WeWork: the world's fifth most valuable start-up

While I was researching co-working space provider Servcorp (ASX:SRV), US-based competitor WeWork raised more funds from investors at a valuation of US$20bn. Apparently that now makes it the world's fifth most valuable start-up.

You'll probably be unsurprised to learn that competitors Servcorp and IWG (LSE:IWG) – which is the global market leader in the co-working space and owns brands such as Regus and Spaces – aren't valued as generously. For the details, including our current view on Servcorp and our Buy list, please consider taking a free 15 day trial.

But let's just concentrate on WeWork.

Very expensive

Its current valuation values each of its 200 locations at A$128m or around A$28,000 per square metre. 

By contrast, Dexus (ASX:DXS), Australia's largest listed office property trust, recently purchased a 25% stake in Sydney's MLC Centre, located in the heart of the Sydney's central business district, for A$360m.

The Dexus Wholesale Property Fund purchased another 25% for the same price, valuing the entire 67 storey A-grade building and associated retail space at more than A$1.4bn or around A$18,000 per square metre.  

The valuation premium investors are giving to WeWork is despite WeWork only leasing office space from landlords and MLC Centre coming with the freehold.   

No competitive advantage

Moreover, the co-working industry has low barriers to entry, low switching costs and high barriers to exit (because breaking a lease is costly). WeWork doesn't seem to have any competitive advantage that I can identify.

Some would argue that there are network effects for its customers – the more WeWork locations open, the more its customers can network and grow their businesses, thereby encouraging WeWork to open more locations, and so on. But if these network effects do exist, competitors such as IWG and Servcorp should also benefit.

It certainly doesn't seem like a winner-takes-all business like many that benefit from network effects. Worse, co-working spaces operate in a highly cyclical industry due to their dependence on the business cycle. This cyclicality can cause problems for co-working companies in a downturn as their leases with landlords are much longer than the leases they enter into with customers.

MLC Centre preferred

By contrast, MLC Centre is an A-grade building that is undergoing a nearly-completed $150m refurbishment of the office tower and attached food court. Located in one of the most desirable parts of the Sydney central business district, it's almost fully occupied with tenants on long-term leases. It will also benefit once the nearby Sydney Metro station opens and there are also opportunities to increase earnings through lifting rents and further development.

Perhaps MLC Centre is expensive too. Low interest rates in recent years have caused investors to pay higher and higher prices for commercial property such as office towers, helped by falling debt costs. And any downturn in demand for office space in Sydney would likely reduce its valuation, albeit probably temporarily.

Yet faced with a choice between investing in WeWork or the MLC Centre at current prices, I'd choose the latter every time.