Description

Airbnb VIC Writeup

At a share price under $ 100 per share (as of last Friday it closed at $ 97.67), Airbnb’s total market capitalization has come down from over $ 100 bn to around $ 60 bn. Considering the roughly $ 7 bn net cash on the balance sheet, we believe Airbnb is an attractive investment at this time.

Airbnb has been written up once before in March 2019, and it is worth mentioning that there are also aspects of Airbnb’s business model that is detailed there.

We believe Airbnb presents a good long term investment opportunity for a great business and increasing margins (reaching profitability) and continued growth should provide a catalyst in the next 2-3 years.

What I would like to do with this idea submission is:

(1)    Detail a qualitative perspective, which I think is different than what has been mentioned before of why I think Airbnb will have a very long growth

(2)    Put more numbers to the investment case especially around valuation and margins. This is something that seems to have been a bit less detailed in previous writeups from reading the comments.

Why Airbnb has a high certainty of sustainable growth for many years despite competition (Qualitative Perspective)

I think when most investors look at a company like Airbnb, they are looking at what moat the business has or what sets them apart from their competitors. While I think this is sensible, I find it not quite sufficient.

I think it is far too easy to find competitive advantages that simply do not persist in a way that is meaningful. When we speak about scale or an important brand, that is something that sometimes it has a lot of value, but sometimes being recognized is not enough.

The approach I take is from the other side. I look for the most dominant players in an industry, those that pioneer an industry or are by some wide margin the company that symbolizes the whole industry. Think Google for search engines or Amazon for E-commerce. Along with this metrics, I look for those companies that are in industries that are structurally growing because a reason I can understand.

I think Airbnb is one of a very few companies in the world that fits this description. It pioneered the alternative accommodation space and is still the company with the most entrenched position in the industry.

Here are different metrics that is evidence of this dominance:

1.       Google Searches clearly show that people are continue to search by “Airbnb” over some of their main competitors.

2.       The large gap that Airbnb enjoys in organic search vs. paid for search compared to Expedia (VRBO) and Bookings.com is well known.

Previous to 2020, Airbnb already enjoyed getting “only” about 20% of their traffic via paid search while this number was closer to 50% for bookings.com and Expedia. In 2019, to be exact, 77% of Aribnb’s traffic came either direct or via unpaid search. Then during 2020 when the first COVID wave hit, Airbnb significantly ramped down marketing spend specifically on paid search. Still, this did not lead them to lose any market share to their competitors. By Q3 2020, for example, in the midst of the decrease in travel, Airbnb gross bookings revenue was just under -40% yoy compared to over -50% for Bookings.com and over -70% for Expedia.com. To me, this really demonstrates their core strength vs. their competitors.

3.       Airbnb continues to be more resilient and grow listings.

The update here in 2022 Q1, which was just announced a few weeks ago, Airbnb showed a growth of 27% y/3y in gross booking value. For Booking Holdings, Inc. (from their Q1 report) gross bookings in the same Q1 period grew 17% compared to Q1 2019. This means that today, through the worst of the 2 year COVID period, Airbnb has come out stronger than even compared to pre-pandemic.

Being the dominant player in and industry is what I am looking for, but it also needs to be in an industry with structural growth. A counter example is: I do not want to invest in the most dominant player in the coal industry. It also has to be a structural growth driver that I can understand. I think I also have this in the case of Airbnb.

That what is called alternative accommodation, or I would say individualized living spaces is an accommodation trend that makes sense to me and that now has over a decade worth of data as evidence for its growth. I do not have to assume something is going to happen that is not already well documented. A combination of cost savings in some instances, and better fit i.e. for families or for groups or duration of stays, and unique experiences aspect are all reasons why this sector is growing and the data is there.

Overall, what I didn’t want is to look at a company and then try to establish whether it has or does not have a moat. I find it far too frequent that when you are looking for something particular, you make up something when there isn’t a real competitive advantage that matters.

With Airbnb, I really think, is a case where its dominance is so obvious that it fits the criteria above for the strongest player in the industry it does not depend on you crossing every last x and o to try to establish a competitive advantage where there might not be one. Moreover, this is supported by hard data that is consistent over time and with different metrics.

For me, this is the most important aspect.

If it remains the dominant player in this industry, and the industry continues to grow for decades, then it is almost a certainty that this business would be worth far more in the future than it is now.

A Short Segway on Growth

While the exact growth in the future of any business including Airbnb is difficult to pin down, and in my opinion, also not the most critical part as long as there is consistent and long-term growth > 10% p.a., I do want to show the big picture on how Airbnb has grown and might continue to do so in the future.

For this year 2022E, Airbnb is projected to have a run rate of well over 400 million nights and experiences booked. This compares to 72 million nights and experiences in 2015. For average booking value, we are looking at a run rate of over $ 60 billion ($ 17bn in Q1). This is a very different scale than the figure of $ 8 billion just a few years ago in 2015.

All of this reminds me of another investment, we have had for a long time. I remember in 2014, Google (now Alphabet) had a revenue of around $ 60bn for the year. Already then it was a huge business. But this year it will have revenues of almost $300 bn.

Most investors and for that matter analysts have a projected growth for Airbnb for the next few years around 20%-30%. To be very honest, I do not know where Airbnb will fall in this range or even slightly below, and I also think that most investors can not accurately predict this precisely.

But what is most important is that the business is growing over the long term, and the above numbers are very clear in that Airbnb is. The growth will be lumpy and this being also a somewhat cyclical business, there is even more variability, but the big picture is clear and I think that should be the focus.

I think at the end, the key question here is whether the discussion of the huge total addressable market of > $ 1.0 trillion in travel accommodation and experiences is valid or just a pie in the sky exercise. I think based on the above, the evidence is very supportive that it is.

