Why Airbnb's IPO may have a lot of room to run

Assif Shameen
Assif Shameen11/20/2020 07:00 AM GMT+08  • 10 min read
Why Airbnb's IPO may have a lot of room to run
Seeking to raise nearly $5.4 bil, Airbnb’s IPO in mid-December will be the biggest since the pandemic forced a global shutdown.
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On Nov 16, just hours after US biotech firm Moderna Inc announced that the ongoing Phase Three of its Covid-19 vaccine trial showed that its drug was 94.5% effective, global home-sharing giant Airbnb Inc filed its S-1 initial prospectus with the Securities and Exchange Commission, which is regarded as an intention to undertake an IPO.

The timing could not have been better. A week earlier, pharmaceutical giant Pfizer Inc announced that the Phase Three results of its own vaccine showed 90% effectiveness. Although Covid-19 cases are surging again as the pandemic’s second wave spreads across Europe and North America, threatening stricter lockdowns that could further disrupt their economies, the imminent arrival of vaccines spurred global markets to new heights this past week.

Airbnb’s IPO in mid-December will be the biggest since the pandemic forced a shutdown of economies around the world earlier this year. The peer-to-peer room and home rental company is seeking to raise nearly US$4 billion ($5.4 billion) at a US$35 billion to US$40 billion valuation. Ant Group’s botched Shanghai-Hong Kong dual listing earlier this month would have been far bigger — raising US$34.4 billion at a US$313 billion valuation — but Beijing forced the FinTech giant to pull the plug at the last minute.

Airbnb, the largest private firm in the US, is a sharing economy giant that allows individuals to rent out their homes or apartments, effectively turning these into hotel rooms and creating a market that did not really exist before. Sharing economy firms like Uber and Airbnb emerged in the aftermath 2008 Global Financial Crisis when capital, particularly late-stage capital, was cheap. With more than 150 million users worldwide as at Sept 30, Airbnb had over 7.4 million listings, of which 5.6 million were “active listings” during the pandemic — including 100,000 cities spread over 220 countries and territories. And oh, quite aside from houses and apartments in cities and the suburbs, it also provides a “community marketplace” for people “to list, discover and book” a wide variety of accommodation — among them, 90,000 cabins, 40,000 farms, 24,000 tiny homes, 5,600 boats, 3,500 castles, 2,800 yurts, 2,600 treehouses, 1,600 private islands, 300 lighthouses and, wait for this, 140 igloos. Indeed, there is something for everyone.

Essentially, Airbnb is an online tool that, for a small fee, allows an individual, or a “host”, to turn his couch, spare bedroom, apartment, house, car or just about anything else into a potential hotel room. It makes money on both sides of a booking transaction, typically charging hosts a 3% service fee while guests typically pay a service fee or commission of 6% to 12%. On average, if you are renting out your home for a few days in a large global city, say London, New York or Hong Kong, Airbnb collects about 10% of the total gross revenue.

The storied rise, fall and phoenix-like re-emergence of Airbnb and its founders is the stuff of legend. Co-founder and CEO Brian Chesky, scion of New York social workers, designed toys and shoes as a teenager, studied industrial design, developed an interest in landscape architecture and was an industrial designer when he stumbled on a unique business idea — renting homes to visitors for short periods. He and his roommate Joe Gebbia, a former design school classmate, could not afford rent after relocating to San Francisco, one of America’s most expensive cities. When the city hosted a design conference in late 2007, hotels were way overbooked, so the duo borrowed money to buy three air mattresses and rented out their own place. Months later, with another friend, Nathan Blecharczyk, they launched Airbed and breakfast (since renamed Airbnb), which will upon listing next month become the most valuable travel business on earth.

Chesky, now 39, and his two co-founders were not thinking of global domination or even building a billion-dollar company when they launched Airbnb. They just wanted to make some money with an idea they thought had potential. Indeed, when Airbnb first pitched venture capital investors, Sam Altman of Y Combinator told the founders to adjust their estimate for potential future revenue by changing the word “million” to “billion”.

Travel super app

But more than creating a market for rooms, Airbnb has developed a platform with a trove of data that can be used to sell a host of other travel-related goods and services. Before the pandemic, Airbnb unveiled a road map to turn itself into a travel super app. It wanted to be the WeChat of travel, allowing people to book flights, ground transport, event tickets and, of course, homes or rooms. In the aftermath of Covid-19, however, CEO Chesky has torn up that plan and is now focusing on its core market — home rentals.

An early issue was vandalism by tenant guests. People would book into someone’s home as a guest, stay a few days, vandalise it and walk away. Chesky installed a 24-hour hotline, additional staff support and a guarantee for theft or vandalism backed by insurance firms. Guests still vandalise properties, and sometimes steal little things but on a much smaller scale, almost at a par with hotels, so it is now just part of the cost of doing business. Moreover, if you gave your credit card number, name, address, mobile phone number and possibly a driving licence number to make a booking, you are less likely to vandalise a home rental than a large hotel because a victim could put your name, photo and other details on the internet, something a hotel company would be loathe to do.

