🏢IWG's move to US-GAAP and the Big Question: What is Leverage anyway?

1. Introduction: IWG Moves to US GAAP 📊

Starting in 2025, International Workplace Group plc. (IWG) has switched its accounting standard from IFRS to US GAAP. The upcoming interim report, due on 19 August 2025, will be the first report to reflect this change. While the full half-year details will be shared in that release, the major implications of the transition are already clear (IWG, IFRS to US GAAP Conversion Presentation, June 2025). Beyond some technical details, the most significant change (as well as a large part of the motivation behind the switch) relates to lease accounting.

As IWG management explains:

“IWG is transitioning to US GAAP from IFRS as it better reflects the financial profile of the business and how the business is run. US GAAP results are similar to Pre-IFRS16, which is how the business has reported alongside IFRS.” — IWG, IFRS to US GAAP Conversion Presentation, June 2025

2. IWG’s Business Model🏢

IWG is the world’s largest provider of flexible workspace. Its brands (Regus, Spaces, HQ, etc.) offer office solutions on short-term or subscription-like contracts, serving everyone from freelancers to global corporates.

IWG operates a dual model: a legacy Company Owned & Leased segment and a newer Managed & Franchised (M&F) segment. In the legacy model, IWG signs long-term leases, fits out spaces, and sublets them flexibly. The M&F segment focusses more on capital-light growth: Here, external landlords fund fit-outs and take lease risk, while IWG only manages operations. This model scales faster, requires little capital, and strengthens free cash flow. But the capital-light strategy is also riskier: Scaling success depends heavily on IWG’s ability to secure property partners for managed agreements, a process that could face obstacles in certain markets or economic environments.

Our focus here is more on the Company Owned & Leased segment which is extremely lease-heavy. To manage leasing risk, IWG holds many leases via Special Purpose Vehicles (SPVs), isolating obligations (ring-fencing) and allowing restructuring if needed. About 30% of leases now include variable rent, linking payments to revenue and reducing fixed-cost exposure.

3. What’s the Difference? Lease Accounting under IFRS and US GAAP 🔁

Under IFRS 16, basically all leases are treated financing-like: they show up as right-of-use (RoU) assets and lease liabilities on the balance sheet, with lease costs hitting depreciation and interest lines in the P&L.

Under US GAAP (ASC 842) the balance sheet treatment (RoU asset and liability) is more or less the same. However, leases are classified as either operating or finance leases (distinction criteria similar to the old IAS 17 criteria). And this classification affects how lease expenses are presented in the income statement: finance leases are treated like IFRS 16 leases (split in depreciation of RoU and interest expenses for the lease liability) while operating leases give rise to a single straight-line lease expense as part of cost of sales.

For IWG, all leases are now classified as operating leases. That means (as compared to IFRS 16):

✅ Less frontloaded overall expense recognition (IFRS 16 record higher interest expenses in the first years of the lease)

✅ EBITDA and EBIT decrease (as full lease payment is now part of operating business)

✅ A clear labelling of lease liabilities as operating and hence a reduction in (net) debt.

⚠️ But the economics of the business do not change and the obligations don’t disappear

4. Interpreting IWG’s Shift to US-GAAP: A Double-Edged Sword ⚖️

➡️ On the pro side: From a business leadership angle, this change to US-GAAP is understandable. Leases are still seen by many management teams as an operating topic, not a financing issue. For internal steering purposes it is often unclear why it should be depreciation and interest expenses (and not the pure contractual lease payments) that keep the lights on. This internal management topic is also one of the main general structural criticisms about IFRS 16.

➡️ On the flip side: From a capital markets’ point of view IFRS 16 brought something extremely important to the core of the investment community: A better understanding of leverage and its impact on risk and returns. This one gets now lost in the switch. Let’s start from scratch for better understanding why this is the case….

5. Fixed Payment Obligations of Companies: Two Analytical Insights🔍

A starting point for the whole leverage discussion is the following: When investors look at fixed payment obligations of companies they are mainly interested in two things:

• 💧Liquidity, solvency, creditworthiness, ability to pay for the obligations: This is the financial perspective and touches default risk.

• 🎢Leverage, volatility, risk amplification, bottom line uncertainty: this is the investment perspective and touches residual position risk or equity risk.

Both perspectives are not independent of each other. All other things being equal, the higher the default risk, the higher the equity risk or volatility. And the other way round: the higher the volatility, the higher the default risk.

➡️These two perspectives are two sides of the same medal.

