In Defense of Adam Neumann

A gift that keeps on giving... We've covered this story religiously – and we're not alone... In defense of Adam Neumann... He isn't the only character in this story... Three key lessons from this saga... What you should do right now...

Adam Neumann's buffoonery has been a gift that keeps on giving...

That's especially true for people like me (Bryan Beach), who write about the markets for a living.

In the past year or so, the disgraced former CEO of office-space peddler WeWork has provided endless questionable moves to critique. We've discussed his antics religiously here in the Digest...

We've covered WeWork's questionable pivots into wave pools, sailing charters, food labs, and even preschools... his copyrighting the word "We" and charging the company $6 million to use it... and much more over the past several months. But that wasn't even all of it...

We haven't yet brought up Neumann's marijuana-infused intercontinental flights on the company jet... or the oddball staff meetings led by kabbalah spiritualists.

We're not alone with our recent skewering of WeWork...

Bloomberg columnist Matt Levine, the world's preeminent WeWork chronicler, has written around 55,000 words on the company... since April. (Legendary author F. Scott Fitzgerald needed fewer than 50,000 words to write The Great Gatsby.)

At this point, delighting in Neumann's downfall has become cliché. The jokes have been made. The mud has been slung. And yet... we can learn so much more from the saga.

In today's Digest, I'll share a few surprising lessons that we can take from the WeWork mess... and why, in this market environment, we should be more like Adam Neumann.

We don't need to belabor WeWork's failed IPO...

Everything about it was unusual, starting with the company's S1 – a document filed with the U.S. Securities and Exchange Commission prior to going public.

S1 documents are typically bland, black-and-white snoozers full of business plans, pertinent financial data, and other information that potential investors might need to know.

But WeWork had a different plan...

Neumann's wife Rebekah hired the Vanity Fair director of photography to send photographers around the world to shoot magazine-grade snapshots. As profiled in the New York magazine, Rebekah then rejected an early S1 draft because the recycled paper was not high-enough quality.

Neumann himself figures prominently in the S1 – with the word "Adam" appearing 169 times, according to New York University professor Scott Galloway. (To put that in perspective, the messaging company Slack recently filed an S1 that only mentioned its CEO 19 times.)

The Wall Street Journal reported that Neumann even told the heads of the New York Stock Exchange and Nasdaq that if they wanted the WeWork listing, they would have to ban meat and plastic in their cafeterias.

The weirdness surrounding the IPO was in keeping with the circus environment Neumann built around WeWork. At other times, he told friends he would run for "president of the world"... that he wanted to live forever... and that he had ambitions of being "the world's first trillionaire."

WeWork never did go public, of course. And Neumann-bashing has become a bit of a national pastime. But keep in mind, Neumann is not the only character in the story...

There's also Japanese billionaire Masayoshi Son and a bunch of rich Saudi investors.

Son is the CEO of Japanese banking colossus SoftBank. He also heads the company's Vision Fund – the world's largest venture capital fund.

Son has escaped the WeWork mess with far less media scrutiny than Neumann, who's often portrayed as an incompetent, greedy, spoiled brat. But picking through the wreckage of the WeWork IPO, I was stunned to realize... We should all be more like Adam Neumann.

Before I explain myself, let's start with a little heresy...

The first thing to know is that WeWork's basic business model actually works.

The company enters long-term leases for office spaces, gussies them up, and rents them out on a short-term basis. That's not innovative, and various companies have made it work over the past few decades.

Its undoing began in 2017. Back then, Neumann was an eccentric entrepreneur looking for funding. Son was flush with cash after raising $100 billion for his Vision Fund, more than half of which came from the sovereign funds of Saudi Arabia and Abu Dhabi.

Son set about giving entrepreneurs far more money than they were looking for. He figured that if a good business requires $10 million in funding... then it can be a great business if you give it $100 million. And Son thought WeWork could be a great business.

WeWork "had been on a more sustainable path until Son and SoftBank showed up in 2017," New York magazine reported. He "told Neumann to make WeWork 'ten times bigger than your original plan.'"

According to the Wall Street Journal, "Neumann has told others that [Son] appreciated how he was crazy – but thought that he needed to be crazier." The Financial Times quoted Neumann as saying, "He came in and said, 'Woah, woah, woah, wait. Why [target] only a million [tenants] when you can have 5 million?'" (At the time, WeWork had around 100,000 tenants, which it calls "members.")

