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A JUNIOR VC

Weekly commentary on startups, entrepreneurship and business

Edition 41

“I was not on weed,
just to be clear"
Elon Musk

Dear *|HTML:FNAME|*,

I'd like to welcome Ajinkya Joshi, who has offered to help with the newsletter every week going forward. The newsletter involves a lot of research, proofing and time. I couldn't be happier to have a perceptive reader like him become part of the team. Thank you for the continuous support in helping grow this to a fairly large community!

Last week, coworking giant WeWork raised $1Bn to accelerate its growth, while Indian coworking upstart Awfis raised $20MM, bringing the amount raised to $8.1Bn for the former and $50MM for the latter.

Coworking is the cooler child of the boring, but gigantic, commercial real estate market. The market is so big because it serves a big human need - setting up the place of work. The startup ecosystem chases broad themes that are built on core human needs, especially those that are B2C. The easiest way to find a billion dollar tech business (i.e. unicorn) is to look at a theme based on a core human need. Food (Swiggy), Home (Houzz), Communication (Whatsapp), Health (Oscar Health), Money (PayTm), Work (WeWork), Transport (Uber), Travel (AirBnB) and Things (Flipkart) have so many 1Bn+ businesses. If you had to pick a market to startup, and are confused, pick a niche in one of these and you'll be in business. Commercial real estate is a $6.1Tn market and the tech savants of the startup ecosystem are definitely not going to leave something like this alone. Added to this, the industry is known to be opaque, fairly complicated and "traditional". As I always like to point out, this is begging to be "disrupted".

But why do coworking first and not go after the larger commercial real estate space? Because nobody looking for large commercial real estate will take a startup seriously. If WeWork started by pitching to provide office space to IBM, it would be shown the door before it entered - but today it can. Coworking is a decade old concept, but nobody looked at it as the Trojan horse to get into large customer commercial real estate. In hindsight, WeWork employed a classic market entry strategy, it targeted a market that no large office provider would find large/profitable to serve (startups), and used it to get into the big game (corporates). WeWork converted a wall into a battering ram by monopolizing the smaller coworking market and then utilized it to prove that it meant business in commercial RE. Peter Thiel would be proud, and WeWork is now in line to be the largest office provider in the massive New York market. 

The coworking companies are utilizing the coworking "revolution" to the hilt. "Make a life, not a living" says WeWork, "Where work meets life" says Awfis, "Cowork, network, grow" says 91springboard. At the core, though, these are commercial estate management companies that started out by providing shared space for startups. These companies provide a plug and play service ("office-space-as-a-service" or OsaaS), that allows to setup your office rapidly. They rent/lease office space, and then convert it to a vibrant office for their customers. The broader goal for these companies is to become the best office manager around, and that has much deeper implications than at the surface. Coworking companies provide real-time data on office use, optimize office spaces for better productivity and reduce real estate costs. If Netflix is using data to improve the quality of your entertainment, the coworking companies are using data to improve the quality of your work!

This isn't far-fetched, WeWork actually has an R&D team that is "optimizing your workspace using data". Beyond the sexiness of data-driven productivity optimization, we must be cognizant that this is a physical business and must obey the (oft forgotten) laws of gravity. Unlike SaaS that can be "scaled to infinity" without much-added cost, every new location WeWork or Awfis adds substantial cost. As these spaces are leased, they need to be utilized to be profitable. These spaces also do not benefit from the "network effects" that most well-funded B2C see, they need to add every new space themselves and get no network benefits. On top of these are management costs that are involved - internet, food, decor, managers, electricity which further hit margins. There are historical signs that a version of this business had a hard time - Regus coworking almost collapsed in 2002, just after the dotcom boom. History is a great teacher, and one tends to forget this.