6. Leverage: What Matters Is the Nature, Not the Name 🔍

To better understand the leverage effect of fixed payment obligations (residual position risk) let’s have a look at a simple example. In this example, a company has expected revenues of 100 and expected fixed costs of 40. As we do not know what the future will bring, revenues are uncertain and actual outcomes can be 10 % lower (90) or 10 % higher (110). Fixed costs are fixed and are 40 in all cases. Looking at the bottom line (earnings) we can now see that we can expect 100 – 40 = 60 but that actual outcomes can be 50 (= - 16.7 % lower) or 70 (= + 16.7 % higher). This clearly emphasizes the residual risk amplifying effect of fixed costs. What was a 10 % uncertainty before fixed costs is now a 16.7 % uncertainty after fixed costs, quite a difference. See also the following illustration.

What is important: It is the economic substance, i.e. fixed nature of payment obligations that drives this leverage effect. It is not important whether you call this leverage one way or the other. This brings us to the different variants of lease accounting…

• If you record lease contracts according to IFRS 16, the leverage is financial. Lease liabilities are seen as financial liabilities, there are interest payments in the P&L and lease payments show up as financial cash flow components.

• If you record lease contracts according to ASC 842 operating leases, theliabilities are seen as operating (not part of net debt), lease expenses are part of cost of sales and are fully recorded above EBITDA and lease payments are operating cash flows components.

But in economic terms NOTHING changes for equity investors. The result? Same constraints on cash flow. Same volatility in net cash flows. Same pressure in downturns. Same same, not different. Leverage is leverage. From this perspective, IFRS 16 is the better standard (at least from an equity point of view). It aims to shows the risk position for equity investors (residual risk position) in an unbiased way.

💡The interesting thing is now: Investors have a clear understanding of financial leverage, but operating leverage is still a bit harder to grasp for them. This is not a big surprise as:

• Financial leverage gives a clear value of the fixed cost position (the value of financial debt), for operating leverage there is no such information readily available.

• Risk assessment of financial leverage is much easier as there are interest rates or yields (which signal the degree of riskiness) related to the financial debt. For operating leverage drivers this is not available.

• Disclosure is much more investment-like and comprehensive for financial leverage drivers than for operating leverage drivers.

However, IFRS 16 has changed this. Over the years, the capital market has much better understood the trade-off between operating leverage and financial leverage and how we can better quantify the risk impact of fixed operating payment obligations. Without downplaying that there are still some problems with IFRS 16, this educational effect is a great contribution of this standard. It has even opened the door for investors to think even broader than just in terms of leases about fixed costs.

Better the devil you know: Strange as it may sound but understanding risk better helps to reduce risk.

7. So What for IWG? 🤨❓

• The educational effect of IFRS 16 on leverage-induced risk gets now lost under US GAAP.

• The EBITDA sacrifice that IWG has to suffer only looks prudent for more superficial investors. The risk downplay-effect is clearly dominant here.

• Equity riskiness of the business is now masked more than it was under IFRS.

• The new disclosed net debt number is far below any reasonable present value of payment obligations of the company

• But comparability with US-GAAP peers is clearly higher now.

Except for comparability with US peers we cannot see any serious other reasons for the switch (at least from an equity point of view):

• IWG has most of its leases in SPVs with contracts being non-recourse to the company. However, the leverage effect to equity investors is totally independent of whether there is recourse or not. It is absolutely the same in both cases. On the other hand, the default risk for e.g. investors of bonds issued by the company is different if the leases are structured via SPVs. But this is more interesting for bonds investors than for equity investors…*

• At IWG around 30% of the company’s leases are structured as variable rent agreements, where most rent payments flex with revenue. However, these lease payments do not give rise to lease liabilities and RoUs anyway under IFRS and US-GAAP. They are expensed as incurred under both principles.

📌 Overall, we do not think that this switch is a great move of IWG. The opportunity of using IFRS 16 to highlight the leverage of the business was missed. It is, however, an understandable move if management seeks for comparability with US-peers. Most smart investors will look through this move anyway.

* this might explain why e.g. the rating agency Fitch welcomed the switch to US-GAAP (“Fitch already treats IWG's payable rents from its operating leases as an operating cost in EBITDA and does not capitalise them.”, Fitch Ratings, IWG’s Transition to US GAAP Neutral to Ratings, 30 June 2025), although we would not recommend the Fitch-way as a bond investor. The Fitch-way risks to underestimate business risk (as compared to financial risk).

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