Backed by Son's cash, WeWork's annual revenues grew from around $400 million to around $3 billion. That sounds great until you read its S1 and discover that during the first six months of this year, the company's operations incurred around $3 billion in costs against $1.5 billion in revenues.

From an operational standpoint, $2 went out for every $1 that came in. Since 2016, the enterprise has burned around $4 billion in cash.

As the profits fell, Son responded by funneling more and more money into the business – $9 billion between August 2017 and January 2019. Son made his last investment at a valuation more than double that of the previous rounds – $47 billion in January 2019 versus $21 billion in November 2018.

That suggests that Son thought WeWork's value increased 133% over a two-month period, despite the company losing cash at an ever-increasing rate. But here's the thing...

As Son recklessly threw good money after bad...

Neumann was selling shares at almost every opportunity...

In nearly every round of funding between 2014 and 2018, Neumann sold part of his shares. According to the Wall Street Journal, he also "took out loans of several hundred million dollars backed by WeWork shares," and then used that cash to buy buildings... which he leased back to WeWork.

There's been much speculation on how he spent the rest of the dough. Among other things, he and Rebekah appear to have spent $90 million on a collection of six homes around the country.

Neumann also found other ways to wrangle cash out of the business. He changed WeWork's corporate structure to maximize tax benefits for early investors. He copyrighted the word "We," changed the company's name to The We Company, and sold the trademarked name back to the business.

It was crazy.

Unfortunately for Son, it turns out potential IPO investors don't consider 'craziness' to be a marketable attribute...

As details of Neumann's exploits emerged, potential investors turned away. To reassure them, Neumann voted himself out as CEO. And he agreed to reduce his voting rights to three times the voting rights of others (down from an absurd 10-to-1).

It didn't work. Potential IPO investors didn't bite. By October, WeWork was facing extinction. The billions of IPO dollars were off the table. The banks, hedge funds, and distressed-debt shops were not interested in extending the company a lifeline.

Meanwhile, Neumann still controlled the company... He owned around 30% of the shares – each with three times the voting rights of other shareholders. As it turns out, those voting rights were the most valuable part of the entire company.

In the final week of October, Son tried to save his investment by committing nearly $10 billion to clean up the mess. This bailout broke down as follows...

• $5 billion loan to WeWork
• $1.5 billion equity investment in WeWork
• $2 billion to buy out early-stage investors
• $1 billion to buy a third of Neumann's existing shares
• $500 million to Neumann to pay off the debts he incurred borrowing cash to buy all those houses.
• $185 million consulting fee to Neumann

Note that only $6.5 billion (the first two bullets) went to bailing out WeWork – and $5 billion of that will need to be repaid at some point. The rest of the $10 billion will go to early investors – primarily Neumann.

In exchange for the payday, Neumann agreed to give up his "super-voting control" shares. He'll just be another shareholder... and will no longer control the business he started. Nearly $1.7 billion was essentially a payment for Neumann to sit down, shut up, and go away.

Neumann remains a popular whipping boy in various media outlets...

The terms "crook" and "fraud" get thrown around a lot. I don't think that's entirely fair... None of his actions are obviously illegal, and all had board approval.

Before I hold myself up for ridicule, let me stipulate... If Neumann is often portrayed as a greedy, spoiled loon, it's because he behaved like a greedy, spoiled loon.

He acted with extreme self-interest... defended his business model using shoddy, unaudited numbers that were obviously ludicrous (but not falsified)... and generally behaved like an entitled brat. So he got what was coming to him.

But so did Neumann's main victims – Son, the egocentric Japanese billionaire, and the sovereign wealth funds that enabled the whole charade.

Son's SoftBank and Vision Fund have paid nearly $20 billion in cash to own 80% of WeWork, which is now valued somewhere between $5 billion and $8 billion. That's a truly horrendous return on investment. Son's investors are down at least 70% so far.

Neumann's saga leaves investors like us with three key lessons...

First, as investors, we should always keep an eye on who controls a company's voting rights... especially when investing in startups.

