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Monday, December 16, 2019

WeWork, Tesla and High-Speed Capitalism

Capitalism is the best economic system mankind has ever invented, but it is not immune to the moral ailment that has become pervasive in government policy.

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Why do people throw billions upon billions of dollars after companies that don't make money? The collapse of WeWork is a conspicuous example, but it is not the only one that has attracted fantasy-level venture investments without reporting a profit.

Tesla comes to mind. According to Macrotrends.net, Tesla has had a consistently negative per-share earnings (EPS) trend over twelve months (TTM). There have been rare occasions when Tesla has been able to pay its bills: a breakdown of the EPS numbers over at Nasdaq shows Tesla with a zero EPS for the first quarter of 2013 and a positive ratio for the third quarter of 2016, the last two quarters of 2018 and the third quarter of 2019. 

It is unlikely that Tesla will be able to improve their record. Elon Musk and the rest of the Tesla management has shown little interest in reforming their operations to become profitable; their business model is to pay for losses by attracting new investors. The latest stunt is to suggest Tesla build a "truck"; a new project to get more people to give the notoriously cash-bleeding business another one-time infusion of cash.

This is not the image of a start-up company trying to find its footing in the market. It is the image of an established corporation operating by a new business model, one that shuns the old-school capitalist formula known as "pay your bills with your revenue". Tesla is the poster child of a new form of high-speed capitalism where the teachers are not Henry Ford or Steve Jobs, but Charles Ponzi and Bernie Madoff.

Elon Musk is not the only entrepreneur out there living the high-speed capitalist life. Adam Neumann, founder of WeWork, is cut from the same piece. His landlord business has basically imploded - a fate that Tesla will face sooner or later - after years of notorious losses and a series of morally (if not legally) fraudulent profit predictions to attract more investors. 

The last straw for WeWork was a badly botched IPO earlier this year. 

In a great example of quality journalism, the Wall Street Journal covered the WeWork story (Weekend December 14-15, Section B), including reporting the company's market cap at $47 billion in January this year.

This number is important. It makes WeWork into something very different than a landlord business. It elevates them to the levels of - yes - Tesla, whose market cap over the past three years has fluctuated around $50-55 billion.

Both these companies, who - again - share the same business philosophy, eclipse traditional businesses such as Ford Motor Company. Their market cap currently stands at less than $36 billion. Yet unlike both Tesla and WeWork, Ford actually makes money. Their EPS trend is positive for the past ten years, safe for the third quarter this year. 

WeWork and Tesla bleed money. Yet somehow these two companies have mesmerized investors into flooding them with billions upon billions of dollars.

But why is it that people get involved in high-speed capitalism? It is understandable that an entrepreneur - or, as we shall call him here, a venturist - thinks he can get away with Ponzying his way through his balance sheets, but why do investors play along?

The question is perhaps easier to answer when it comes to Tesla. There is no question that this electric-car manufacturer has been a Ponzi operation for quite some time now. Now the Wall Street Journal exposes WeWork as being in the same category. 

WeWork did not grow from a small property-leasing business in Brooklyn, NY, in 2009 into a $47-billion company with global aspirations by being the best landlord business in the world. That is not to say there are bad landlords: they may be good at what they du, although ten years without turning profit a single quarter indicates that they probably don't rise above their crop of competitors.

Instead of making money like traditional businesses do, the high-speed capitalists behind Tesla and WeWork chose to rely on an investor pyramid to fund their businesses According to the Journal (Dec. 14-15, pp. B6-B7), venture investments in WeWork went from $17.5 million from Benchmark Capital just a couple of years into WeWork's existence, to $5 billion from T Row Price in 2014 and $10 billion from Fidelity Investments half a year later.

In a landlord business. 

But that was not all. A Chinese investment company, Hony Capital, decided to invest in WeWork, and in 2016 Japanese SoftBank pumped $4.4 billion into the company. 

At this point, WeWork is seven years into its life, and it still can't pay its current expenses with revenue from current operations. According to the Journal, the founder and CEO, Adam Neumann
continuously said profitability was just around the corner. In reality, its losses were swelling far larger every year. A presentation for prospective investors in fall 2014 projected the company would turn a $4.2 million operating profit for the year. When the year as through, just three months, later, the company reported an operating loss of $88 million on $74 million of revenue, according to internal documents.
These numbers are startling. Just one investor, T Row Price, pumped $5 billion into a company that had $74 million in annual revenue. That is more than $67 of investment per $1 in revenue. Even if the company paid its bills and ran a small profit, it would take decades for the investment to pay off.

