IWG: A Wonderful Company at a Wonderful Price

How the drama in office real estate is a massive tailwind for IWG

Summary

• Why IWG’s legacy business model of providing flexible workspace is already a good business currently trading at a great price.

• Why IWG’s ongoing transformation to a capital light provider of managed/franchised flexible office space will make it a wonderful business.

• What it takes for IWG to be a 10 bagger (or more)

  over the next decade.

Disclaimer: This writeup is not investment advice. I am sharing my research insights and positioning on individual companies for informational and entertainment purposes. In particular, I do not take into account any readers personal financial situation. Please do your own research.

IWG is currently by far the largest position in my portfolio with 16%. IWG is currently ticking all the boxes in what I am looking for in my investments. As a reminder, I ideally strive to “invest in great companies with long growth runways trading at reasonable prices.” If the price is not only reasonable, but cheap, all the better.

In this article I will share why I am so optimistic about IWG’s growth runway and its transformation from a capital heavy to a capital light business model. Moreover, I will discuss why IWG may be heavily mispriced by the stock market today.

1) IWG’s Company Owned Operations - A Solid Legacy Business Model

Founded in 1989, IWG is the global leader in flexible workspaces. IWG currently offers 3,445 locations across 19 different brands in 120 countries, totaling over 1 million rooms (or seats) for more than 8 million users. IWG serves 500,000 companies, including 83% of Fortune 500 companies. Importantly, IWG is leading the competition by a mile.

Most investors are familiar with the collapse of Wework. I would thus like to address the key differences upfront. Wework under CEO Adam Neumann and with the support of Masa Son’s money from Softbank was managed for maximum growth like a tech company, perhaps hoping that scale economies would magically appear once a certain revenue threshold is exceeded. One simply cannot operate like this in a physical real estate operating business. In search for reckless growth, Wework overpaid for inflexible leases and had no discipline when it came to the capex for building out the office workspace. A cultural problem that could not be fixed.

Why is IWG different from Wework?

My father used to work in the pricing department of a global office furniture provider. He repeatedly experienced IWG as the toughest negotiators for office furniture deals he came across in his career. The company ended up producing the office furniture for IWG at very little margins above costs. This example hints at operational excellence and a culture of cost consciousness at IWG.

At the recent investor day, IWG shared the following slide to summarize how they are different from the pack.

The most important difference compared to Wework is that IWG has a history of profitability. EBITDA has approached $500 million prior to Covid. Note that this EBITDA also includes about $150m from its software business, so the legacy operating business EBITDA should be at about $350 million pre-Covid and likely again for 2024:

This is thanks to stable margins at the company-owned workspace centers.

IWG’s company-owned operations business segment is still recovering from Covid. Contribution margins were 21% in H1 2023, vs. about 30% historically. However, EBITDA is almost back to pre-Covid levels. For the FY 2023, IWG guided for $700m contribution profit from company-owned operations. As described above, I expect EBITDA for the segment is about $350 million. At 8.5x EBITDA, the legacy business would be worth about $3.0b.

The slide below shows the maintenance capex assumptions that IWG shared at the investor day:

Turning from EBITDA to free cash flow, maintenance capex is expected to stabilize below $100 million per year. IWG has currently about $750 in net financial debt, which is expected to fall below $500m by 2025, so interest payments are modest (about $25m a year at 5%). If we assume $70m for interest payments and taxes, FCF should be about $180m per year. At my EBITDA-based valuation of $3.0b from above, that would equate to a FCF-multiple of 16.6. Note that this valuation assumes no growth for the company-owned part of the business, as virtually all future growth will come from the capital light managed and franchised business (see below).

In sum, I estimate the current value of IWG’s company-owned flexible workspace business at $3.0b. Deducting the current net financial debt of $750m gets us already pretty much to the current market capitalization of $2367m (per Feb 11, 2024).

