Weekend thoughts: disruptors disrupted
In November, there were two major “disruptors” that went through some type of financial distress:
After dancing around it for a long, long time, WeWork finally filed for bankruptcy.
Spirit (SAVE) reported Q3 results so poor that a popular parlor game among event and arbitrage investors is “Has Spirit suffered a material adverse event (MAE) that would let JetBlue break the merger contract?”
I personally think the answer is quite clearly no; SAVE’s financials are a disaster and they’re quite clearly distressed as a standalone, but JBLU signed a tight merger contract, they don’t have an out, and I think Spirit will get a huge chunk of money to cover the GTF issues (which helps with all sorts of issues).
Both WeWork and Spirit had huge disruptive effects on their industry. They were:
Spirit: Most of the airlines offer “basic” fares these days (tickets that do not include a carry on bag, the right to chose your seat, etc.). The basic fares are a direct result of competition from Spirit; Spirit offered super low prices in part by charging consumers fees for everything (water on board, seat selection, bringing a carry on, etc.), and other airlines responded to Spirit’s competition by offering their own unbundled fares.
WeWork: On the WeWork side, it’s a distant memory now, but back in ~2018 every office landlord was getting asked questions about WeWork and if the office landlord / owner business model (which generally consisted of signing very long term, very large leases) could survive when WeWork was offering small flex leases with month to month terms.
With both businesses going into distress, it got me wondering: as interest rates go up and we continue to leave the “ZIRP” world, are there businesses that are going to prove much more profitable than their recent history suggests just because so many uneconomic competitors are leaving?
Now, it might be a little of an unfair comparison lumping Spirit and WeWork together. Spirit was profitable every year until COVID, and airlines with a similar low cost / unbundled model have proven profitable in Europe (though Europe and North America do have quite a few differences that could justify / propel different business models)….. but I do wonder if Spirit’s model could only be profitable under a very specific set of circumstances (low interest rates, low fuel costs) that existed in the mid-2010s, and in any other world (like today’s!) the business doesn’t work (or at minimum doesn’t work as well).
WeWork is a different beast entirely. The business was never profitable (despite the fact peer IWG / Regus had been profitable for years) and the business never had a chance to be profitable as it was structured. You could look at a lot of the VC funded businesses for 2018-2021 and see similar shades of structural unprofitability (Uber, AirBNB, the 15 minute delivery services, etc.); many of them were operating at burn levels that were only sustainable with unreal subsidies from VCs pumping in huge swaths of money at impossible valuations. And those subsidies had huge impacts on the real world; I personally would sometimes find it was cheaper to take an Uber than it was to take public transit in NYC. When I went on trips, AirBNB would often price beautiful houses that could sleep 10 cheaper than a single hotel room, and it would often be significantly cheaper for me to order groceries through a 15 minute delivery service and have them dropped off at my doorstep than it would be for me to walk to the grocery store and buy them myself (to say nothing about the time and hassle I’d save by not needing to physically go to the grocery store).
That’s not to say these businesses could never be profitable! Both Uber and AirBNB have real scale advantages and seem set to generate a lot of profit now that they’ve normalized their businesses and cut out a lot of their subsidies! I simply mean to say that the level of discounting they did in the mid-2010s through late 2021 was completely unsustainable, and there were plenty of businesses out there that were burning enormous amount of VC money that had business models that would clearly never be sustainable.
Anyway, I’m not writing this post to hate on these businesses (or love on them, though I did love and do miss the subsidies!). I’m simply writing it out of curiosity: the economic environment over the past 18 months has had the largest shift we’ve seen since probably the GFC. Fuel prices are up, inflation ran rampant for a while, interest rates are no longer zero, etc. There’s a whole host of businesses that were profitable (or maybe not profitable but at least viable…. or maybe not viable but at least fundable) in the conditions that ran from the mid to late 2010s that aren’t profitable/viable/fundable in today’s condistions.
One of the things I’m focused on / thinking about currently is finding businesses that were fighting on the other side of that subsidized model. For example, I think something like IWG (which my friend Yaron had a really nice podcast on earlier this year) is really interesting right now; the company managed to stay profitable despite uneconomic competition from WeWork and the COVID induced office hangover. Now that WeWork is restructuring, could IWG’s profitability increase as they pick up some distressed pieces and industry pricing / competition gets a little more rational?
IWG’s obviously just one example (though it’s a very good one), but I suspect there’s going to be a lot of alpha generated over the next few years by buying companies that look cheap-ish on a trailing basis but whose futures are getting a heck of a lot better as all of their competitors retrench / restructure. To throw in two more examples:
Rental cars: Subsidized uber in the late 2010s meant there was almost no point in taking a rental car. It was often cheaper and more convenient to fly into a city and just uber everywhere. I remember one time I flew to Austin and a rental car would have been something like 100 dollars/day (and you have to find parking and deal with pick up and such with a rental car); I think I took 7 ubers a day and the total cost would come out to around $60/day. Now some of those ubers were short (a 5-10 min drive from a bar to an Airbnb), but some were pretty long (the trip from the airport, a 45 min drive to the suburbs to see a friend or a famous off-the-beaten path BBQ spot). Anyway, the point is the subsidized cheap ubers really hit into rental car models. Now, with subsidies dropping and uber prices reflecting more economic levels, a rental car makes sense for a whole lot more trips (though there are still plenty of trips that I would have rented a car pre-uber that don’t make sense today!), and I wonder if rental cars have a little bit of a comeback…
Just to clarify: this is obviously very broad. Rental car companies are enormously dependent on used car pricing and a host of other things, so I wouldn’t exactly YOLO the “uber prices are up, rental cars ARE SO BACK” thesis! I’m just saying on the margins it’s interesting, and given the huge fixed cost of a rental car company “on the margins” can be a big swing!
Banking: I’d argue First Republic and Silicon Valley Bank took enormous share among a very profitable clientele (the super rich / affluent) because both banks were way underpricing risk in order to cater to them (offering extremely low rate loans that would blow up on them if we ever left a low interest world). With those banks gone, there are a lot of really profitable relationships floating out there that could be picked up by banks that were more prudent (CFG is making a go of it now). Banking’s such a big business that it’s hard to identify just one company that will really benefit from the death of an irrational competitor or two (I believe it’s more likely that most of the well run players generate a little bit of a boost over the next ~5 years as they pick up some of the remains from First Republic / SIVB and the competition for super prime customers becomes a little more rational), but I do think that’s another nice example of companies that the industry looked at as disruptors but who were really just riding ZIRP while taking on huge risks.
Feel free to lob in your favorite candidates for this type of “competitors retrenching leads to future profitability” opportunity in the comments; I may do a write up on my favorite suggestion in the near future!