting both of these mistakes. Just like in the dot-com era, an inverted pyramid of leverage has built up since the last crisis, a huge unlisted balance sheet seemingly all dependent on the bigger fool in the listed equity markets paying off all the bills. From the VCs and Private Equity funds in silicon valley, through the leveraged loans and Private Credit markets on Wall Street we have seen a wave of ‘risk averse’ institutional money rush into these markets and that wave has just crashed onto the rocks of reality. The equity market isn’t buying this narrative. WeWork isn’t worth $47bn, $20bn or even $10bn. And nor for that matter are exercise bike makers like Peleton worth twelve times sales or Hollywood agents like Endeavour six times sales to name two other Unicorns that also just failed this week.

As they used to say post the tech bubble bursting “Sales are Vanity, Profits are Sanity”. The unlisted markets can pass the parcel all they like at whatever valuations they care to imagine amongst themselves, but ultimately cash flow is what matters. Looks like the equity market isn’t so dumb after all.

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