While these companies are solving real pain points, would they be able to evolve into actual profitable businesses and return money for their investors? WeWork revealed its numbers, along with its fundraising announcement and there is as an ocean of red. The company's annualized loss of $1.5Bn, was 105% of its revenue and therefore had an expense of ~$3Bn. It has raised an unusual amount of capital, $8.1Bn that is feeding the cash-hungry leasing business. Because of the lack of network effects, the business is a land grab - the companies to acquire spaces first win. It is no wonder WeWork is spending aggressively to acquire spaces, it has grown to 600,000 seats (assuming ~2000 seats per center) and has a lot more in the pipeline. 

That puts the company ARPU to be close to ~$3,000, and assuming a 29% operating profit, it makes $900 operating each seat, or spends $2,100 operating a seat. Assuming 70% of the total expenditure (70% of $3Bn i.e $2.1Bn) was in running seats (both newly leased and occupied), the company is sitting with an inventory of $2.1Bn/$2,100 = 1MM seats. That implies that the company expects a revenue of $3Bn by the time these seats get utilized, which still implies a 7x revenue multiple for it's $20Bn valuation. Compare this to the 1x revenue multiple on valuation that IXG (i.e. Regus) has. You're then looking at the company needing to reach a revenue of at least $10Bn, or 3MM commercial seats, to hit today's valuation. Let's say investors are looking at even a 1x return (i.e. same public market valuation) in 2 years, the company needs to almost double its seats every year (and at scale). WeWork even has a "community adjusted EBIDTA", and you can see why its accounting needs to get so creative. 

The rich growth optimism is not as contagious with the Indian counterparts. Awfis has raised $20MM at a valuation of $120MM. Using the similar snoopy math as WeWork, and scaling down both expected revenue and cost by 3x (PPP), it's $1K of revenue and $700 of operating cost per seat. Awfis presently operates ~25K seats, and at an 80% utilization, that puts the company at $20MM of revenue. This puts the revenue multiple as 6x for the valuation of $120MM. This implies the company has probably grown 10x from its $2MM in 2017, and the Awfis investment appears to be panning out much better than the WeWork one. Awfis has a greater focus on mid-sized corporates rather than startups or giant organizations, positioning it better than (and not directly against) WeWork. It is thus less immune to the volatility in the startup ecosystem. Other operators such as 91springboard are probably a close second, while innov8 and the rest of the pack are more "boutique". The Indian community behaviour, smaller landmass than the US, coupled with higher population densities would have possibly optimized office spaces better in India. The clear winners in India will thus be good commercial real estate operators, and not "shared" spaces, which is a tact the Indian players should take.

Will the coworking craze take WeWork to legendary scale or will it only leave a few like Awfis standing?
 
This week, I look at Ranbaxy, Sushi and Subscriptions. 
  1. [Large Startups]: How the Singh family burnt through $2Bn with their guru
  2. [Work Culture]: Quitting your job without a backup plan may help your career
  3. [Growing Startups]: The ShareChat phenomenon*
  4. [Buzzwords]: Aggregation theory, thin protocols and recentralization
  5. [Life x Startups]: The microeconomics of subscription businesses
  6. [The New Monopolies]: Instagram is ruining Sushi in NYC
  7. [Data!]: Visualizing the hidden logic of cities
  8. [Modern Economics]: The strange infinities of e-commerce
  9. [Classic Economics]: What it means to be rich - income v/s wealth
  10. [Business is Entertainment]: Atal Behari Vajpayee and his Achilles Heal
Based on an excellent recommendation by members of the community, I asterisk* paid articles. I have started adding podcasts, which use a caret^. Please do drop in reads that you found interesting this week here and I would love to accommodate them. You can pass on the love by sharing this with your friends and colleagues who can sign up here, and these are all the previous editions

I started this with the belief that there is a whitespace on conversations by venture capitalists in the entrepreneurial and startup ecosystem in India. This is my small way of starting a conversation. In case you have any feedback on the structure, design or content please feel free to reach out to me in reply to this email. 

Cheers,
Aviral
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