A Potential WeWork Ch.11 Filing Could Be Influenced By Details In The Bankruptcy Code

wdstock/iStock Editorial via Getty Images. It is not surprising that WeWork (NYSE :WE) may file for bankruptcy in 2023. They have a failing business model and potential liquidity issues that could be impacted by the U.S. Bankruptcy code. WeWork was negatively affected by changes in how and where people work.
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They are still burning cash. Even if SoftBank offers to extend their debt maturities, that will not suffice to keep them out the courtroom. They could face a global recession that causes them to go bankrupt, at least in the U.S.
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My business partners would rent the entire first floor of a Manhattan commercial building and receive very attractive leasing rates due to their strong financial records. My business partners would divide the space into multiple units and then rent these at higher rates per square foot to other businesses. This often led to very good profits. WeWork leases large spaces in office buildings and offers desk space and offices for those who are unable or unwilling to rent traditional offices.
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WeWork's nine-month total revenue was $2.397 billion and its total lease expenses were $1.896 million. This resulted in a gross profit margin of $501 million. The $501 million didn't cover the $406 millions in additional costs at locations, $578million selling, general, and administrative expenses, or $116 million interest expense.
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WeWork reported a loss in the bottom line for the nine months. 3Q and 9-Month Income Statement-2022 & 2021 sec.gov. (Note that the 2022 results per share reflect a higher average number shares outstanding than 2021 due to the large number of new shares issued as part of the SPAC merger transaction. This effectively reduces the reported loss per shares. Results have been affected by less than stellar occupancy rates. It is not clear what level of occupancy would finally result in breaking even.
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Management seems to have a problem with optimum pricing of their services. Their already fragile operating model has been negatively affected by the dramatic shift in where businesspeople work now due to the pandemic. Before the pandemic, many businesspeople wanted a business location to call their business "home" and there was a certain perceived stigma if a new business operated out of someone's house/apartment/basement/garage
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This is no longer true. This stigma has been lifted as partners in major law and investment firms now work remotely. People used to want to have access to a conference room for meetings with customers.
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Meeting via Zoom is now a common business practice. A conference room is no longer a necessity. For a meeting, they can use the standard business lunch at a restaurant.
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They don't need WeWork services. WeWork has been closing down some of their locations, and they announced in November that 40 more would be closing. In Ch.11, the U.S.
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WeWork could accept or reject leases under section 365. This is an incentive to enter Ch.11 to restructure. In a recent article by Bed Bath & Beyond (BBBY), I discussed the details of leases and section 365. However, more than half of their offices are outside the U.S.
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The potential issues surrounding filing bankruptcy in the U.S.A and their impact on foreign operations are something I will be covering in detail in a future article.
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WeWork may require additional cash for operations. WeWork continues to burn cash. This is remarkable considering that WeWork received $800million (80 million shares) under a PIPE, and $333million from the SPAC trust accounts in October 2021 under a SPAC merge deal with BowX Acquisition Corp. They also received $150 million (15,000,000 shares) from Cushman & Wakefield.
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They used $645million cash to operate for the first nine months in 2022. Their cash position at September 30th is worse than it seems. Their cash position was reported at $460 million. However, if you add the $103 million accounts receivable to that number, and subtract the $496 million accounts payable, you only get $69 million
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This is a very troubling number.
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Is it possible that they are not paying their bills on time? In reality, those who owe money under accounts payable are actually helping WeWork's cash liquidity. What happens if the payment terms are more restrictive? Recharacterization of Debt into Equity in Bankruptcy: Balance Sheet sec.gov Many investors believe that SoftBank (OTCPK.SFTBYY) will lend WeWork more cash to keep it afloat. However, this assertion ignores certain details in the U.S.
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Bankruptcy Code. Bankruptcy Code. If WeWork files for Chapter 11 bankruptcy, that loan could, in my view, be recharacterized under section 105(a). This would put it in the same lowest recovery class under a Ch.11 plan as WE shareholders. This is obviously a complex matter.
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In bankruptcy court, claim holders (such as unsecured creditors) may argue that a new loan from SoftBank is really equity interest to ensure that they get a better recovery under a Chapter 11 reorganization plan. This is because if the loan is recharacterized to equity, it would lower the priority level to zero. It could be used by multiple stakeholders, including WE shareholders to negotiate better terms for their recovery. Problem is, the different federal courts have different interpretations about the bankruptcy court's authority to recharacterize the debt as equity under section.105(a).
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In June 2017, SCOTUS granted a writ de certiorari in a case called PEM Entities LLC v. Eric M. Levin (16-492). This would have provided some clarity about the issue.
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Because the parties settled the case within weeks of the writ being issued, the case was not heard by SCOTUS. This SCOTUS case is worth a mention. This case involved one of Eddie Lampert’s law firms
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Why was the case closed and not heard by SCOTUS. SCOTUS could have ruled that a bankruptcy court could easily decide under section 105 (a) to recharacterize equity. This would have had a very negative impact on Lampert, as he had made large loans to Sears Holdings, which might have been recharacterized equity if Sears filed bankruptcy. Because WeWork's headquarters are in Manhattan, I expect them to file for bankruptcy in the Southern District. A SDNY bankruptcy court did in 2021 recharacterize debts as equity interests in the Live Primary LLC Ch.11 case. (Oddly Live Primary was a startup company that shared office space. This decision was largely based on AutoStyle Plastics, Inc., 269F.3d 726, 747–48 (6th Cir).
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2001. requires that we look at a lengthy list of factors to recharacterize. However, the list is not meant to be used as a scorecard requiring each factor to be met. These factors include (1) the names of the instruments that are used to show the indebtedness; (2) the existence or absence a fixed maturity date, schedule of payments, and (3) the source of repayments. (4) The identity of the creditor and stockholder. (7) The security for the advances. (8) The corporation's ability and willingness to borrow money from outside lenders. (9) The extent to which outside creditors subordinated the advances to their claims; (10) How the advances were used in order to acquire capital assets. (11) The presence or not to repay the sinking funds to cover the repayments. SoftBank may argue that WeWork should not file for Chapter 11 bankruptcy as there is a high risk of recharacterization. This is because all the SoftBank debt could be recharacterized to be the lowest priority class, i.e. equity.
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Theoretically, claim holders could make that assertion, but I think it would be highly unlikely. SoftBank purchased the notes, and there were other financing activities taking place, including the $800 million PIPE transaction. (See #8 above.)
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To avoid this risk, terms must be very restrictive. This includes a very high rate of interest. It will make the loan look more like a loan to high-risk companies and not an equity transaction. The primary purpose of the loan is to increase cash flow and cash flow. Additional cash is required.
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SoftBank is likely to agree to extend any maturing debt. The key issue in a bankruptcy filing is not maturing debt. SoftBank seems unwilling to take the risk that any new loans made to WeWork could be treated as equity interest by a SDNY bankruptcy court judge, if WeWork files for Chapter 11.
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WeWork's failed business model continues to burn cash, and there is the possibility of bankruptcy filings, especially in the event of a global recession. I recommend that you sell WE stock.