IPO Report: China’s answer to WeWork files for IPO and it feels like deja-vu all over again

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Ucommune Group Holdings Ltd., a Chinese office-sharing company, has filed for a U.S. initial public offering, undaunted by the collapse of U.S. rival WeWork’s effort to go public in September.

The four-year old office-sharing company, which started life in Beijing, will inevitably draw comparisons to WeWork parent, The We Company, which was forced to cancel its IPO after the paperwork revealed huge losses, high leverage and questions about corporate governance.

Ucommune’s prospectus shows a number of parallels with WeWork, albeit on a far smaller scale. For one thing, its business model is exactly the same as WeWork’s.

Ucommune makes money by leasing space from landlords, and then refurbishing and renting it to the millennial, Gen-Z and other workers that have embraced the co-working trend. It also offers services like catering, fitness, health care and training, along with a host of more conventional office functions like payroll, in return receiving member fees or sharing revenue.

Just like WeWork, Ucommune has long-term liabilities in the form of leases that exceed the length of rental agreements with members, leaving it exposed in the event of an economic downturn.

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Like WeWork, Ucommune is planning to list with a dual-class structure that will ensure its Founder, Chairman and Chief Executive Dr. Daqing Mao, will control most of the voting rights.

Like its U.S. rival, it’s experiencing rapid revenue growth but has yet to post a profit.

As of Sept. 30, the company had 197 co-working spaces across 41 cities in Greater China and Singapore. It had 171 spaces in operation, providing approximately 72,700 workstations to members and had 26 spaces under construction or preparation for construction.

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But the company is facing more challenges than just the likelihood that the WeWork fiasco remains fresh in the minds of investors. It is attempting to go public in a bad year for Chinese IPOs, according to Kathleen Smith, principal at Renaissance Capital, a provider of institutional research and IPO exchange-traded funds.

The Renaissance IPO ETF IPO, -0.05%  has gained about 30% in 2019, outperforming the S&P 500’s SPX, +0.09%  26% gain. The average IPO is up 15.2%, but the 22 Chinese companies that went public this year are down 18%, she said.

“Investors are worried about growth in China and overall financial conditions,” said Smith.

After WeWork, the IPO market went through a pullback as investors began to reassess the ‘new economy’ financial model and push back against companies with high private valuations but shaky underlying financials, Smith said. She cited as examples Uber UBER, -0.07%   and Lyft LYFT, +1.18%, the two big ride-sharing companies that saw their shares tank after IPOs amid concerns about losses and the lack of a clear path to profitability.

James Gellert, chief executive of RapidRatings, a data and analytics company that assesses the financial health of private and public companies, said the timing of the deal is also unusual, coming in the last two weeks of the year when the IPO window is shutting down.

“When you see a company coming to market at a bad time of year, there’s obvious hair on the deal, it’s in an industry the market doesn’t like and looks like another company that others didn’t like, there’s only one reason, that you desperately need money,” he said.

The company has offered few details of how much it plans to raise, using the placeholder sum of $100 million. It has applied to list on the New York Stock Exchange under the ticker symbol “UK.”

Here are five things to know about Ucommune ahead of its IPO:

It has never made a profit and concedes it may never do so

Ucommune, like WeWork, has never made a profit. In the first nine months of the year, the company’s net loss came to $80.2 million, wider than the $62.3 million loss posted for all of 2018. Revenue rose to $122.4 million in the nine-month period, compared with $62.7 million for all of 2018.

By comparison, WeWork disclosed losses of $909.8 million in the six months to June, when it filed paperwork earlier this year, wider than the $722.9 million posted in the year-earlier period. Revenue of $1.5 billion was about double the year-earlier’s $763.8 million, but was less than expenses that totaled $2.9 billion.

For more on WeWork, click here.

Ucommune is still in an investment phase as it works to build out its network and upgrade technology systems. “These expenditures may make it difficult for us to achieve profitability, and we cannot predict whether we will achieve profitability in the near term or at all,” the prospectus cautions.

Smith from Renaissance calculates that Ucommune has more negative margins than WeWork, losing about 68 cents on every dollar of revenue, compared with just 50 cents at WeWork.

Gellert from RapidRatings said an analysis of the company’s financial health, which looks at one-year short-term default risk and viability, assigned it a rating of 28 out of 100, placing it firmly in the high-risk category. The company’s core health rating, which looks further out at underlying efficiencies, gave it a rating of just 18 out of 100. Even WeWork has a core health rating of 38, said Gellert.

“It’s also more indebted with a debt-to-equity ratio of 1 times, compared with WeWork’s 0.74 times,” he said. “It’s smaller, but it’s not a better company.”

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U.S. investment banks seem to have shunned the deal

Ucommune’s IPO is being underwritten by five Chinese banks, Haitong International, China Renaissance, The Core Securities, Prime Number Capital and CRIC Securities.

Two underwriters that were named in earlier paperwork filed in November of 2018, Credit Suisse and Citigroup, were not included in the prospectus, with Reuters reporting this week that they walked away from the deal, balking at its desired valuation.

“It’s unusual to attempt a U.S. listing with no U.S. banks,” said Gellert. “It looks as if they are not anticipating getting a lot of U.S. investment, or even trading, as you need those banks’s support. The listing may be more about brand and marketing awareness than capital markets logic, but they may have a tough time getting a groundswell of excitement.”

Like WeWork, Ucommune has some possible conflicts of interest

WeWork’s prospectus included the nugget that it had engaged in transactions with related parties that could present possible conflicts of interest, not least the properties that were part owned by Neuman, or leases involving other board members.

Ucommune has the same risk factor.

“Certain of our officers and directors are now or may in the future lease the building spaces they own to us or have other transactions with us,” says the prospectus. It cites as examples, spaces leased from Youxiang Group, an affiliate of Founder and head Dr. Mao.

“Those related parties negotiated satisfactory terms that are in the best interests of their businesses as a whole, which may not necessarily be aligned with our best interests,” it continues.

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Its auditor is not inspected by the PCAOB

Because Ucommune is based in China, its auditor is not subject to inspection by the Public Company Accounting Oversight Board. “As such, you are deprived of the benefits of such inspection,” says the prospectus.

What’s more, the company is not planning to pay dividends any time soon, meaning investors must relay on stock price gains for returns.

It has the risky corporate structure that is typical of Chinese IPOs

Like other Chinese companies with listings outside of China, such as Alibaba Group Holding Ltd., Ucommune is a variable-interest entity, or VIE, a structure created in the 1990s as a work around for Chinese companies not allowed to have direct foreign ownership.

Under the VIE structure, the Chinese company creates two entities, one in China that holds the permits and licenses needed to do business there and the other an offshore entity, in this case in the Cayman Islands, in which foreign investors can buy shares. The Chinese entity, which is usually owned by top executives, pays fees and royalties to the offshore company in contractual arrangements. The risk is that foreign investors don’t actually own stock in the company, and local management or even the Chinese government could force a split with the listed company, leaving U.S. investors high and dry.

“Our public shareholders may have more difficulty in protecting their interests in the face of actions taken by our management, users of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States,” says the prospectus.

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