International Workplace Group
Like WeWork but with less free beer and more free cash
Credit to Yaron Naymark of 1Main Capital and Uzo Capital who have previously discussed this idea
Not financial advice, for entertainment and research purposes only
Ticker: IWG.LSE
Market Cap: GBP 1.8Bn
Share Price: GBP 1.75
Thesis in a Nutshell
IWG is undertaking a structural change in its business model to a capital-light operator/management business. Future growth will be driven by a revenue royalty vs. IWG’s historical capex heavy growth model, leading to an inflection in free cash flow
Growth capex has fallen ~85% from $467m in 2019 to $60m in 2024
One off working capital impact from change to prepaying quarterly rents in 1H 2024 obscuring progress YTD
New segment comps to cap-light hotel operators (e.g. Hilton) which have >50% EBITDA margins
Market not yet giving credit for developing success of new cap-light business model which is growing at 50% YoY as a result of a ~18 month delay from client signing to financial contribution
Core business recovering strongly from post-COVID slump, 1H 24 EBITDA +13% YoY with room for margin expansion to historic norms (and above) through rationalisation of underperforming centres + new higher margin cap-light model
Downside protection through still depressed valuation at 5x 2025 EV/EBITDA / 12% FCF yield, with strong potential for margin re-rating as capital light model is proven out
Company projected to hit 1.0x Net/Debt / EBITDA target in 1H 2025 and has committed to starting material capital returns program thereafter
WeWork (now bankrupt) was previously depressing sector wide returns on capital as a result of its unprofitable leasing model
IWG is operating in a sector with a secular growth tailwind (transition to hybrid work) and is by far the largest and most scaled player globally (120+ countries) which lends significant network effects alongside a meaningfully improved competitor landscape post WeWork bankruptcy
Business overview
IWG is the global leader for flexible office / co-working space with operations across >3,500 locations in 120 different countries and 50% of its revenue from North American operations. Similar to the hotel industry, IWG has a range of brands that cater to different market segments / geographies including Regus, Spaces, HQ and Signature. IWG’s global scale is a key differentiator from its competitors, particularly for enterprise customers who highly value a partner with global coverage as evidenced by its client roster which contains >80% of Fortune 500 companies.
Whilst often compared to WeWork, IWG was founded in 1989 and has a long-term history of profitability - demonstrated by founder and still current CEO Mark Dixon maintaining a 25% stake in the business (which would be impossible if the business was reliant on continued capital raisings to function).
Notably, IWG has a long-term track record of profitability and maintained positive EBITDA margins in the depths of WFH / COVID.
Post COVID, IWG’s margins are strongly recovering and the company is benefitting from a structural tailwind in the broad shift towards hybrid work (which necessitates flexible office space). In CBRE’s 2023 US Occupier Sentiment Survey, 62% of respondents noted that they were executing or negotiating with their landlords for the right to have flexible expansion and contraction options within the terms of their lease. Similarly, the still-high rate of office vacancies has made landlords increasingly amenable to providing flexible office options.
IWG’s business is comprised of three core segments;
Company Owned & Leased (88% of Revenue): this is IWG’s main business line and driver of earnings, and is comprised of co-working / flexible office spaces where IWG either owns or is the master leaseholder.
Managed and Franchised (1% of Revenue): a nascent business but a primary growth driver moving forward. This is a capital-light version of the CO&L business in which instead of owning / leasing the office space, IWG acts as an operator only for building owners (who pay all capex and operating costs) in return for taking a 16% cut of revenue under a 10 year contract. IWG is fully committed to this model going forward, with the M&F segment representing 95% of new centres opened in 1H 2024.
Worka (11% of revenue): a combination flexible workspace marketplace / services platform through which individuals and businesses can book flexible working space + other services. 50% of revenue comes from its ‘virtual offices’ segment whereby a company can use an IWG as a registered office address and also get mail forwarding / receptionist services + ad hoc use of meeting rooms onsite. Worka is an independently managed subsidiary and could potentially be spun out of IWG in the medium term. This business has disappointed in recent years but still maintains ~40% EBITDA margins and is expected to grow at MSD in the medium term.
Shift in Strategy
The main factor in IWG’s attractive investment case today is their shift in strategy from the highly capital intensive CO&L segment, to their royalty based M&F segment. Historically, almost all cash generated by the business would be absorbed by growth capex. Going forward, this surplus cash will be directed into capital returns to shareholders which is expected to commence in 1H 2025 once the company hits its target 1x Net Debt / EBITDA ratio. Significantly, IWG can pursue these capital returns without reducing growth via its partner led M&F segment.
It is important to note that building owners are fronting potentially millions of dollars in capex to launch these locations and agree to 10 year contracts. As a result they are highly incentivised and committed to making the model work.
Historical Operating Cash Flow vs. Total Capex (US$m)
Note: LTM OCF impacted by ~$120m one off impact from pre-paying quarterly office rents
Historical Growth CAPEX ($USm)
Business Performance
Alongside IWG’s new strategy, the underlying business is starting to inflect positively due to;
An ongoing recovery in CO&L post COVID
M&F contributions starting to flow through to the income statement, with there being a ~18 month period between initial signing and material earnings contribution
As a result, we have an attractive combination of increasing earnings, reducing Capex spend, significantly reduced capital requirements to sustain growth, and a commitment to return free cash flow to shareholders. Looking forward, management have repeatedly communicated a medium term target EBITDA of $1Bn. Even falling well short of this goal would result in an attractive outcome, with IWG currently trading at 5x 2025 EV/EBITDA / and a ~12% FCF yield.