The short-term rental platform chalked up US$1.34 billion in revenue in the July to September quarter, or an 18% drop from the same period last year, its S-1 filing revealed earlier this week. For the first nine months of the year, losses exceeded US$700 million on revenue of US$2.5 billion. Airbnb reported US$219 million in net income in the third quarter, up from a US$575.6 million loss in the April to June quarter. It also reported US$328 million in free cash flow during the last quarter as it continued to slash expenses. Much of those profits were due to savings largely stemming from cuts to its marketing budget.

How can a hospitality firm make money during a pandemic? Airbnb did far better than hotels as economies began to open up because it is more focused on vacation travel. It also helps that it has a higher reliance on domestic, short-haul tourism with travellers driving to the door rather than flying into town. Growth in same-country travel was up 14% year-on-year in terms nights, 35% year-on-year in terms of spending. Short distance travel grew almost as fast. In the third quarter of 2019, Airbnb spent 26 US cents on sales and marketing for every dollar of revenue it generated. This past quarter, it spent just eight cents per dollar. Its detractors note that in 2019, it spent US$5.3 billion to chalk up US$4.8 billion in revenues. But having aggressively slashed costs to get back to profits, it is unlikely that it will go on a spending spree again anytime soon. Airbnb’s reduced cost structure and post-Covid recovery means its path to profitability has become better lit, and shorter. Moreover, it still has more cost levers that it could pull. For example, contactless check-in, a safety measure during the Covid era, could be a cost-saving one in the future, say analysts.

Airbnb had US$4.5 billion in cash, cash equivalents and marketable securities on Sept 30,including US$1.8 billion in long-term debt. By raising nearly US$4 billion in new equity in the IPO, plus a 15% “greenshoe” overallotment option that would lift the total amount raised to over US$4.5 billion, a profitable Airbnb will soon boast a stellar balance sheet.

For the home-sharing firm to eke out a small profit in the last quarter amid the Covid-19 outbreak is significant because the pandemic nearly crippled the firm with bookings plunging 72% in March and April. It needed cash to stay afloat. Chesky did not want to do a down round, or raise money from venture capitalists at a dramatically reduced valuation, so he took US$1 billion from private equity firms and US$1 billion in loans while drastically cutting spending, laying off more than 1,900 people or about a quarter of its staff. The company also slashed US$1 billion in marketing expenses. To save money, Chesky started living with his mother. Now, he is refocusing on core home rentals to revive growth.

So, what makes the home-sharing platform so special? “Airbnb’s capital assets are both the most ubiquitous on earth — residential real estate is the single biggest category of investment — and the most adaptable because what it offers is the package of home-plus-host,” says Byrne Hobart, an analyst and blogger for The Diff. “Its marketing is cost-effective, and it makes use of the world’s largest asset class without putting any of it on the balance sheet.”

While delivery and ride-sharing companies place a large share of the unit cost variability on their own profit and loss statements, Hobart notes, Airbnb’s biggest out-of-pocket risk is incentives and refunds, which were running at a steady 5% to 6% of revenue until the pandemic hit, and were 14% of revenue during the last nine months.

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Biggest moat

“Airbnb has the biggest moat in travel,” Scott Galloway, a professor of marketing at the New York University’s Stern School of Business, pointed out in his recent blog post. “I believe this time next year, Airbnb will be one of the world’s 10 strongest brands.” The San Francisco-based platform, he wrote, will likely be worth more than the three largest global hotel firms — Marriott International Inc, Hilton Worldwide Holdings Inc and Best Western International Inc — combined.

The way he sees it, Airbnb has something that ride-hailing firms like Uber or giant hotel groups like Marriott lack. “Ride hailing requires local supply — drivers — and demand — or hailers. Hotels need local supply — rooms — and regional demand — or guests,” Galloway noted. A global hotel brand requires both local supply and global demand, as guests are from all over the world. Airbnb has global supply, boasting more listings worldwide — more than the top hotel groups combined. “Airbnb is the only hospitality brand that has the global awareness to generate unrivalled demand.” The NYU professor argued that Airbnb is also better value than hotels, offering more space at a lower cost. There is no check-in, elevators or common areas, which makes guests feel safer during a deadly pandemic.

How does one value Airbnb? “It’s clearly not a hotel business, or a recurring revenue generating software-as-a-service, or SaaS, firm,” said Galloway. Airbnb, he added, is a “highly disruptive” tech firm that has a greater share of employees with an engineering background than either Amazon or Uber. The only listed firms that he can think of that have similar global demand and supply as well as brand equity with an asset-light high-margin business are credit card firms Visa Inc and MasterCard Inc, whose stocks trade at over 20 times their annual revenue. If Airbnb can meet or beat its projected US$5 billion to US$6 billion in revenues next year, it could be valued at US$100 billion to US$120 billion, he argues.

But before it gets there, Airbnb faces new challenges. Competition is coming in the shape of Google Hotel Finder, Booking.com’s HomeAway and Expedia Group’s Vrbo. There is also tighter regulation from cities around the world which have imposed caps on the number of nights that can be legally offered by an Airbnb host. If Chesky can navigate those, Airbnb will be the platform to beat in the travel sector.

Assif Shameen is a technology and business writer based in North America

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