Why IWG Is Undervalued

• Jonathan Price analyses IWG’s competitive advantage over other flexible space companies and questions why it has long been undervalued. 
• IWG’s lean cost structure and large footprint of suburban and smaller city/town locations is helping it through the pandemic crisis “relatively unscathed”. 
• The company’s long-term franchise strategy and “war chest of capital” sets it apart from other operators, and could drive a significant re-rating. 

Over my 20+ years being professionally involved in finance and investment in serviced offices, I have been largely unimpressed with research into the sector. Prior to 2005, interest in flexible space was so limited that no-one had thought it worthwhile to do any analysis, let alone publish any research. 

As a result, the Business Centre Association, as it was then, had to cajole property firm DTZ into publishing the first ever research by effectively promising that a working group, which I chaired, would do all the work for them. 

Sixteen years later the situation has vastly improved with regular analysis on the market being published by the Instant Group and Allwork.Space over a number of years, and more recently by the big property services groups like JLL and C&W, plus equity market analysis on the small number of quoted companies and on WeWork – more about them later. 

The improved quantity of research does not necessarily mean improved quality and analysis of the listed companies, like IWG plc, has tended to be superficial and cliché ridden. If I had a penny for every time I have read that Mark Dixon, IWG’s CEO, used to sell hotdogs, I’d be a rich man. 

So it is noteworthy when you come across a really good piece of analysis, as I did last week on the financial website, Seeking Alpha. 

The piece in question, entitled ‘IWG plc: A Cheap Cyclical Compounder’, was written by Belgian analyst, Thomas Coppens. In it, Coppens explains what the flexible market is, and what is driving growth in the market, which regular readers of Allwork.Space will be familiar with, but also analyses in depth IWG’s competitors and its competitive advantage over them. 

He also considers IWG’s long term strategy — to be a franchisor, rather than an operator — which sets it apart from other operators, and then speculates on how it might use the war chest of capital it has built up through recent issues of shares and convertible bonds. 

The three most important factors of profitability in serviced offices are, scale, scale and scale. Despite not being an industry analyst, Coppens has grasped this essential point and analysed the right and the wrong ways to go about building scale, considering IWG and WeWork respectively. 

Looking at the EBIT margins for new business centres opened by the two operators, he notes that the initial losses were much higher for WeWork than for IWG, which he suspects was caused by the very aggressive pricing of the former. He quotes with approval Mark Dixon’s comment that many former competitors of Regus, IWG’s main brand, went bust because they focussed on revenue, not profit. 

IWG shows us that the key to profitable growth is cost discipline. Over the past five years IWG has had a relentless focus on squeezing costs, reducing SG&A from 20% of revenue down to 10% as the footprint has doubled. This enabled it to withstand the margin reduction pressure exerted by WeWork and other competitors. 

Another key factor in IWG’s success is maximising ancillary revenues from telephony, IT, virtual offices, and so on. Because of its size, IWG is also able to offer disaster recovery services in a credible way that other smaller operators could not. In total IWG’s accounts have 120 lines of ancillary revenues. 

The move into franchising is an important move for IWG but not a new one. 

While it was still called Regus, it made two attempts to push franchising, both of which failed to gain traction. This time around it seems to have got both the timing and the business model right with sales of Master Franchise Agreements for three important countries — Japan, Taiwan and Switzerland — to major investors raising around $600 million in upfront cash with a continuing stream of franchise fees to follow. Coppens also reports that a much larger deal to franchise all or part of IWG’s largest geographical market, the USA, would have been signed in 2020, were it not for Covid-19. 

Talking of the pandemic, IWG has suffered much less from centre closures than have its competitors such as WeWork and Knotel. 

The reason IWG has come through relatively unscathed, and is likely to continue to prosper is that, unlike its competitors, it has a very large footprint of suburban and smaller city/town locations. Although these locations are not as profitable as city centres in normal times, Mark Dixon understood very early on the importance of having a diversified range of locations to offer different customer groups. Indeed he discussed with me, more than ten years ago a project to systematically locate and engage with business centre operators in small to medium sized towns and cities in the UK with a view to bringing them into the Regus network. It is precisely these locations that remain open and at good levels of occupancy today, while prestigious locations in deserted city centres have been abandoned by staff reluctant to commute, or not allowed to. 

Of course, IWG’s lean cost structure also helps in difficult times as does the fact that the vast majority of its locations are leased on terms that are ring-fenced so as to prevent local bankruptcies having a domino effect, or incorporate break clauses limiting the financial exposure. IWG is also famous for its tough negotiating style with landlords. 

What does the future hold for IWG? 

Coppens thinks that the company is undervalued by the market at today’s price of 355p and that it could be worth as much as 1200p per share. What would drive such a re-rating? Having seen off WeWork, there is no other meaningful competitor in sight and IWG is flush with cash available to make strategic purchases of operators suffering pandemic distress – Coppens estimates this cash pile at £860 million, but I think it is over £1 billion. 

In addition to this, there is the prospect of more cash arriving if the deferred US franchise deal does close. 

One thing is certain – it would be foolish to bet against IWG. One of the UK’s noted bears, Simon Cawkwell, aka Evil Knievel, insisted on shorting Regus back in 2001, despite my advice not to, and lost £2 million of his personal cash as a result. 

Despite a compound annual growth rate (CAGR) of 24% in the decade 2010-2020, flexible space still only accounts for 2-3% of total office space globally. The long-term structural trend will take that number to 20% in my view, a view which I have held for 20 years. Coppens largely agrees predicting continued 15-30% CAGR until 2030 which at the top end would take the share of flexible space up to 30%. He could be right. In either case, IWG can double from where it is today and double again. 

Under the astute leadership of Mark Dixon, architect of its successful strategy, it could well do so. He says he’s not in it for the money. Perhaps not, but he’s going to have a lot of it anyway.