Valuing coworking and serviced office businesses
Cast our mind back a few years and the Australian flexible workspace landscape was completely different. The product offering was narrower and the large footprint businesses were serviced office operators like Regus and ServCorp. Since then, we have seen the goings of Gravity, CEO, Naked Hub and Victory and the comings of 100’s of operators including The Commons, Creative Cubes, TWP, The Great Room, The Flexi Group and JustCo.
Plenty more changes are afoot, and one factor is a likely increase in mergers and acquisitions. Whether you are a buyer, a seller or just a keen observer you may be wondering what are the factors that go into determining the value of a site or a portfolio. Well, there are several ways this can be done, so let’s dash through a few of them and then focus on what I observe is the primary method.
Discounted cash flow, which is determining the probable business value at a future date and working back to determining a current value.
Asset value, which is the value of fitout, equipment and other property less liabilities such as rental and debt instalments.
Comparison methodology, where value is informed or validated by prior comparable sales or the terms of outside investment in businesses.
Multiple of EBITDA, where the earnings before tax, interest, depreciation, and amortisation is multiplied by an agreed number to determine value.
I have personally not seen or heard of a flexible workspace operator transaction based on discounted cashflow, although I acknowledge it will be used in the backroom of larger purchasers.
Some negotiations have started by using an asset value methodology but generally these are underperforming businesses, and the end result is a sale price well below asset value and the seller is just pleased to hand over the lease tail.
In practice, comparison methodology is used to help inform the dominant methodology and that is multiple of EBITDA. These multiples vary significantly, and we will get into that in a moment. First let’s look at EBITDA.
What’s in an EBITDA?
EBITDA is a good focus point for measuring sustainable net cashflow because it is less susceptible to accounting and financial manipulation. It helps pares back the factors owners and managers have discretion over and reveals the underlying operational health of the business. Nonetheless, arriving at an agreed EBITDA is still not straight forward. There are two reasons for this.
First is the COVID factor. Usually, prospective purchasers would look at the past three years of performance to assess the validity of the current EBITDA. Is it at a high, is it volatile, is there upside opportunity? In rare instances, I have seen buyers blend 2-3 years’ performance to determine the EBITDA. The problem here is that the impact of COVID has been so extreme that past results are a shadow of likely future results. I prefer to see a reliance on data from the last twelve months and consideration given to the reasonable forecast for the next twelve months.
Second is that there are varied approaches to what costs are attributed to centre-level and what are corporate overheads. Key examples are management, accounting, marketing, training and compliance. A seller who is running lean might see their reported EDITDA stripped back by a prospective buyer overlaying their methodology of allocating significant overhead costs to the centre P&L. Conversely, I see some sellers presenting P&Ls and balance sheets that reflect their individual circumstances and unwittingly understate their performance.
What’s in a multiple?
People love M&A gossip, and discussion about multiples is everywhere. During Adam Neumann’s WeWork days I recall chuckling when I heard him declaring, ‘Not 10x – 100x’. A tad more realistically, in the USA and UK people casually throw around figures of 10-16.
I note listed companies ServCorp and IWG are at the time of writing showing an Enterprise Value/EBITDA of around 3.9 and 6, while WeWork sits around -15. The problem is that there are presently just not enough publicly available data points to embolden markets to confidently attribute what I consider rightful values. So what should those values be?
I would suggest multiples of 8-12 are the preserve of those elite businesses with either significant reach, have some important element of differentiation, or are strategically significant to the buyer.
For more standard (but well performing) flexible workspace operators multiples of 3-7 are more probable, with most skewed to the lower half of that range. Single site operators in markets that attract heavy landlord incentives will likely see multiples below the range.
But these approaches are just means to get to a starting point. As hinted, there are a lot of variables that play a significant role in determining value. So, is your business that generates a normalised EBITDA of $500,000 worth half a million or six million? Let’s dive into some more deciding factors.
Macro drivers
No matter how great a business is, there are big-picture factors that will influence its value.
Cyclical demand - Are one or two operators in the market looking to aggressively grow through acquisition? This might be a simple growth agenda, or a pitch at product diversification or geographic distribution.
Convergence or diversification - Is a non-operator wanting to gain exposure to the industry or perhaps obtain operational knowhow? Companies behind this have included corporate real estate houses like CBRE and Cushman Wakefield, real estate investment trusts like Brookfield, Blackstone and Frasers, private equity firms like KKR, Wingate and 33 Degrees.
