WeWork’s cash needs come at a dire time for the borrower as its recently pulled IPO accelerated a liquidity spiral that’s on pace to break the balance sheet within a year. But the breaking point for market support may be even sooner than that if covenant restrictions and a track record of underperformance render turnaround strategies unemployable, according to an investor in the credit, three buyside sources, and one sellside source.

While the company’s S-1 showed run-rate revenue of USD 3.3bn as of 30 June – predicting 86% of year-over-year growth – adjusted EBITDA fell to roughly negative USD 1bn of 1H19, compared to negative USD 467m as of 1H18. In light of solvency concerns stoked by the negative EBITDA trend, a high cash burn rate and a pending liquidity crunch, WeWork management’s desperate play is that its investor base – mainly shareholder Softbank and holders of a USD 702m 7.875% senior unsecured note due 2025 – is just as desperate to safeguard its positions from falling to zero, the sources noted.

To that end, Softbank, which owns about 33% of the borrower’s equity, is reportedly working with counsel Weil Gotshal to weigh a deal that can simultaneously buy out other shareholders at a discount, and also backstop a new debt raise to inject capital. The firm’s investment in WeWork thus far totals USD 10.5bn.

The company’s other rescue strategy revolves around meetings JPMorgan is holding with certain restricted investors and existing bondholders this month to gauge support for upwards of USD 5bn in new debt financing, three additional buyside sources noted.

Hard work

The prospect of further investments flowing into WeWork raises feasibility questions around the company’s ability to ever earn itself into the black, the sources said.

During its last bond raise in April 2018, heavy adjustments the firm used to prop-up a positive USD 233m EBITDA figure as a run-rate proxy for existing open locations got widely chastised. As a result, the subsequent S-1 filing from this summer stopped short of marking up the bottom line with adjusted rent, tenancy costs and building and community operating expenses.

Without the adjustment card to play this time around, construction of a best-efforts debt raise is up against the added obstacle of new investors wanting collateral security to sit ahead of the existing notes, the sources said. In the S-1, WeWork listed USD 27bn in total assets – USD 6.7bn of which was property and equipment.

Further complicating the borrower’s quest for raising new capital are covenant restrictions on added debt incurrence, one of the buyside sources and an additional source said. A special report today from Debtwire affiliate Xtract Research noted the company is permitted to issue around USD 1.1bn of additional secured debt (bonds or loans), and USD 2.5bn of incremental unsecured debt — the latter of which is dependent on meeting a minimum liquidity target. Also subject to a minimum liquidity test is the ability to issue USD 3.5bn of secured LCs.

The borrower also has relatively limited room to issue incremental secured debt at foreign subsidiaries, according to Xtract.

While the covenant limits may incentivize WeWork management to explore refinancing the existing bonds in tandem with a bigger debt raise that provides for excess liquidity, doing so would come at an elevated premium given the notes are not callable, save for a 30% equity claw. The existing 7.875% unsecureds changed hands at 87 on Friday (11 October) to yield 11.074%, up from a recent low of 81.438 to yield 12.629% on 10 October, according to MarketAxess.  

As it stands, management will have to get creative since a traditional longer-dated unsecured offering sized at USD 5bn not only runs wide of incurrence parameters, it would also likely command a low-teens area coupon to keep wide of the 11% yield on the 2025 notes, the sources said. On the other hand, if the company can negotiate around covenant restrictions to bring a priming secured offering sized at USD 5bn, the interest rate could shift inside of current bond yields at 9%-10%.

While a secured deal would in theory price inside the secondary yield, it could also come higher should investors balk at collateral coverage and, to get around covenant restrictions, the unsecureds get taken out by the larger and more levered secured debt issuance. However it plays out, WeWork’s cash flow buffer is ill-equipped to absorb an escalating interest burden, the sources continued. Case in point, a projected interest rate of roughly 12% on USD 5bn of new debt would add roughly USD 600m of interest expense to the current USD 100m per year cash interest burden. Under that scenario, the company could burn up to USD 4bn of cash annually after accounting for the negative USD 1.64bn of LTM adjusted EBITDA and USD 1.6bn of 1H19 annualized capex.

In a similar vein, if interest shakes out to the 9%-10% range, the cash burn would improve only slightly to negative USD 3.85bn-USD 3.9bn, the sources noted.

Liquidity as of 30 June stood at USD 2.7bn through USD 2.5bn of cash and USD 200m in standby letters of credit availability.

WeWork did not respond to a request for comment.

2019 Debtwire