WeWork's attempt to tap junk-bond investors isn't working this time - 'Their borrowing model is seriously in question at this point'

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WeWork CEO Adam Neumann

• According to news reports, WeWork is exploring the possibility of issuing junk bonds to fulfill its funding needs after its biggest shareholder SoftBank reportedly urged the group to shelve its pending IPO plans.
• The company has issued junk bonds 2018, but investors wouldn't be as receptive now given its recent slash in valuation and uncertainty around its finances.
• "If the company's value is in question the whole thing unravels," said John McClain, a portfolio manager at Diamond Hill, in an interview with Business Insider.
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WeWork's days of running between different groups of investors to fund itself may well have caught a snag.

In a flurry of bad news this week, the company's IPO is potentially set to be shelved on the recommendation of its largest shareholder SoftBank, and WeWork's latest plan to issue junk debt to meet its funding needs is spooking investors.

Unprofitable, propped up by billions in funding from SoftBank, and with more than $1 billion in long-term debt outstanding, WeWork's plan to tap junk-bond markets to sustain itself has caused consternation. It has gone to high-yield bond investors before, but that was back in 2018, when junk bonds were the hot unicorn trend.

As of yesterday morning in New York, the price of WeWork debt tumbled, as jittery investors sold the bonds. Its existing junk debt was yielding above 8% as investors continued to sell off holdings in the company.

WeWork is now in a funding bind, having lined up a $6 billion credit line that is contingent on it raising at least $3 billion in its IPO, according to its S1 offering prospectus.

Read more: WeWork's valuation is under fire. Here's everything we know about its IPO plans, finances and concerns around CEO Adam Neumann.

"The whole company is built on continuously sourcing money from different investors based on higher and higher valuations. If the company's value is in question, the whole thing unravels," John McClain, a portfolio manager at Diamond Hill, a US investment firm that manages fixed-income funds, told Business Insider in an interview.

"Their borrowing model is seriously in question at this point," he added.

Holders of WeWork's existing debt have already started selling off their holdings as a result of the IPO's struggle to gain traction. The company had initially hoped for a massive valuation of around $47 billion, but The Wall Street Journal reported on Sunday that the company reportedly could slash the valuation to below $20 billion.

McClain said in the case of WeWork, he had never seen a unicorn with such a high valuation seemingly have so little support from both equity and debt investors.

WeWork declined to comment to Business Insider.

WeWork's hunger for junk bond debt in 2018

WeWork previously issued $702 million in unsecured bonds in 2018, at a hot point in fixed income markets. The company is rated B, sub-investment grade or junk, by ratings agencies Fitch and S&P, meaning its debt issuance appeals to high-yield investors who are willing to take on more risk to fund a company.

The company's inaugural junk bonds yielded 7.875% and attracted plenty of investor interest, following in the path of other fast growing tech companies like Uber, Tesla, and Netflix in tapping the high yield market. However, investors have become increasingly wary of cash burning companies piling on leverage amid dubious financials.

Highly rated private tech companies with valuations north of $1 billion, known as unicorns, are not traditional occupants of the high yield space. But they found a sweet spot of investor demand starting last year amid low US Treasury yields and a boom in leveraged lending.

The attractiveness of these companies was previously described as a "halo effect," but a lack of cogent information about a company's explicit financials can cause investor sentiment to tumble.