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WeWork Wrestled With SEC Over Metric Just Before It Scrapped IPO

The Wall Street Journal. logo The Wall Street Journal. 11/11/2019 Jean Eaglesham, Eliot Brown
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Just weeks before WeWork expected its stock to begin trading publicly, the startup was still wrangling with the Securities and Exchange Commission over a controversial key financial metric and a litany of other concerns about its planned multibillion-dollar IPO.

On Sept. 11—after the initial public offering prospectus had been public for nearly a month, and after the SEC had already made dozens of demands about the document—the regulator sent the shared-workspace company a list of 13 still-unresolved concerns, according to previously unpublished correspondence reviewed by The Wall Street Journal.

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The back-and-forth shows that WeWork was scrambling to clean up big problems as its IPO was crumbling. The timing was indicative of the chaotic management that gave investors pause and ultimately led the company to pull the offering and Chief Executive Adam Neumann to step down under pressure.

We Co., as the WeWork parent is known, had filed its draft prospectus confidentially with the SEC for review in December 2018, giving the company months to negotiate with the agency behind closed doors about its contents before unveiling it to the public.

But as the IPO loomed, the SEC zeroed in on how WeWork framed its heavy losses, particularly through a bespoke profitability metric called “contribution margin,” a version of which had formerly been known as “community-adjusted Ebitda.” The agency had first ordered WeWork to remove the measure, before the company offered to substantially change it.

In mid-September, the day before WeWork had hoped to start the roadshow to peddle its IPO to investors, the metric was still mentioned in its revised prospectus more than 100 times. The company planned to amend the filing before starting the roadshow, according to a person close to WeWork—but instead shelved the IPO, as investors questioned the company’s worth and its corporate governance.

“It’s highly unusual to have issues that are so important still being disputed while they are out there marketing the stock to investors,” said Minor Myers, a law professor at the University of Connecticut who reviewed the correspondence at the Journal’s request. As WeWork was battling the SEC over its metrics, its advisers were “figuring what they can sell using these numbers,” Mr. Myers added.

WeWork deployed a battalion of Wall Street lawyers to try to win over the regulator, according to people close to the tumultuous process.

The SEC sent Mr. Neumann a nine-page letter on Aug. 30, telling WeWork to remove mentions of contribution margin. “As currently calculated and presented, we believe that your [contribution margin] measure could be misleading,” the letter said. “Please remove disclosure of this measure throughout your registration statement.”

The letter also questioned forecasts that assumed 100% occupancy of offices leased out by WeWork, and pushed for greater clarity on a $5.9 million payment WeWork made—and later reversed—to a company controlled by Mr. Neumann for rights to the word “We,” which he had trademarked.

A spokeswoman for Mr. Neumann said he and the company “disclosed related-party transactions in the [prospectus] in accordance with applicable law and good governance.”

WeWork fought back hard, especially on contribution margin, the correspondence shows. One version of the metric, which previously WeWork had called community-adjusted Ebitda, was widely derided because it excludes costs to such an extent that it flipped WeWork’s bottom line for 2018 from a net loss of about $1.9 billion using standard accounting, to a $467 million profit.

WeWork’s resistance to removing the metric was directed by Mr. Neumann, people familiar with the discussions said. Mr. Neumann had previously boasted about the metric to reporters and investors, to show how the company’s core business was profitable.

Within five days of receiving the SEC’s Aug. 30 letter, WeWork’s advisers at two top-tier Wall Street law firms, Cravath Swaine & Moore LLP and Skadden, Arps, Slate, Meagher & Flom LLP, sent responses totaling 45 pages, including a letter focused solely on two financial metrics, and filed a revised, 223-page prospectus.

The Cravath letter, from former senior SEC official John White, said WeWork still believed its metrics were fair but was willing to ax those the SEC most objected to—excluding certain lease costs—to try to “find a course forward.” Mr. White and a Skadden spokeswoman didn’t respond to requests for comment.

Many of the SEC’s comments to WeWork “went straight to the heart of the issues that ultimately caused the IPO to unravel,” said Erik Gerding, a law professor at the University of Colorado, who reviewed the correspondence for the Journal. “The SEC staff shined a laser light on many of the business metrics and spotted a number of the conflicts of interest and holes in the prospectus,” he said.

An SEC spokeswoman said the agency doesn’t comment on individual companies’ filings.

Among other issues the SEC targeted was what the WeWork prospectus called “illustrative annual economics.” The agency questioned how the company had arrived at some rosy numbers. “Please explain to readers and tell us how your assumed workstation utilization rate of 100% is realistic,” its letter said. In reply, WeWork agreed to drop the illustrative economics section from the prospectus.

WeWork’s liberal use of customized metrics that don’t comply with generally accepted accounting principles, or GAAP, was central to its wrangling with the SEC, according to people close to the process. The draft prospectus WeWork filed in December cited at least six non-GAAP metrics; by the time it issued the prospectus in August, the tally had fallen.

Despite going through several revisions, the prospectus WeWork made public in August contained significant errors and omissions, the Journal has reported.

This past Friday, after markets closed, WeWork published a slide deck from Oct. 11—after Mr. Neumann resigned—that showed financial results including a “location contribution margin” that appeared to be a renamed version of the metric at the center of its dispute with the SEC.

The SEC is stepping up scrutiny of creative financial measures, lawyers said. Nearly all big companies now use at least one non-GAAP financial metric. Last year, 97% of S&P 500 companies used non-GAAP metrics, up from 59% in 1996, according to an analysis for the Journal by research firm Audit Analytics.

It isn’t unusual for companies to go through several rounds of comments with the SEC in the run-up to an IPO. The stock can’t be sold until the agency gives the green light to the prospectus, and SEC officials will nitpick details of the disclosure until they are happy, lawyers say.

Write to Jean Eaglesham at jean.eaglesham@wsj.com and Eliot Brown at eliot.brown@wsj.com

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