Recent 1H 24 earnings showed the business progressing as expected towards this goal, with M&F fee incomes increasing 23% YoY (+ rooms opened +52%) and business wide EBITDA +13% (in constant currency terms).
There was however a fly in the ointment in the form of a one-off expansion in working capital as a result of IWG shifting to prepayment of rental expenses in order to secure better terms that had the impact of reducing FCF by ~$120m.
Progress in the M&F segment can be seen in new centre / room openings, with rooms signed increasing 50% YoY and rooms opened increasing 160% at 1H 24. The lag in associated fee income is a result of the 10 month gap between signing and opening, and then a further ~12 month period until maturity.
M&F Segment Rollout
Why does this Opportunity Exist?
~$90m selldown from founder / CEO Mark Dixon in May spooked market, not viewed as a concern given he retains ~25% of the company and had a need for liquidity (has a number of other business interests)
Largest institutional investor (Toscafund) has been progressively selling down holding to fund redemptions (this has reportedly now completed)
Investors aren’t willing to credit capital-light management business until the model is more proven
Interestingly, Yaron Naymark of 1Main Capital (has 20% of his fund in IWG) performed a survey of 50 building owners who were IWG clients and found an overwhelmingly positive view of the success of their IWG partnership to date.
Only 7% ranked the experience as 2 or below on a scale of 1-5
“Vast majority of respondents ranked IWG as a 4 or 5”
Signings and openings are continuing to accelerate, albeit take ~18 months to flow into the financial statements
Poor historical disclosure in addition to changing accounting rules (IFRS 16) and reporting currencies have made for a very complex set of historical financial statements
Bankruptcy of WeWork and impact of COVID on office makes investors highly sensitive to IWG’s lease-risk, despite IWG structuring its operations in bankruptcy remote SPVs with no recourse to the parent or having the option to terminate leases within 6 months.
This has been cheap for years, what has changed?
Momentum in Managed and Franchised: growth in IWG’s capital light M&F model is accelerating, as of 1H 2024 rooms opened increased 164% YoY with 37k rooms opened (~$18m annualised revenue at maturity), impact soon to be recognised in financials given 18 month delay between signing and meaningful contribution
Transition to USD accounting: simplifies business financials and is appropriate given ~50% of earnings are USD denominated
Free Cash Flow Improvement: company generated strong free cash flow in 1H 2024, however this was partially obscured by a decision to prepay quarterly rental expenses (~$120m impact) in order to get better terms
Capital Returns: IWG is projected to reach their Net Debt / EBITDA target of 1x (currently at 1.4x) in 1H 2025, after which management have committed to capital returns
Improvement in reporting disclosure: new IR team have significantly improved quality of disclosure, albeit historical adjustments / inconsistency of reporting is still a major hurdle for many investors
Transitioning to US GAAP: expected to occur within the next 12 months, will enhance IWG’s screening given current treatment of lease ‘debt’ under IFRS. Also a potential for a US listing in the medium term
Bankrupt of WeWork has significantly shifted the competitive landscape in IWGs favour
Overhang from major shareholder sales cleared
Key Risks
Failure of M&F model: while early indications are positive, future growth is dependent on the successful rollout of IWG’s franchising model which is still in its early innings. If IWG is unable to execute on a structure that is profitable for itself and its partners, then growth prospects will be significantly impaired
Excess supply in office market from ongoing WFH impact has the potential to depress margins marketwide
Continued competition from local players and/or building owners who opt to offer flexible space ‘in house’
Relatively opaque financial reporting blurs historical profitability and cash generation capacity of the business - albeit this has improved in recent reporting periods
Flexible contracts from underlying customers ensure that IWG office space will be a target for cost reductions in the event of an economic downturn
Valuation / Projections
I model IWG reaching its target leverage ratio in 1H 2025 with excess cash flows used for share buybacks at this point. FCF growth driven by operational leverage + ongoing reduction in amortization of landlord contributions and growth capex. There is additional upside beyond this as I model 0 positive impact from working capital contribution as a result of new lease sign-ups.
Notably, IWG is targeting a medium term goal of ~$1bn in EBITDA, assumed to be reached in 2029-2030.
In terms of fair value, historically the business (pre transition to capital light) traded at a ~7-9x EBITDA (pre COVID), and pure play royalty comps (such as Hilton) trade at 15-20x. While this is still very much a ‘prove it’ story until the M&F section is generating material cashflow, I believe the business today at least warrants the lower end of its pre COVID trading range (~60% upside), with the capacity for significant upside above this as and when IWG transitions to a capital light model given the major improvement in free cash flow conversion that this would unlock.
Conclusion
IWG presents an attractive set up in my mind for three key reasons;
IWG currently benefits from structural tailwinds in the form of a major increase in demand for hybrid office space + a weakening competitive environment post the dousing of the WeWork cash bonfire
There is building evidence that after years of anticipation, IWG’s shift to a royalty focused business is gaining traction (accelerating room signings and openings)
This structural shift is not being priced in today by a long suffering investor base, and downside is protected through IWGs already depressed valuation, giving a strong margin of safety combined with multi-bag potential as FCF inflects
Disclaimer
Do not interpret anything above as financial advice. This article has been prepared for informational & educational purposes only. The writing contains certain forward-looking statements and opinions which are based on the Author’s analysis of publicly available information believed to be accurate and reliable. These statements and opinions are subject to unknown risks, uncertainties and other factors that could cause actual results to differ materially from those projected. As of the date the Report is published, the Author holds a position in the security mentioned. Nothing in this Report constitutes investment advice. Readers should conduct their own due diligence and research and make their own investment decisions.