AirBnB: Should You Invest In the Hype?
By: Arhat Bhagwatkar
Tags: Airbnb, Housing, IPO, Work From Home, Travel

Airbnb Has A Resilient Business Model

In early 2020, as the pandemic disrupted travel across the world, Airbnb’s business declined significantly. But within two months, their business model started to rebound even with limited international travel, demonstrating its resilience. People wanted to get out of their homes and yearned to travel, but they did not want to go far or to be in crowded hotel lobbies.

Domestic travel quickly rebounded on Airbnb around the world as millions of guests took trips closer to home. Stays of longer than a few days started increasing as work- from- home became work- from- any- home on Airbnb. The lines between travel and living are blurring, and the global pandemic has accelerated the ability to live anywhere. Airbnb has proven adaptable to meet these new ways of traveling.

The Most Anticipated IPO

Photo by Blogging Guide on Unsplash

The IPO price of Airbnb (ABNB) was priced at $68 valuing the company at ~$47B. The stock price closed at around $138, valuing the company at around $100B. Such a valuation is well above the firm’s $18B valuation at the beginning of the COVID-19 pandemic.

But even if Airbnb continues to execute as it has to date, will the firm be able to achieve the future cash flow expectations implied by a $100B valuation? Let’s see.

There have been recent IPOs and several stocks where valuations were sky-high as AirBnB. AirBnB can be profitable and have a growth beyond the current rate if the company can:

Maintain its newly lowered cost structure to improve margins Leverage its large global footprint of hosts to meet consumer lodging demand Leverage its scale and network effects to grow its footprint with minimal extra cost

Why did Airbnb go Public Amidst Slow Travel and Declining Revenue?

It’s important to understand why a company goes public. DoorDash (DASH) recently went public. It makes sense to go public while demand for food delivery is at an all-time high. On the other hand, it seems like strange timing for a travel firm to IPO in the middle of one of the worst stretches for global travel in decades.

According to a report by Wall Street Journal, Early investors and employees have been applying pressure on Airbnb’s CEO to go public this year, as they’re set to lose their stock options next year.

Ultimately, a risk of investing in Airbnb’s IPO is the fact that that the shares sold provide little to no say over corporate governance.

So What Is Airbnb Really Worth?

Airbnb’s IPO is a perfect exit strategy for existing investors but is its higher valuation justified?

I wouldn’t say that at $100B Airbnb is overvalued but as per analyst’s consensus and key operating metrics of the company, the valuation does not seem realistic.

If we were to plan out two different scenarios justifying the current and prospective valuation, it could go as follows:

Scenario 1: Let’s assume Airbnb maintains revenue growth similar to pre-pandemic levels, while successfully lowering its marketing expenses and achieving margins on par with the industry average. Specifically, Airbnb can:

• Improve its EBIT margin to 9% over four years, compared to -8% in 2019 and -16% over the TTM, as compared to estimated industry average of 25% EBITDA margin by 2025 (Statista estimates) and

• Grow revenue by 34% compounded annually for the next five years (Revenue grew 32% YoY in 2019).

Airbnb estimated its total addressable market (TAM), which includes spending on short-term stays, long-term stays, and experiences, to be around $3.4 trillion.

Scenario 2: Now let’s assume Airbnb is aggressive on cost efficiency and at the same time ready to sacrifice some revenue growth to achieve profitability on par with Booking Holdings, the most profitable travel firm.

Specifically, assume Airbnb can:

• Gradually improve its EBIT margin to 16% over the next five years

• Grow revenue by 20% compounded annually for the next five years, which equals Booking Holdings’ revenue CAGR over the past decade

If AirBnB is able to grow revenue, EBIT, and free cash flow (FCF) more efficiently, shares could have even greater upside and the current valuation could be portrayed as “reasonable”.

What seems to be the problem?

