The meteoric rise and spectacular fall of WeWork is one for the ages. To sum up: The real-estate leasing start-up, which incinerates money, was planning just two months ago to go public at a valuation that some thought would be as high as $47 billion. Once investors got a good look at its finances they couldn’t stop laughing.
The company instead needed a bailout from its biggest investor and now is valued, perhaps optimistically, at $8 billion. Maybe this episode marks the beginning of a sobering up of cash-burning growth companies with dismal unit economic. If that’s the case, what will that process look like?
Maybe the transformation of music-streaming service Pandora helps show how busted unicorns — closely held start-ups valued at $1 billion or more — can find new life.
When Pandora had its initial public offering in 2011, it was a tortoise-beats-the-hare success story, after it launched during the dot-com boom in 2000. It survived several near-death experiences, putting a damper on the cockiness and growth-at-all-costs mentality often seen in fast-growing start-ups. Rather than grant its chief executive officer super-voting shares and complete control, the CEO owned less than 3 per cent of its stock after several rounds of capital injection that diluted his stake.
One can’t fault investors for enthusiasm during Pandora’s first few years as a publicly traded company. Between the fiscal years ended in 2010 and 2013 it increased its active user base from 16 million to 65.6 million. Annual revenue rose from $55 million to $427 million, much of it driven by ad revenue. The company was still losing money, but it appeared to be manageable. The story was that over time it could convert users into paying monthly subscribers while negotiating better royalty rates on content, leading to margin expansion and profits down the road. When the stock peaked in early 2014, the company had a valuation of $9 billion, or roughly 10 times the $920 million in revenue it would go on to generate that year.
That’s when the downward spiral of slowing growth, increased competition and a falling stock price began. After more than doubling in 2014, revenue only grew by 26 per cent in 2015. Spotify became the new darling for music streaming, and other companies such as Apple joined a never-ending parade of entrants into the market. Profit margins eroded along with the slowing revenue growth. Between its 2014 peak and the end of May 2017, Pandora’s stock price fell by 78 per cent.
The following month was the beginning of the end of Pandora’s life as an independent company after Sirius XM Holdings Inc invested $480 million for a 19 per cent stake. Pandora divested its share of Ticketfly, a noncore business, at a loss as it sought to preserve cash. In January 2018 it cut 5 per cent of its headcount and moved other employees to Atlanta from Oakland, California, in a cost-saving move. Eight months later, Sirius bought the whole company for $3 billion in an all-stock deal that was worth about a third of the company’s peak valuation.
Sirius made a good marriage partner for Pandora investors for a few reasons. Pandora had tens of millions of active users, but unlike Sirius it had not been very successful at converting them into paying subscribers. By buying Pandora, Sirius now had access to a huge audience of music streamers who might become future subscribers. Pandora also had technology that was useful to Sirius, and the combined entity was able to eliminate duplicate positions.
So far, it seems to be going as planned. In its second-quarter earnings report, Sirius said that Pandora’s revenue increased by 15 per cent while costs only grew by 4 per cent, leading to 40 per cent growth in gross profit. Although it wasn’t successful as an independent company, Pandora still has 65 million monthly active users and is an increasingly profitable part of a $29 billion parent company.
The lesson here is that when a start-up grows quickly, investors often are willing to overlook all sorts of flaws as long as they buy into the long-term vision of a company, whether that’s dominating commercial real-estate leasing or music streaming. But when growth slows and cash runs low those growth investors will abandon ship, forcing companies to pitch a value proposition to very different types of investors. Some companies might be able to become profitable in their own right, but for others it might mean seeking out a buyer. Pandora’s salvation was having tens of millions of users and technology desired by a competitor. Investors who bought the stock in those heady days in 2014 were never made whole, but five years later the business still exists, albeit in a different form, continuing to provide a service that generates revenue.
The high-profile reversal of fortune suffered by WeWork in the public eye over the past few months is leading people to wonder how many other potential disasters loom for closely held money-losing growth companies. But as Pandora shows, although valuations may not recover, that doesn’t mean these companies are necessarily doomed.