If you're mad that Neumann got $1.7 billion for selling his voting rights, blame the investors who allowed him to accumulate those voting rights in the first place. Any investor – especially Son – could have pushed back on Neumann's controlling shares before they ponied up cash to invest. They didn't, and they paid dearly for that error.

Super-voting rights are not unusual. These days, it happens almost every time an entrepreneur takes a company public. Founders like to sell a bunch of shares and get a huge payday. But the shares they keep have super 3-to-1, 5-to-1, or even 10-to-1 voting rights... so they maintain control of the company despite selling their shares.

Facebook (FB), Alphabet/Google (GOOGL), Snap (SNAP), Lyft (LYFT), Uber (UBER), Pinterest (PINS), and dozens of other IPOs from the past decade feature owner-weighted, super-voting structures.

Before investing in a business, make sure you understand who really controls it... Absolute control consolidated in the wrong hands can bring down an entire company.

The next lesson is great news...

The market can recognize junk when it sees it...

As recently as April, the WeWork IPO was a foregone conclusion.

Plenty of shaky businesses had already gone public. There was no reason to doubt that the market would suddenly reject the madness. The only question was how much money the offering would raise...

Since then, we've learned that the market is indeed capable of rejecting valuation fallacies. This is a huge win for passive investors. For the first time ever, the market's gatekeepers said no to an IPO that stood to generate hundreds of millions in fees for investment bankers.

The final lesson is more controversial...

We can all learn one important thing from Neumann...

Neumann's words suggest that he's a loopy windbag. But his personal financial statements reveal a guy who's smart enough to know a bubble when he sees one.

For months, this puzzled me.

Neumann seemed to believe the nonsense he was spouting. He is reportedly despondent about how his company has imploded. But if that's the case, then why wasn't he buying more shares as the WeWork bubble inflated? Why was he constantly selling?

It takes more than an egomaniac cheerleader to inflate a bubble. It takes billions of dollars in capital. Since 2017, the capital that inflated the WeWork bubble has primarily come from one man – Masayoshi Son.

Now, the bubble has burst...

Son is left holding a bag full of garbage that nobody wants to buy. But Neumann has six houses, stakes in other startups, commercial real estate investments, and still owns 20% of WeWork. You can call Neumann a loopy windbag... but you can't call him stupid.

Neumann was wrong in so many ways...

The WeWork business model, as applied by Neumann, didn't work. He believed Son's ill-conceived hype. He misjudged the market's willingness to put up with his control-freak tendencies. And the way he used WeWork as his personal piggybank was, at the very least, distasteful.

But as his behavior became more erratic, his rhetoric became more outlandish, and his ego became impossible to manage... he just kept clipping profits.

There's a lesson here. If you're bullish on an investment that keeps going up... maybe you should "pull a Neumann" and continue to clip profits along the way. After all, your bullish stance may be wrong.

Here's what that means for you...

We're 10 years into a raging bull market. All long-term market participants are sitting on huge gains. Is there more to come?

In Stansberry Venture Value, I focus on the smallest part of the market – typically speculating in companies with market caps less than $300 million.

Heading into 2020, I think there's a great chance that the market will remain strong. I am optimistic about finding outstanding investments and speculations among some of the stock market's smallest companies. But I'm also realistic...

My optimism could be misplaced. A correction could be imminent... The market could be headed for a full-blown collapse (though I doubt it).

As I weigh these options, I find myself thinking of Neumann. He was wrong... but despite his optimism about WeWork's prospects, he dutifully took profits along the way. For a value investor like me, Neumann is an odd market exemplar. But here we are.

It was largely with Neumann in mind that, in the November issue of Venture Value, I told my subscribers that we would be selling off a third of our portfolio positions before the end of the year. Cutting some losses here and there, for sure. But mainly, we would be locking in profits on some of our best-performing positions.

In November, we sold out on three huge winners. I'm optimistic on the outlook of each of the companies... But the quick and easy gains were in, so I took what the market had already given us.

I sold three more positions in our December issue... and scaled back holdings on another big gainer. As Neumann proved, it can be prudent to take profits during a bull market, even if you're still enthusiastic about a business' prospects. Our slimmed-down portfolio will free up some "dry powder" for new opportunities in January and beyond.

The end of the year is a good time to look hard at your winners and ask some tough questions...

