IWG’s share price must be affected by the collapsing valuation of WeWork, its higher-profile rival in the serviced office sector. So opined this column 10 months ago. At the time, WeWork’s main backer, SoftBank, had just invested a lot less than it had planned to and at a much lower price, leading Lombard to suggest further buying of IWG shares by Toscafund “seems anything but optimal”. It wasn’t. It was super-optimal. IWG’s shares have indeed been affected as WeWork’s valuation has plummeted: they are up 78 per cent since then, having added 4 per cent in the past two days.
Some of the recent gain may be attributed to WeWork’s inability to defy valuation gravity and, in the words of IWG boss Mark Dixon, “the god of accounting rules”. He says office landlords have become keener to talk business since sentiment turned against the lossmaking US group and its former boss Adam Neumann. Credit Suisse analysts say “IWG expects to benefit, from a demand perspective”. Peel Hunt analysts say “sophisticated investors appear to be shrugging off . . . the WeWork psychodrama”.
However, most of the gain can be attributed to a realisation that came to many investors after January, and was reinforced by news on Monday and Tuesday: while WeWork proves that no profit must mean a lower valuation; IWG proves that less profit can mean a higher valuation.
Monday’s news of a new franchising deal in Switzerland showed how the latter trade-off works. IWG is selling its office business in the country for £94m to investment groups J Safra and P Peress, which will then enter into a franchise agreement. This will cut IWG’s full-year operating profit by about 13 per cent to £135m, reckon the Peel Hunt analysts, but selling up for an enterprise value that is 15 times historic earnings and three times sales, “is highly encouraging and value enhancing”. Not least because these are the same multiples that IWG has achieved in similar sale-and-franchise deals in Japan and Taiwan.
Tuesday’s positive third-quarter trading update — showing 9 per cent revenue growth — was followed by guidance from IWG management on a “steady stream” of such franchise deals over coming years. This suggested three further benefits, and contrasts, with WeWork: the proceeds from sale and franchise transactions are helping to cut debt, from £460m to £300m in the past nine months; the local knowledge and local capital that franchisees deploy can double growth rates in overseas markets; and the transfer of lease and market risk to franchisees is accelerating a move to an asset-light model whereby IWG sells services to licensed operators, rather like InterContinental Hotels.
WeWork’s failure was to not grasp this last fact. As Mr Dixon once put it: “Essentially, the space is a break-even business and the profit comes from the services.” But WeWork’s approach was more like “running a hotel and giving away the room service and having a free bar”. Even this column can see that might be suboptimal.