Despite another profit warning, demand to buy International Workplace Group (IWG) has never been greater. Robin Marriott investigates the reasons for the interest and reviews the long line of suitors.
International Workplace Group (IWG) has received takeover interest from five groups since December 2017 and last month a sixth company entered the fray. Terra Firma, the London-based private equity firm, confirmed it had contacted the global market leader in flexible office workspaces, underscoring huge interest in the group. There are even some expectations that yet more interested parties might emerge.
Andrew Shepherd-Barron, analyst at Peel Hunt, said the interest can be explained not just by IWG’s market-leading status – it has 3,125 office locations in 96 countries with Europe being the fastest expanding - but by the fact that its share price has been depressed by two profit warnings. ‘More to the point, it is extremely cash generative and we know how much private equity appreciates that. After all, it gets paid by all its customers two months up front and most of the fit-out costs of the buildings it leases are funded by the landlord.’
IWG is a massive occupier of office buildings with a total of 52 million m2 of space but it is facing increased competition from rival operators such as WeWork. It believes part of the answer to staving off this competition is to expand further and add new brands, but it has come at a cost.
Hemant Kotak, head of UK and Swiss research at Green Street Advisors, commented: ‘In terms of space, IWG is the dominant player in the flex office market and accelerating that growth at the expense of near-term profits shows its commitment to defend that position. But growth plans may be ill-judged in what is a highly competitive, low-barrier, and very cyclical market; near-term investing in growth may pay, but with contribution per desk having halved over the past decade the jury’s out on longer-term returns.’
He added: ‘The interest in IWG from financial players is in large part about immediate access to scale. If a suitor can jazz up the dated offering and fix operational issues while the market’s white hot the payoff could be very attractive….timing will be critical.’
Collection of brands
IWG started out as a serviced office provider under the Regus brand and its fortunes are tied to how it competes in the multi-faceted, burgeoning flexible office market. In reality, IWG is actually a collection of brands. It owns Regus, which it is best known for, but also Spaces which offers a ‘free spirited vibe’, No18 which is its ‘cosmopolitan members club for businesses, a blend of workplace and residence’, OpenOffice for those looking for ‘professional modern, easy-to-use workspaces’, Basepoint, acquired in the first half of last year with premises in southern England offering a ‘unique type of business centre offering high-quality workspaces and additional services’, and Signature, its ‘exclusive luxury workspaces for discerning business clientele at the very highest levels of refinement and discretion.’
Combined, the brands generate serious cash flow. On 6 March, the company reported that it posted a profit of £163.2 mln on revenues of £2.35 bn in 2017. IWG’s strategy has been to push harder to expand its network and up its game in terms of quality of premises and services – crucial given the competitors that have come in to challenge it. Last year it added 314 new locations totalling 5.5 million sq ft. The pipeline in 2018 is for another 230 locations, again adding 5.5 million sq ft.
Basically, annual results suggest IWG had a better 2016 than 2017. It generated a gross profit on less revenue - £448 mln profits from £2.23 bn of revenue in 2016 compared with £401.6 mln from £2.35 bn in 2017. That said, after tax, profits were more or less even (£376 mln in 2017 versus £379 mln in 2016). It explained it had increased headcount costs to help with areas such as dedicated corporate account development and had boosted its development capability. It won more corporate accounts but the investment led to new centres being loss-making initially.
Expanding too fast?
Peel Hunt’s Shepherd-Barron said IWG’s CEO Mark Dixon had traditionally always been criticised for expanding too fast. He added: ‘In my view IWG is run quite well though new private equity owners might run it differently. Mark Dixon has always been criticised for expanding the business too aggressively and never letting the cash flows from mature centres come through in the form of dividends. Private equity would have the ability to expand it even more aggressively. You could argue this is an attractive business that is being held back by being in the public market.’
Asked if he thought the company would get taken over, he said: ‘It is completely in the eye of the bidders. What we know is there are a number of bidders who are serious. If you look at normal metrics, it is not expensive and it is a global leader. I think there is a good chance it will get taken out.’
The good news for shareholders is that IWG increased its dividend for 2017 by 12% to £5.70, saying it was confident about its long- term outlook. Maybe its suitors are too. Co-working space is certainly one key battleground for it to compete in – that sector has attracted the most hype. In response to rivals, IWG has been rolling out its large co-working formats and opened 56 new premises, taking it to 78 overall and 13 new countries. In its annual results, Dixon called 2017 an ‘important year for the flexible workspace industry’ generally, adding that he felt the firm could benefit from accelerating customer demand and a competitive advantage from scale, its global network and quality. ‘According to a 2017 survey from CBRE, one of many such reports to come out last year, 71% of occupiers believe that productive and flexible workspaces are vital to delivering corporate real estate objectives,’ he said. ‘This figure was just 57% the previous year. And 84% sees the disruption from the flexible workspace revolution as a permanent feature.’
Strongest growth in EMEA
Europe seems to have kept good momentum for IWG - with the exception of the UK. Performance on the Continent was reportedly solid, barring France and Switzerland. There were very good performances from the Netherlands, Germany (where IWG only has 100 premises), Italy, Spain, Ireland and Israel. More challenging were markets like Russia and parts of the Middle East and Africa. EMEA is actually the company’s largest growth area in terms of new locations – 136 opened last year. It has 909 offices in the region, having added offices in Iceland, Azerbaijan and Gibraltar.
But UK revenue is the focus of concern. Revenue last year from open centres increased 1.6% to £425.8 mln but total revenue including closed centres declined 4.8%. Revenue from the mature business in the UK declined 2.9%.
Shepherd-Barron: ‘IWG is very well diversified and present in practically every country in the world, but 20% of its profits come from its home market of the UK and we all know what WeWork has been up to. WeWork is being very aggressive, prepared to accept 12 months of losses to establish itself and it is thoroughly well backed by SoftBank and is a very tough competitor to IWG. A year ago, WeWork had 200,000 work stations in the US and UK, but by the end of this year will have doubled this to 400,000 whereas IWG to date has around 520,000 meaning it is suddenly competing against 200,000 new work stations. Any new operator opening is in competition with IWG.’
London and the regions
IWG has said there is a big contrast between London and the rest of the UK. Revenue outside London increased in 2017 and saw sequential quarterly year-on-year improvement while revenue from its mature London centres declined significantly and was particularly weak throughout the second half. The absence of larger deals in London was a particular issue, especially in the third quarter.
In March 2018, the company provided an update for the first three months of the year. Revenue growth across all its open centres increased by 9%. There was double-digit growth in EMEA and high single-digit growth in the Americas, driven by the US and Canada and Asia Pacific. The UK, as anticipated, was broadly flat. Then on 27 June it issued an unexpected profit warning, citing additional growth costs and underperformance in the UK.
The current share price stands at around £3.12 but it is felt that without the financial bidders circling, it would be a lot lower. ‘Let’s face it, the share price would be down below £2.40 without these bids,’ said Peel Hunt’s Shepherd-Barron. ‘I think there is a good chance that it will be taken out in the price range of £3.20-£3.50 a share although frankly the top of that range is looking a bit big given the recent profit warning.’