Poor industry transparency – Businesses that are not already in the flexible workspace sector can be put off from investing in (or even lending to) operators because there are no set models for industry reporting, and much of the information that is available is a collection of convenient truths and here say. This contrasts with, say, the hotel sector where business data is largely standardised, and reporting is much more transparent. This promotes greater investor confidence and thus more sector liquidity.
Growth or profit mandate – At times, much to the chagrin of the many profitable businesses out there, a higher value is placed on businesses with no or low EBITDA but a great growth story.
Market failures – High profile failures trigger a period of reluctance.
Micro drivers
Then there are elements that are more specific to the individual business.
X-factor - Does the operator have or do something that is especially desirable. This might be a foothold in a tightly held coveted market, a leverageable brand or recognised leading operational methodology or personnel, or consistent performance in fast ramp-up and sustained occupancy.
Lease liabilities – Is the business heavy on leases and bank guarantees? Some businesses will attribute a higher multiple to liability-light operations achieved through partnerships and services agreements, although I will point out the partnerships and services agreements typically produce for the operator a lower EBITDA.
Lease term – Theoretically, a multiple of 5 takes that many years to cover costs. If the lease has a fixed remaining term of six years, the valuation does not make sense. Often landlords will pre-agree to extending the term if/when the business is sold - but be careful in deciding when and how you raise it with your landlord(s).
Lease incentive – If the lease came with a significant cash incentive which is effectively built into the ongoing rent, then the multiple will likely be less than where the operator funded its own fitout and consequently pays a lower rent.
Cash or share swap – It could be argued that the multiple will differ depending on whether the sale is paid for by cash or shares in the acquiring business. Capital in the flexible workspace sector is typically expensive – and this is keenly felt during significant expansion. Where a prospective purchaser’s growth mandate coincides with low liquidity, they likely have more to give through a share swap. A lot more could be said on this matter – but it is a can of worms and contingent on too many individual circumstances to elaborate here.
Earnout – Generally, earnouts involve an upfront payment and a later payment based on your staying in the business and achieving agreed performance metrics, or the business achieving those metrics without you. I observe these arrangements can get messy but are a useful way to bridge the valuation gap between what a seller seeks in total consideration and what a buyer is willing to pay.
Fitout standard – Fitout is expensive at the moment. A business that has allowed its interior to become tired or out of date necessitating a $500,000 spend will be significantly penalised when it is time to sell.
Fitout philosophy – Demand side growth is for product that overlays private spaces with compelling and generous community areas and services. Traditional serviced office with minimal breakout areas and traditional coworking with minimal private offices will not attract strong buyer interest.
Floor size – Small floor areas are challenging to monetise and often dip in and out of profitability. Some buyers will not look at spaces below 800sqm - 1,000sqm and some buyers will disregard spaces less than 1,500sqm – 2,000sqm.
Scale of business – There is a significant cost to the purchaser in assessing, negotiating and closing the deal and then integrating the acquisition into their business. Some economies can be achieved by procuring on scale and this might have an impact on attractiveness and price.
Efficiency – I am staggered by the variation in business ratios applied across the sector. In many instances there is unrealised revenue. A savvy purchaser will identify the upside and, whilst that may not play a big role in increasing the multiple, it will help get the sale over the line.
Growth commitments – A business with assured and quality centre growth in its pipeline (eg signed lease but not yet opened) or revenue growth (eg a newly opened centre with growing occupancy) should achieve a valuation boost above what its EBITDA suggests, or at least attract an earnout kicker.
Assignable licences – An important value component is continuity of reported occupancy. Customer licence agreements that are not automatically assignable are both risky and burdensome to a purchaser.
Despite significant growth, the coworking sector in Australia is highly fragmented. This is not necessarily a bad thing, because it allows for diverse offerings to respond to a range of customer requirements. Nonetheless, are we poised for a period of industry consolidation through increased investments and M&A? Possibly. Certainly, some international operators are actively considering acquisition opportunities in Australia, and some local operators are keeping an eye out for strategic acquisitions. We may also see some REITs making strategic investments to move their customer proposition up the value chain.
So, what does all this mean? For one thing, when you hear of a low or high multiple sale, don’t be too quick to think that applies to the value of your business. There are just too many variables.
My top tips for best positioning your business for sale are maintain your fitout, keep good business records, have a good working relationship with your landlord, move your customers onto automatically assignable licences and get good industry-specific advice when you are considering selling.
Copyright 2023
This article written by Clive Dale was originally published in ‘Flex Futures 2023’ industry report by Flexible Workspace Australia.