In a normal business world - in the reality of sound capitalism - a decades-long commitment is fine, even virtuous. But it is not an expression of prudent business practices to throw this copious amount of money into a business that is unable to even pay its own bills. 

Even worse: the losses are bigger than the revenues. Not only does the company spend more than it takes in, but it spends more than twice as much as its revenue. The loss of $88 million is what is left when the $74 million in revenue have paid their share of expenses. 

In other words, in 2014 WeWork spent a total of $162 million while taking in $74 million. It earned less than 46 cents of every dollar it spent and consequently had to take investors' money to cover 54 cents of every dollar of operating expenses.

That is not good stewardship of other people's money. SoftBank, Hony, Fidelity and T Row Price all get their investment capital from someone else. Yet despite WeWork bleeding money, they participated in its high-speed capitalist Ponzi scheme.

Why?

To some degree, they may be forgiven by WeWork's con-artistry. The company kept presenting rosy profit outlooks, which the Wall Street Journal reports on in its article. Having obtained internal WeWork documents, the Journal presents accounts of three profit forecasts, one from June 2015, another from March 2016 and the third from March 2017. All of them predicted strikingly optimistic profits for the coming years. Yet it did not take long for each of these forecasts to fall through the floor; if the failure of the first forecast did not dissuade investors by the time the second one came out, at least by the time of the third forecast the investors should have slammed the brake pedal and brought funding to a screeching halt.

That did not happen. As late as in January this year WeWork was able to lure more investor billions into its financial ramshackle.

It is easy to get the impression that high-speed capitalism works. It helps if there is some intangible ingredient thrown into the mix. Elon Musk has capitalized on the itching need of some investors to dispense virtue signals. People who want to look good will gladly pump their money into the black hole of electric cars. 

Tesla has also had access to an even more reliable virtue-signal driven cash faucet: government. Thanks in no small part to the enviro-crazies in the Obama administration, taxpayers have been on the hook for gobs of money that Elon Musk otherwise would have had to raise out in the open. This has also helped him with getting private money: if your investment is at least in part guaranteed by government, your risk of losing money is all of a sudden much lower than if you had to put your trust in the free market. 

The combination of a virtue-signaling product and government-guaranteed cash flow is a powerful business model, at least until government pulls out.

It does not seem to be the case that WeWork ever had Tesla's access to coerced funding. Instead, they had to rely entirely on private investment money. Nor did they have much of a virtue-signaling product either: being a landlord is far less glamorous than giving the appearance of saving the planet, one child-labor dependent, precious-metal loaded electric car at a time. 

There is, of course, nothing wrong with being a landlord. Renting out real estate is an enterprise as old as real estate itself. However, it does not lend itself to the practices of high-speed capitalism. If you for some reason prefer the business model that relies on a Ponzi scheme instead of traditional capitalism, and if you still want to be a landlord, you will have to spice up your business proposal to make it look like something it is not. 

WeWork founder Adam Neumann was somehow able to sell his business as a "tech" company.

Never mind the fact that it was not a "tech" company: once he had slapped that label onto it, he could jet off to Silicon Valley and open a whole new range of venture investor wallets. 

It was a smart move, for sure. Venture capitalists in general, and in the technology industry in particular, are used to seeing return on their investments years down the road. Yet such investments often pay off: God - and fat bank accounts - bless those who believed in Steve Jobs, Bill Gates, Larry Page and Sergey Brin. Yet the patience and hard work required to turn a true venture - a start-up with all its risks - into a sustainable, durable and profitable enterprise, is too much for some people.

When Adam Neumann showed up and offered a "tech" idea that looked like it was going to deliver positive cash flow faster than a traditional investment, it was easy for many to get onboard.

But there is still one more ingredient missing. The idea of a quick buck may be as old as the tradition of speculating in equity markets, but that is not what happens in businesses like Tesla and WeWork. Even if you are a venture capitalist and you initially believe in an idea, there comes a point when the entity you put your money into is not delivering as promised. 

It is like walking into a lake: when the water reaches up to your chin, you ask yourself if you can swim to the other side - or if it is safer to turn back.

