Last week, WeWork filed for bankruptcy. If you’ve followed the business headlines, the narrative of WeWork's collapse is often attributed to its substantial debt burden, exacerbated by an unfavorable interest rate climate.
But blaming WeWork’s collapse entirely on external financial pressures is too easy. It doesn’t explain the success of other highly leveraged businesses that face the same challenges.
So, what really happened here? As Warren Buffett said, "You don’t find out who’s been swimming naked until the tide goes out."
So why did the tide go out on WeWork?
A tale of two debts
Let’s compare two highly leveraged companies: WeWork and United Rentals.
United Rentals is in the business of leasing heavy equipment and construction tools. In 2022, United Rentals had a combined $12 billion in debt and capital leases—compared to only $106 million in cash.
Compare that to WeWork that same year. WeWork’s debt + capital leases totaled over $18 billion in 2022. They were sitting on $287 million in cash. Sure, the numbers weren’t exactly the same. But it’s safe to say we’re working with similar figures here.
Is this much debt risky in both businesses? Of course!
Will high-interest rates necessarily bring companies with this much debt to their demise? We need more context. Specifically, we need to know what each company gained for their debt.
Printing or burning money
United Rentals has something WeWork didn’t: A profitable return on capital employed (ROCE).
United Rentals can get away with carrying heavy debt, even in a high-interest rate environment, because they know how to consistently make more money with their money.
United Rentals hasn’t had a year of sub-10% return on capital since 2012. In 2022, they made almost 15 cents in profit for every dollar invested. Even in a high-interest rate environment, they can more than cover interest payments.
Meanwhile, WeWork literally produced the opposite. They had a negative return on capital, otherwise known as burning money.
WeWork’s annual returns on capital ranged from -7% in their best year to -18% two years back to back.
Even when interest rates were low, WeWork consistently turned dollars into cents. As interest rates rose, WeWork’s negative cash flow expanded against them.
WeWork was already driving toward a wall. High interest rates simply forced them to step on the gas.
Maybe that’s harsh. Maybe it’s too simplistic. But we’re talking about business fundamentals here.
There’s a reason why investor Bill Ackman defines his investing thesis: “An investment must be a simple, predictable, free-cash-flow generative, dominant business.”
WeWork ignored the boring fundamental question at the heart of every great business: Are you turning cash into even more cash?
WeWork didn’t have a debt problem or an interest rate problem. They lacked something far more fundamental: A profitability problem.
Hopefully, the next owners will do things differently. After all, it’s only a matter of time before the tides move out again.
