The New Criterion: flexible space operators grapple with co working in the social distancing era

Tim Boreham

Independent Investment Research

In the new era of germ awareness, co-working spaces have transformed from a booming sector to a public health hazard.

Exalted as a creative collaborative zone in the industry’s millennial friendly jargon, the humble tea room is now maligned as a potential virus super spreader.

The lockdown conditions have not augured well for the office sector overall, but have been particularly virulent for the co-working (or flexible) space providers. While traditional tenants are tied to a long lease, most co-working tenants are on rolling arrangements and free to leave without penalty.

When they are tied to a lease, the foregone rent is usually not worth pursuing given the size of the client.

Having said that, the National Australia Bank reports that both business confidence and job ads lifted in May, the former by a record degree. As always, there’s a price for everything and investors may find opportunities among the battered and bruised listed exponents.

The pure-play Victory Offices (VOL) this month emerged from a one and a half month trading suspension with an urgently needed recapitalisation to raise $15 million.

Underwritten by Ord Minnett, the one-for-one entitlement offer is struck at 37.5c, a hefty 27 per cent discount on the last traded price of 51c.

Victory chief (and 63 per cent owner) Dan Baxter describes the COVID-19 effect as temporary. “Additionally, with the return of occupancy to our services offices, virtual office facilities and our flexible workplaces, we believe we will emerge in a stronger position than our competitors.”

As a rule of thumb, co-working operators need an occupancy rate of 80 per cent or more to be profitable. In the March quarter the trend was Victory’s friend, with occupancy climbing to 81 per cent from 76 per cent in December.

This improved usage resulted in March quarter revenue of $12.1m and a modest net profit of $1.3m – but that was before the COVID-19 proverbial really hit the overhead fan.

Victory forecasts an occupancy rate of 20 per cent up to September, rising to 50 per cent of “pre COVID-19 levels” by December and 80 per cent by June 2021.

Global operator Servcorp (SRV) is still working through the COVID-19 implications, but expects a “significant but temporary reduction in services office occupancy and slowdown utilisation, with some offset from our virtual office products.”

Founded by octogenarian Rich Lister Alf Moufarrige in 1978 and listed since 1999, Servcorp was a pioneer in serviced offices (the ones where the common receptionist answers the phone in the name of Acme Fasteners one moment and Acme Consulting the next).

Taken aback by the emergence of co working giants such as WeWork of the US, Servcorp responded by spending $60 million on converting floors to the more casual co-working format.

Servcorp operates across 146 floors in 22 countries, with a significant presence in Japan and London.

Owned by shareholders of the Blackwall Group (BWF), WOTSO Workspace has sought to retail its own clients by suspending memberships and guaranteeing desks and offices when they return.

Blackwall demerged WOTSO in January via an in specie distribution to its shareholders, ahead of a planned listing which has now been postponed.

Blackwall retains 14 per cent of WOTSO.

Launched in 2014, WOTSO has 17 sites covering 34,000 square metres (including one in Kuala Lumpur).

Its flagship site, the Bakehouse Quarter in Sydney’s North Strathfield, is best known as the former Tim Tams factory which Blackwall divested last year in a sale and leaseback deal.

Not surprisingly the operators have been wielding the scythe, with Victory cutting its casual workforce by 40 per cent and Servcorp letting go of 100 staff globally (remaining staff have taken a 20 per cent pay cut).

But the real key to the sector’s recovery is the willingness (or otherwise) of the landlords to provide relief – and after playing hard ball initially they seem to be ceding to reality.

Victory reports that half of its landlords have agreed to reduce or defer obligations, “with discussions ongoing with the others.” So far the operator has won either three to six month rent holidays or a 50 per cent reduction for six months.

The remaining landlords are expected to fall into line with at least 50 per cent reductions. Overall the company expects its rent payments to fall 58 per cent between March and August, to $1 million a month.

Blackwall notes that its major tenant WOTSO falls under the provisions of the mandatory code for rent relief and is also playing nice with waivers and deferrals.

Victory shares listed in June last year after its initial public offer raised $30 million at $2 a share. The shares peaked at $2.54 in October, but with the shares trading at or near record lows former Victorian premier Steve Bracks no doubt wondering why he took on the chairman gig.

As Victory stresses, it’s not the only one facing woes the fragmented sector. As the morale boosting COVID-19 line goes, we are all in this together.

“The liquidity pressure of COVID-19 creates significant head winds for a large portion of co working offerings due to their inability to access funding, resulting reduced margin pressure and increased competition.”

Meanwhile Servcorp shares almost halved at the height of the market rout in March and are still 38 per cent off the pace. The company has in its favour $76m of cash (as of December) and no gearing.

“I used to have a lot of debt,” Moufarrige says. “Now I’m old and if I want money no-one will give it to me.”

Unusually, the company has a share buyback program to purchase up to three million shares, or roughly 3 per cent of its capital.

Moufarrige and his family interests account for more than half of the register.

Moufarrige says he’s not ready to retire, but says succession planning is not being ignored despite last year’s departure of his sons Marcus and Taine. “We are training up people to run it,” he says. “Servcorp would be in good hands if I did decide to topple off my perch.”

The market is valuing Servcorp at $228m and Victory at a paltry $15m.

Tim Boreham edits The New Criterion

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Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

Editor of New Criterion
Independent Investment Research

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

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