Where Are the Moats? (Revisited)
November 22, 2019 | James Sprow | Blue Vault
In our November 13 Blue Vault article entitled “Where Are the Moats?” we pointed out that two of the biggest multi-billion dollar start-ups were vulnerable to competition, and hence, over-valuation because their business models were not based upon defendable markets. Warren Buffett coined the term “moats” as an illustration of what successful businesses need to build value over time. A moat can be any factor that a business owns or controls that competitors cannot duplicate. In commercial real estate, we can readily identify one key factor that can make one property more valuable than another and that cannot be duplicated: location. In other businesses, the moats can be patents, exceptional management teams, economies of scale, or any number of other unique attributes.
In the recent article we said:
“WeWork became a billion dollar company by leasing office space around the U.S. and turning it into flexible, short-term work spaces with amenities like shared spaces, coffee bars and other trendy features. Uber became a billion dollar company by enlisting free agent drivers and providing them with the software that connects them to people who need a ride, allows them to drive when and where they want to in their own vehicles, and get paid quickly. But neither company has a moat. Neither company was so unique or had such unique and irreplaceable assets that competitors were effectively shut out of their respective markets. Other companies can lease office space and turn it into flexible work space with amenities and short-term tenant rental commitments (e.g. Regus and at least 22 others). Other companies can link free-agent drivers with people who need a ride or want something delivered (e.g. Lyft, Curb, Grab, Ola, GrubHub, DoorDash, etc.). Neither the flexible office space concept nor the free-agent driver concept is patentable or otherwise protected from competition.”
Two news articles confirm what we suspected.
The Wall Street Journal reports that WeWork is laying off 17% of its staff, about 2,400 jobs, following its botched initial public offering. We Co., the parent company, had planned to raise up to $10 billion in equity and debt through its IPO. SoftBank, a Japanese conglomerate committed $6.5 billion in debt and equity in exchange for a nearly 80% ownership stake. At a recent briefing in Tokyo, SoftBank’s billionaire founder Masayoshi Son said this month’s financial results were a “mess” and that overvaluing WeWork was a judgment error. According to Bloomberg, “Son said that he had consulted with lawyers to see if he could back out of a $1.5 billion warrant SoftBank had pledged to WeWork, but they said he couldn’t. Instead, Son decided to buy even more shares at a discounted price, lowering the average cost of SoftBank’s equity in the business.”
Bloomberg reports on November 21 that Uber co-founder Travis Kalanick has sold almost $1.5 billion of his stake in Uber Technologies. Over three days last week, he sold about $578 million of stock, extending a series of transactions since a lockup ended November 6, and a November 11 filing signals Kalanick may sell his entire stake in the company. This divestment by Uber’s co-founder is hardly a vote of confidence in the long-term value or the future of Uber.
With both WeWork and Uber, we see an overconfidence stemming from the early success of a business concept, followed by a frothy valuation, followed by a failed IPO, followed by insider shareholders, who know more about the business than the public, seeking to bail out. The lesson here is: to have sustainable long-term value, a business must possess unique assets that competitors cannot readily duplicate. These are the “moats” that allow a business to protect its markets from competition and extract economic rents over time. Neither WeWork nor Uber has those moats.
Sources: Wall Street Journal, Bloomberg, Blue Vault
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*What is an Economic Moat?
Conceptualized and named by Warren Buffett, an economic moat is a distinct advantage a company has over its competitors which allows it to protect its market share and profitability. It is often an advantage that is difficult to mimic or duplicate (brand identity, patents) and thus creates an effective barrier against competition from other firms.