2) Worka - IWG’s Fast-Growing Profitable Marketplace Business

Besides the core business, IWG also has the Worka segment (formerly Instant Group). Worka is the largest independent global marketplace for flexible workspaces providing a broad spectrum of digital and physical services. Digital services range from tools and software for yield management to bookings and reservations services. Worka also provides consultancy services as well as basic F&B services. In 2023, Worka is expected to generate about $448m in revenues, which split into 150 different product revenue lines, some of which IWG has illustrated at its investor day:

At the investor day, Tim Rodber, CEO of the Worka unit, broke up the Worka unit into three segments. 1) Worka Connected Marketplace, which he described as the largest flexible marketplace connecting businesses and their employees to 40k+ flexible spaces across 170 countries and 5,500 cities. Services offered range from virtual offices and meeting rooms, to coworking spaces and private offices. 2) Worka Services, spanning managed offices, portfolio management, and flexible office spaces. The Managed Office productizes the lease for landlords and clients: short lease dedicated spaces on time and on budget. Portfolio Management transitions portfolios from long leases to flex leases. Finally, Flex Office Services to open new locations for operators and landlords for single or shared occupancy faster. 3) Worka Data, Consulting, and Sustainability, providing the industry’s leading data platform, a market leading corporate real estate consultancy, as well as market leading sustainability practice.

Worka has shown solid growth and profitability. For 2023, EBITDA of 150m is anticipated, with margins expected to increase further in the future.

In March 2023 there were rumors that IWG was seeking to sell a stake in Worka or listing it in the US as a standalone company. Back in the days, the article mentioned a 2022 EBITDA of GBP 112 million and a potential valuation of GBP 1.5 billion.

With the updated 2023 EBITDA from the investor day from November 2023, the same multiple would lead to a valuation of about $2.0 billion for Worka.

In its recently published Q4 2023 shareholder letter, Greenhaven Road Capital also provides a writeup on its new IWG position. I highly recommend reading the writeup and would like to cite a section on Worka:

“Over the last decade, Worka’s revenue grew at a 20%+ CAGR on a combined basis. The company expects this growth rate to continue over time.”

Personally, I would not be mad if IWG would keep the full Worka stake. Back at the time of the rumors about the Worka spinn-off. It feels to me that the spin-off was an attempt to address the depressed share price at the time. Citing the Sky article:

“Mr Dixon is said to believe that the company is severely undervalued by public market investors, and has considered deals including a combination with a US-listed special purpose acquisition company for Worka, an app that helps IWG clients to compare and book places to work at thousands of sites globally.”

In Worka manages to keep growing 20% a year in a capital-light manner, and the business shouldn’t require much capital to grow, the rumored price targets seem to undervalue the unit in my perspective. Should IWG manage to maintain only a 15% EBITDA CAGR over the next decade, we would speak of $600m EBITDA in 2033. At 10-15x EBITDA, the future value of the segment could easily range between $6b to $9b. If we take the midpoint of $7.5b and add the $3.0b valuation for the legacy business, IWGs terminal value for these two segments alone could approach $10b about a 4x (or 15% CAGR) from today’s valuation. And that does not even account for the cash generated between now and then. Today, the two units produce about $500m in EBITDA. If we assume constant $350m EBITDA for the legacy business and $600m for Worka by 2033, the combined EBITDA would grow to almost $1 billion.

3) New IWG: A Hilton/Marriott for Managed & Franchised Office?

If there ever was a bull case for Wework, it was the size of the addressable market. Office real estate represents a highly fragmented untapped market. As the clear industry leader, IWG’s market cap is currently tiny relative to the opportunity, but it is also tiny relative to the market cap of industry leaders in comparable industries (e.g. Uber or Airbnb):

The problem, so far, was the capital intensity of the business model, and it was what broke Wework’s neck ultimately. Once Wework or IWG signed a new lease, they needed massive growth capex investments (and later maintenance capex) to build out the space to make it an attractive coworking offering. The only way Wework could grow so fast was through the nearly unlimited pockets of Softbank back at the time.

IWG took a much more prudent approach and financed its growth largely internally. The obvious disadvantage is that the capital intensity hence allowed only for a rather modest 7.5% revenue growth rate.

A look at the hotel real estate sector shows that it doesn’t have to be that way.