WeWork's Failed IPO Hammered Shareholders. It Could Be Worse for Bondholders

How badly did WeWork crash after it bombed out of the IPO process?

Big backer SoftBank took a $9.2 billion write-down. And that’s after putting $10.3 billion into the company through both common and preferred stock.

But shareholders aren’t the only ones licking their wounds after a skeptical market tanked WeWork’s plans for an IPO. Anyone still holding the company’s bonds are likely facing an extended period of being underwater.

Just three months ago, back in August 2019, the bonds hit a high of 103.21 (100 being par, or the face value of the bond) on secondary markets. They now sit at a flat 85. Yields, which move in the opposite direction of a bond’s price and are a measure of the risk level of a particular security, were 7.875% at issuance and are now at 11.66%.

In the bond world, this is called a disaster. And a lot of big-name financial services firms have millions tied up in these bonds, with the top holder at almost $199.7 million.

When WeWork had a presumed valuation of $47 billion, the skeptic might have wondered on what foundation it was built. After all, International Workplace Group, the largest name in subleasing office space, currently has a market value of about $4.4 billion. IWG has notched an annual revenue of about $3.2 billion on 3,334 locations. It is profitable.

WeWork, in comparison, has lost billions of dollars on 600 locations with a valuation that—at least in the not-too-distant past—was almost 15 times higher.

The $47 billion WeWork valuation the company reached in early 2019 now of course seems downright crazy. Large amounts of private investment, the promise of unbridled growth, and lack of financial details helped fuel credulous press coverage, which eventually turned the company into a unicorn darling. (Exceptions like Fortune’s Andrew Nusca who, in 2016, saw the company as one to bet against, were few and far between.)

Even before the massive valuation in early 2019, investors hungry for profits wanted in. That resulted in a successful April, 2018 WeWork bond issuance of $702 million that would come due in January 2025.

Secondary market bond prices fluctuated from the high 90s down to the high 80s in early 2019. After the early 2019 news of the $47 billion valuation and the mid-August release of the IPO filing, the bonds soared, topping at 103.21 on Sept. 4. Then came growing skepticism based on the newly disclosed IPO financials. On Oct. 16, the bond price plummeted to 79.7.

At this point, the bond is trading at a steady 85. But what does that mean?

WeWork’s Risk Profile Increases

“The classical answer is the credit risk is greatly increased in the view of the market,” says George Calhoun, an industry professor in the School of Business at Stevens Institute of Technology and director of the Hanlon Financial Systems Center.

The more credit risk a company faces, the greater a yield investors demand. If there’s a greater risk of default by the company, they want a bigger potential return. A price of 85 means that bond investors see a significant chance that a default could happen. “Frankly, I’m surprised it’s as much as 85 cents on the dollar,” Calhoun says.

“The bonds now offer close to 12% yield to maturity,” says Ted Bauman, economist and senior research analyst at Banyan Hill Publishing. “That’s very close to the average yield on a Credit Suisse index of triple C-rated high-yield debt. WeWork’s corporate debt is just one notch above the lowest level of corporate junk bond.” In other words, the bonds, already junk-rated, could be seen as highly vulnerable to a default should the price drop even further.

However, Bauman thinks the price now may only be temporary. “Currently, about $70 million worth of bonds, or 10% of the total, is out on loan to short-sellers,” he says. Just like stocks, investors can short bonds. The investors would borrow WeWork bonds from holders and sell them at the current market price in the anticipation that the price will drop even more. The short-seller than buys the bonds back at the lower price, restores them to the lender, and profits from the difference.

Seeing this level of shorting activity isn’t normal. “That’s an exceptionally high figure for a corporate bond and suggests that the smart money expects the price of WeWork’s bonds to fall even further,” Bauman says.

Institutional speculation

A Fortune analysis of Bloomberg data based on the latest available SEC financial filings shows eleven institutions—including such names as Columbia Management Investment Advisors, BlackRock, and PIMCO—held anywhere from $13.7 million (RBC Global) to $119.7 million (Lord Abbett) across all their reported divisions and funds. Another 16 had at least $1 million, and 42 had lesser amounts. Fortune reached out to the institutions with at least $10 million invested in the bonds. Only a few responded before publication, saying they didn’t address individual holdings.

Some of these institutions are so massive that one bad bond bet barely rises to the level of a rounding error. As a PIMCO spokesperson emailed Fortune, “Also keep in mind that this amount is a very small given our total [assets under management] of $1.9 trillion.” PIMCO’s total WeWork bond holdings are just $48.6 million.

Others may see the bonds as a calculated gamble. There’s an “ample timeline [for the WeWork bonds] to recover from this liquidity situation,” says Parul Garg, associate portfolio manager for fixed income at the PenderFund Capital Management, which does not invest in WeWork’s bonds.

Plus, if WeWork survives, it might have opportunity to sell all sorts of services to tenants. “Maybe ten years from now they’re not providing just office space but providing financial advice services to those people in the spaces or they’re linking up with gyms and health clubs,” Prof. Calhoun says.

What Calhoun notes is something that many investors may hope for—WeWork becoming a miniature Amazon for the working world. In that view, the company would build multiple lines of revenue and value with an existing set of customers. That would drive revenue and, therefore, an increase in the company’s fiscal strength. Prices would rise as bond traders took note. “People are cutting each other’s throats over a 2% [return],” he says. Buying bonds at 85 and watching them hit 90, for example, would be a big win.

There’s another possible outcome, as well. “One scenario is that SoftBank could take them through a preplanned bankruptcy and restructure the company and balance sheet,” Calhoun says. Such proceedings are bad for bondholders, whose holdings are unsecured and not protected in bankruptcy.

“In that kind of process, the existing bondholders would be expecting a haircut,” Calhoun says.

Ouch.