Has the easy money been made? Is it possible that the current price reflects undue optimism? If you still like a company whose shares are up substantially, does it make sense to sell a partial position? And perhaps most important... If I'm not selling today, at what price would it make sense to sell this stock?

The WeWork debacle was epic. Business schools will be talking about it for years. Neumann will go down as the biggest financial bozo of 2019. To some extent, that's deserved.

But I submit that Son, not Adam Neumann, was the real loser.

And so, as you head into 2020, happily riding a 10-year market move higher... look at your portfolio and ask: Would I rather be a Neumann or a Son?

New 52-week highs (as of 12/18/19): Alibaba (BABA), Blackstone Mortgage Trust (BXMT), CBRE Group (CBRE), WisdomTree Emerging Markets High Dividend Fund (DEM), iShares Select Dividend Fund (DVY), Electronic Arts (EA), New Oriental Education & Technology (EDU), Equinox Gold (EQX), Hannon Armstrong Sustainable Infrastructure Capital (HASI), iShares Russell 2000 Fund (IWM), Masco (MAS), Nordic American Tankers (NAT), New Pacific Metals (NUPMF), Nvidia (NVDA), Pan American Silver (PAAS), Invesco S&P 500 BuyWrite Fund (PBP), Invesco High Yield Equity Dividend Achievers Fund (PEY), ProShares Ultra Technology Fund (ROM), Southern Copper (SCCO), ProShares Ultra S&P 500 Fund (SSO), TAL Education (TAL), ProShares Ultra Russell 2000 Fund (UWM), and Vanguard S&P 500 Fund (VOO).

Today's mailbag is overflowing with feedback about yesterday's Digest on "The Things They Don't Teach You in School." What's your story? How did you get started investing? E-mail us at feedback@stansberryresearch.com.

"Great work on why most Americans are financially stupid. It starts with the parents. You cannot count on the schools to cover this. We gave our three kids a checking and savings account when they started 7th grade. No allowance. If you wanted money 'in' there [you did chores] and labor for neighbors. We did 'pay for grades.' An A gets X, a B gets Y, you pay me below that. We did give a clothing allowance at the start of each year, you must buy X pairs of underwear and socks, pants, shirts and shoes. After that if you want the pricey Polo shirt go ahead (or get five shirts for the same price). We furnished a car at age 16 and basic liability-only insurance. You are in a wreck, well there are bicycles in the garage as replacements. Gas is on you. Housing and meals are free.

"How did it work out? The boys are now 42, 38 and 36. The lowest 'retirement savings rate' between them is 26%. All own a home (yes there are mortgages and they are paying extra on 15-year mortgages, not counted in the retirement savings above). Two are entrepreneurs with their own businesses. The third has a great job at a firm handling major defined benefit and defined contribution plans. One got a five-year full ride to any state school in our state. He then got accepted to the AI master's program at Stanford and got the medical school to cover the cost as a 'link' between the genetics/genomics group and the computer science group. None have asked for anything since leaving college. All are financially literate and responsible, no 'entitlement culture' at our house.

"Stop waiting or blaming the schools, folks. If it is that important then do it yourself. As George Peppard said in the A-Team 'I love it when a plan comes together'." – Stansberry Alliance subscriber Steve B.

"Corey: Today's Digest, "The Things They Don't Teach You in School" invited our stories on our investing origins. Well, I've got one for you. When I was about 8, my dad invited me to buy three stocks. I'd saved my allowances and chores money. His deal was he would cover the costs of purchase (commissions), and would guarantee I wouldn't lose money.

"As I recall, I had close to $150 to invest, my entire fortune. I bought one share each in Kerr-McGee, Massey-Ferguson, and in Columbia Broadcasting Systems. I received the gorgeous stock certificates, each for one share, kept them in my lock box, would get them out and look at them, and received tiny dividend checks. I watched the prices on the stocks, knew how much I was up (dad never had to make good on the guarantee), and finally, about seven years later, sold them and bought others. The purchase was about 1964, the sale was about the time Nixon took us off the gold standard, [and I] bought South African gold stock ADRs, which also worked out well.

"I've owned stocks of one kind or another every day since then. Was one of the greatest learning experiences a kid could ever be given. Was a lesson I never had the opportunity to thank my dad for." – Paid-up subscriber Walt H.