What is a Fair long-term margin for Airbnb and is it overvalued?

Based on the discussion and comments about Airbnb so far mentioned here on VIC, it seems that one other aspect that is often discussed but where I feel there has been too little in the way of actual numbers has been the margins of the Airbnb. 

I have detailed the major cost buckets and operating margins for Airbnb in the last 5 years below.

I think the central question here is what a likely long-term steady state margin is and when it can reach that. The company often speaks about operating margins at around 30%, but is this remotely realistic?

The approach I have taken is to look into each cost item and see which ones of these are likely to change with increasing scale and operating leverage for Airbnb and which ones are unlikely to change.

By definition this is based on my own assumptions of what seems realistic, and I would welcome an open discussion of this. This is just my best estimate based on my understanding of how those cost items could move in the future.

Costs of revenue this major bucket includes payment processing, merchant fees, chargebacks (account takeovers/fraud), AWS costs to host Airbnb, and amortization of technology.  It includes stock option costs which are separately broken out in the annual and quarterly reports. In almost all years from 2015-2021, this figure had amounted to roughly 25% of revenues. This has declined somewhat in 2021, partly due to cost savings efforts and decreased payment processing costs.

I think for cost of revenue, this bucket is unlikely to move significantly long term as a percentage of revenues. The costs have been fairly steady pre-2020 and scales essentially with the volume of business. Some cost optimizations and reductions in payment processing in 2021 have reduced this a bit, but long term, I would expect this cost item to remain in the 20-25% of revenue range. I take 22% as long term-assumption.

Operations and Support, which amounts to around 20% of revenue, include costs such as customer relations costs, community support personnel, and insurance costs. Customer relations costs seems to be a variable cost that varies with amount of bookings.

This cost item has varied over the years but has been between 14-26% of revenues in the most recent years. As the costs are associated with managing any operational issues around each booking, like conflict resolution and booking issues, I would assume that the costs increase proportional to more bookings. In fact, due to more regulation, one could make the argument that some of this might even go up from the host side.

I assume that long term a steady state cost of operations and support remains at 20% of revenues.

Product development includes facilities and information technology.

This cost bucket has been a highly variable bucket in the last two years as Airbnb focused on continue to build out new products and innovative features, with several major updates.

On the whole this is has cost between $ 400 million and $2.7 billion over the last few years. Here, as these are developmental costs for new products, I would assume that as the company becomes even more mature that these developmental costs will remain steady and decrease significantly as a percentage of revenue.

I assumed in 5 years time, this figure remains at $ 2.0 billion (just under the high level of 2021 when they were introducing new products), but decreased as a percentage of revenue to 14% from the current figure.

Marketing & sales: Marketing costs includes coupons to customers and social media marketing (to third parties). It also includes travel and entertainment expenses and personnel costs. Much of this is discretionary. This is why it was able to decrease this amount by about 65% in 2020 vs. 2019.

Here also, given the aforementioned strength of Airbnb’s organic search traffic and just less promotional marketing as the business matures, I would expect this to have significant potential to decrease as a percentage of revenue from here.

I would assume that Airbnb increases spending here from around $ 1.2 billion per year to $ 1.5 bn on this, which still represents a decrease as a percentage of revenues to around 10%.

G & A: Overhead costs have gradually decreased from 36% of revenues to 14% of revenues between 205 and 2021. I would expect this trend to continue somewhat as the business gains more scale.

I assume that we have G&A as 10% of revenues in 5 years. It is just a guess, but that represents $ 1.4 billion in cost, or about 30% higher than today.

Long term-margins: Based on the above assumptions on each cost item and how they may develop in the next five years, I think it is not unrealistic that Operating margin improves to the mid-twenties. In particular, I would expect the percentage of revenues going to cost of revenue and operations & support to stay relatively stable, but product development costs, G&A, and sales/marketing costs to decrease as a percentage of total revenues over time.

To triangulate whether this assumption of improving margin is realistic, I want to show the last 4 quarterly margins of Airbnb. This below is directly from Airbnb’s latest quarterly report.

As you can see, Airbnb has quite an operating leverage, and both operating income and their reported Adjusted EBITDA varies significantly when there are more bookings on the same operating cost basis. As Airbnb is also seasonal, with Q2 and Q3 the summer months being the most important travel quarters, it is easy to see how margins directly improves with higher operating leverage (i.e. more bookings). 

I take this also as another indication that an improving margin as the business continues to grow traffic and mature, is a fair assumption.

All, in all, I have modelled an operating margin of 28% which leads to a net income margin of 20% in 5 years in 2027. I welcome discussion here, but this is what I believe based on best estimates to be realistic.

Assuming steady state earnings of around $ 3.1 bn on revenues of $ 14.7 bn (I assume a CAGR of 20% p.a.), the current valuation of $ 60 bn represents a net income multiple of under 20x for that earning a few years out.

The most important thing in my opinion is that Airbnb maintains its dominant position in the industry and that alternative accommodation grows for many many years, but I would say based on the above, the current valuation is at least not wildly overvalued.

Conclusion:

I hope that I was able to shed some light on what I think are the reasons to be fundamentally very positive about Airbnb as an investment. I find it especially the case at the current valuation.

I see a clear catalyst in the increase in margins as Airbnb resumes its continued growth and operating leverage allows some of the cost items to decrease significantly as a percentage of revenues.

Assuming this happens, the business model and capital light economics of Airbnb would naturally make it a wonderful compounder.

I would welcome discussion around the qualitative aspects and perhaps what is evidence supporting or against the view that Airbnb will continue to be the dominant player in a growing industry for many years.

Catalyst

Increasing margins (reaching profitability) and continued growth should provide a strong catalyst in the next 2-3 years