The lack of consistent profitability

It is not surprising that Airbnb’s revenue fell steeply in the first half of the year, given the COVID global pandemic. An upward trend in customer travel drove the firm’s profits in 3Q20, but it was never enough to reverse the downward trend COVID Provided an Opportunity, but Still Negative Profitability

When the pandemic hit, it provided the travel firms with an opportunity or forced some to make some significant changes to its operations. Airbnb laid off nearly 25% of its workforce in May 2020 and significantly slashed sales and marketing spend which were ~50% less through the first 8 months of 2020. Such actions helped ABNB present a clear path of profitability moving forward, given that they were still able to attract customers to their platform with low marketing spending. AirBnB expects sales & marketing expenses to decline as a percent of revenue as the firm shifts its marketing approach to attract more users via direct and unpaid channels and less from more costly SEO and other performance marketing channels. If this shift in marketing expenses results in a more profitable business, it would be an excellent news for investors as AirBnB still has negative profitability. Airbnb’s Network Effects Could Scale Advantages

Airbnb’s existing platform model of property owners and room listings creates and sustains a true network effect that provides a greater scale advantages. In essence, the more listings available on the platform, the more consumers will look to Airbnb first, which will drive more property owners to the platform to reach the largest audience. As Airbnb states, “guests attract hosts, and hosts attract guests.” Airbnb truly benefits from scale, as with each new listing, it becomes easier, and theoretically cheaper, to attract users, and vice versa. As per the latest data, Airbnb has ~7.3 million, Booking.com has ~6 million and Marriott Rooms has ~1.3 million listings.

During the pandemic, the rise in demand for short-term rentals over hotels when choosing somewhere to stay could further benefit Airbnb. If the pandemic can cause a permanent shift in consumer behaviour in the next 4–5 years, Airbnb could stand to reap the benefits given its larger scale compared to peers, as some analysts don’t see full hotel occupancy till 2023–2024.

What should be the long-term strategy for Airbnb?

Unlock more hosting: ABNB should look out for emerging travel trends, such as local travel and remote working, and design new ways to host their guests Invest in the brand: In 2019, ABNB had 247 million guest arrivals, which only accounted for 3.8% of the estimated 6.5 billion overall domestic and international paid overnight trips that year. The benefit and uniqueness of the brand should be at the forefront of brand value creation in the coming years Design new products and offerings: Covid opened up opportunities that one could only previously dream of. As the world continues to change, ABNB should bring together new technologies to expand possibilities for hosts and offer new experiences for their guests

What Now?

Regulations have always been a determining factor of the company’s business survival. It has fought legal battles and still faces restrictions around the world. The business model is disruptive and has more prospect to change over the years as we yet don’t know what lies ahead in the future of travel.

In the short-term, Local travel will be the bread and butter for ABNB. Competition exists on a global scale but their geographic reach, the strength and loyalty of the host and guest community, the platform functionality, including community support, payments, and host protections, and the extensibility of their platform are among several factors that have differentiated them.

The hype of its valuation is there to stay but what lies ahead for them is still uncertain. The premier trading day has proved that its not EBITDA the investors were after but rather Earnings before Everything Else (EBEE).

Is it Tech Bubble 2.0?

The current state of market is pure speculation and it will however revert to normal, however, no one knows when. UBER, LYFT, DoorDash among others listed themselves driving prices absurdly high.

This is looking eerily similar to the dot com bubble. The companies are not making a profit. Any large investor, institutional investor who is worth their weight will look at the company and see that it is pure speculation when they are making no profit and their stocks are skyrocketing pricing in future growth. This happened in the dot com bubble when every retail investor thought they would “make it big” on one of these companies. The same thing is happening now with many companies and retail traders holding the bag once again.

Only time will tell, but its certain that these companies will pop and drop and people will drive the prices down. This is not saying that the market is overvalued, money has to go somewhere and there are many solid companies, but speculation can only last so long before the fundamentals of a business kick in and institutional investors pull the rug.