"My dad told me, when he was middle-age and deep into his engineering career, that he wished he had started investing earlier. But he didn't bother to teach me anything about it. And I didn't learn anything about investing or finance in gaining an engineering degree and then a doctorate in applied math from first-rank schools. What saved me was that I became a science reporter, and so learned about an early biotech discovery in the 1970s that I knew would be transformative. So I sought out investing newsletters and put $1,000 (all I could afford) on each of three small companies. One failed, one went nowhere, and the third was Chiron, which I sold somewhere after 50x. I was hooked. So in the 1980s I invested in biotech (still on a small scale); in the 1990s, having had advance knowledge of the Internet, I put my kids through college on Intel and then Cisco. (I managed to sell Cisco right at its peak.) But I didn't really learn to be a thoughtful investor until I became an Alliance member and began to absorb the wisdom that Porter, Doc, and Steve had to offer." – Stansberry Alliance member Al H.

"I was very lucky to have parents who instilled savings in me and my three sisters at a very young age. We received a dime, a grade, a week, allowance for doing our household chores. Saturday morning we ate breakfast. After breakfast dad came downstairs and put our savings account books on the counter and then put our allowance on the counter. We then went to the savings and loan and half of our allowance was deposited in the savings account. Yes, we were making five- and 10-cent deposits in the mid 60s. We got $5 from grandma for our birthday and the next morning half was in the savings account.

"I remember when I was around 12 (seven years of training on half the money goes into savings). I was in the store with my best friend. I was building plastic model airplanes and he was building plastic model cars. We were trying to decide which one we were going to get next. He made a comment about spending his birthday money. I said something like 'You mean you are going to spend ALL of your birthday money?' He said, 'Yeah why not?' I said, 'You mean you aren't going to save ANY of it?' He said, 'Save it for what?' It was at that moment that I realized my best friend had no idea about what money was all about. I didn't fully appreciate the education about saving until years later but it was at that point I understood different people had totally different ideas about how to handle money." – Paid-up subscriber Jeff H.

"In Wed. article you wrote: 'Finance should be a mandatory class in high school, according to Anderson. (I countered with middle school.)'

"I would agree that most adults never received formal financial education. However for too much of America, including Baltimore, the problem is much more basic. Many did not achieve a meaningful level of education. Since basic arithmetic and reading are beyond their achievement, much of financial education would simple be incomprehensible.

"But there is hope for the future if America reorganizes its primary education on the format proved by this year's winners of the Nobel prize in Economics. These researchers discovered that massive improvements in educational achievement occur when: 1) children are tested for their achievement in the third grade, 2) they are then placed in classes with other children with similar achievement and taught at their appropriate level, 3) they receive individual tutoring in their problem areas.

"Of course all of this directly contradicts federal education guidelines and all the PC preaching of uneducated educators." – Paid-up subscriber Kendrick M.

"I took my savings in 1966 and invested in an odd-lot (30) shares of General Instrument. The stock was rising daily while I was working my way through college. In 1973 I became a financial consultant and taught my middle-class clients how to invest. Over a 40-year career I made my clients into millionaires. No account was too small. I totally agree that capitalism and investing should be a mandatory course in high schools and colleges." – Paid-up subscriber Vincent W.

"All well and good that your readers are lifelong learners, but the issue you portrayed with our generic financial knowledge deficit is serious. Some collective 'we' will continue to be asked to foot the bill, i.e. treating the symptom but not the disease. That's clearly impossible over the long term. So what is the idea for which we might become advocates? Most of us take a defensive posture on issues such as this, but that is ultimately doomed as well. Look forward to the daily editorials. Thank you." – Stansberry Alliance subscriber Arlene A.

"So amazed everyday with the great content. I'm currently spending too much vacationing the world, though this year plan a Lifetime membership. The tools and knowledge gained is overwhelming. As far as a story, it started with BP stock falling in toilet after the Macado well blew! I was a Stansberry subscriber and had invested some money with recommended picks. I sold everything and dumped a ton of capital on BP stock when it fell around $20. Six months later the stock had recovered! I was hooked after that and wanted to learn everything I could." – Paid-up subscriber Wayne C.

Regards,

Bryan Beach
Baltimore, Maryland
December 19, 2019