Adam Neumann was able to convince a good many WeWork investors to keep walking.

To be able to convince investors to keep walking, people like Musk and Neumann have to believe in the Ponzi model for corporate finance. They have to believe that they are entitled to run a business on the premise that operating revenue does not have to pay for operating expenses. They have to think that they have the right to pay their way through life with money from other sources than business sales. 

This is the same philosophy as when a person lives off tax-paid entitlements, or when a Millennial gets stuck in his parents' basement snap-chatting "OMG I hate Donald Trump" all day long.

To get money without selling a product is to separate effort from reward. The Ponzi schemer's very business idea is to inflate reward far up and above effort. While nothing new per se, there is a new ingredient that helps explain why both venturists like Musk and Neumann, and their investor benefactors, get involved in this scheme. 

Effort is separated from reward wherever the welfare state goes. 

A person who runs his business on the premise that investor money permanently pays for operating costs, is philosophically no different from the person who agrees to being dependent on tax-paid entitlements for his livelihood. Just as the savvy businessman - the venturist - expertly plays the Ponzi game, so the welfare-dependent individual can play the entitlement game, and make a reasonable amount of money doing it.

The idea that a business should not have to pay its own expenses makes sense from a strict logical viewpoint. It is morally wrong, and it violates basic principles of how you go about both your own life and being a businessman, but it is the logical conclusion if egalitarianism is your moral domicile. It makes sense that a person who holds such values will try to solicit as much money as he can without having to produce something of value to earn it. 

Just like the person dependent on welfare, the Neumanns and Musks of this world simply convince themselves that others have a moral obligation to fund their enterprises. But that is also the point where the venturist runs into a problem, especially if he is basically just a landlord. Unlike government abbreviations like the TSA and the IRS, private entrepreneurs cannot force themselves into other people's pockets. 

Likewise, their private investors have a bottom line to adhere to. Eventually, someone gets tired of losing money.

But why does the investor accept to play the government's role with the venturist? His desire to make a quicker-than-usual buck is part of the picture, but there is also the intangible side of it. The investor who decides to pour billions of dollars into a company that bleeds money, must somewhere share the venturist's perception about how you make money. In his case, it is by means of rapid capital gains. 

Forget positive cash flow: the investor looks at a company like WeWork and thinks that if he gets in early he can increase his money by selling off stock once the company has grown to a certain point. 

Unfortunately, Ponzi schemes only work until they run out of new investors. At some point, someone gets stuck at the top of the pyramid. The faster you can make money on the scheme, the more likely you are to not be that guy.

Adam Neumann knew this. So does Elon Musk. Their solution to attracting new investors has been to constantly launch new projects. Tesla has the fortune - pun intended - to be able to roll out a new car model whenever Elon Musk needs more money. From the Model S to the "SUV" to the Model 3 "affordable" car, they have always had a new project in the making. Now they want to launch a "truck" to compete with real trucks

Instead of solidifying existing operations - which are notoriously negative in cash flow - Tesla tries to attract new people to their Ponzi scheme by marketing a new project.

WeWork did the same. Instead of slowing down to make sure their existing operations paid for themselves, they steadily sought new markets and "more growth". In fact, the Wall Street Journal article - a great example of top-tier journalism - is peppered with examples of how Adam Neumann pushed business growth not only to continue, but to accelerate. 

Again, this is the only way you can keep the Ponzi scheme going. The Tesla scheme is more dragged out than WeWork's, in part because of government, but it has the same fundamentals to it.

The pursuit of a quick buck in investment markets is not new. Ponzi himself operated in the 1920s, and he was not even the first in paying old investors (and other current bills) with new investment capital. It does not matter that the current Ponzi schemers are draped in entrepreneurial robes, or even pass their businesses off as "tech" companies; the underlying financial scheme is the same. 

So long as the investor thinks he can get out of the pyramid fast and early enough, and so long as the venturist thinks that he add yet another layer to the pyramid, they will both press on. Driven by a shared moral premise that it is okay to separate reward from effort, they press on until the scheme reaches the end of the rope.

High-speed capitalism at work.

The only remedial part of the WeWork story is that government was not involved. That keeps taxpayers out of the clean-up after the collapse. 

Things will be different when the Tesla scheme comes to an end. 

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