Airbnb

A new and safe way to travel

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Introduction

The company that is the subject of today's thesis aroused my curiosity for my own user experience (Peter Lynch style). Since I started using Airbnb services 4 years ago, I have not slept in a hotel when I travel. The simplicity, reliability and satisfaction that it generates every time I use their services have made me decide to analyze and value it as a possible investment.

Airbnb was born in 2008 by Brian Chesky (current CEO, maximum shareholder and core of the thesis), Nathan Blecharczyck and Joe Gebbia in a small apartment in San Francisco, totally unexpectedly.

"When we created Airbnb, it was about more than just travel. In 2007, my roommate Joe and I inflated 3 air mattresses one weekend and converted our apartment into an air mattress and breakfast. We hosted 3 guests that weekend, Michael, Kat and Amol, and in doing so, we became the first hosts. Our guests arrived as strangers, but left as our friends. And the connections we made that weekend made us realize that maybe there's a bigger idea here." - Brian Chesky

After more than a decade in operation and revolutionizing the travel industry, it goes public in December 2020, in the middle of the Covid pandemic, being this industry, along with the restaurant and aviation, the hardest hit worldwide.

Its estimated valuation at the time of its IPO was at $68 per share, but to everyone's surprise, it does so for slightly more than double that estimate, showing the euphoria or optimism with that company. Looking at Chesky's face in the following video, it seems to be more the former.

It currently capitalizes 128,000M, has 627M shares outstanding and revenues that have grown at over 30% CAGR over the last few years. The pandemic has caused its revenues in 2020 to fall by almost 30%, but in 2021 they are already showing 10% above 2019, a sign of resilience, as it has not only not survived the pandemic, but possibly accelerated its growth, as we will see below.

Business

Airbnb is a two-sided online platform that allows the rental of a room, apartment or any private room to sleep. On one side we would have the host who has a property to rent and on the other the guest who wants a space to spend the night. Airbnb is in charge of connecting supply-demand by charging a fee on the total cost of the stay, which is around 16%. This can be increased if they include the experience service, where in addition to hosting, the host shows the city and enjoys it as if he were a native.

The total number of guests now exceeds 4 million hosts and more than 1 billion total guests since the company began operations. Chesky's goal is to reach 1 billion hosts, whether it is reached or not, makes it clear that the capacity for growth is enormous.

The main value of Airbnb, beyond its size, is reliability and trust. To stay in a stranger's home you need to be sure and calm to make a reservation. This is achieved thanks to its scale, as the more reviews, the more confident the future guest is that they will not have any problems during their stay and vice versa.

From the host's point of view it also plays a very relevant role. If they want to have more bookings they are obliged to provide an optimal service to get good reviews and therefore maximize their bookings.

It is true that in the years 2011, 2012 and 2013 there were some problems related to hosts as there were thefts and even some violent situation. Airbnb got down to work to clean up its image and above all to get the guest to trust again. Some of the measures were:

• Professional photographs: It allowed a much more serious image, without junk photos and also ensured the location of the rooms.

• Connections with Facebook: Which made you stay not at a complete stranger's house, but at a friend of a friend's house.

• Trust and Safety Team: 24-hour guest service team for any problem.

• Insurance: They reached an agreement with Lloyds to insure damages up to $1,000,000.

All these actions have had a very positive effect, but it doesn't end there. Chesky is obsessed with excellence. He knows that the most important part of his business is the hosts, so Airbnb pulls out all the stops to make sure they provide excellent service. Education, ease of start-up (less than 10 steps), help declaring earnings (they're working on it) and SuperHosts (Host with lots of experience and reputation) collaboration with new hosts.

The idea of Airbnb is only possible thanks to the host. Without a host, you're a stranger in the place you're visiting. A great host does more than just share their space. They provide a deeper connection to the places you visit and the people who live there. That's why, 14 years later, hosting is still at the heart of Airbnb. Our plan for 2021: educate the world about hosting, recruit more hosts and set them up for success, simplify the guest experience, and deliver world-class service. - Brian Chesky

90% of your Hosts are non-professionals, who rent out their home and that has allowed them to enter this type of business for the first time. This implies a high degree of permanence and that Airbnb is the only medium where they publish and share their accommodations. All this is achieved thanks to the above points.

The satisfactory experience of the guest allows in many occasions to turn him/her into a host. This allows word of mouth to do the company's marketing work, avoiding large advertising and SEO expenses, as people when they want to stay in an apartment, they don't search on Google, they go directly to Airbnb.

"I think we take a very different sales and marketing approach than our competitors. What we have is a full funnel integrated marketing approach. And what we repeat is PR, brand marketing and performance marketing. And really PR, in addition to word of mouth, is what really built our brand over the last 10 years. And so Airbnb is a noun and a verb that's used all over the world. And that's led to 90% of our traffic not being paid or direct even as recently as Q1." - Brian Chesky - Conference call 1Q 2021

One of the biggest concerns that many investors have is related to regulation. In my view this is not a risk but an advantage. The short-term rental business is very new, so there hasn't been enough time to write laws about it, so sometimes you can provoke governments and municipalities to make decisions that could hurt the company.

Airbnb works closely with all these governments to draft laws that are beneficial to both parties. I don't think any government in the world is interested in closing doors to new tourists. In addition to this, no single city has a greater than 1% share (about 200 countries and 40,000 cities) of Airbnb's revenue, so any decision contrary to the company's interests would have little impact.

Japan, New York and Paris have been some of the cities that demand certain conditions to be able to rent properties, such as the obligation to share certain information about the hosts, a public list of accommodations, a limit of days per year to rent...

Industry

The industry in which Airbnb operates is the tourism industry. I am not discovering anything new if I say that it has undoubtedly been the most damaged in the pandemic. Cancelled flights, lockdowns in all countries, hotel closures, hotels without guests... a real disaster. But in all this chaos, the company has been resilient and has been the one that has recovered the fastest thanks to:

• No contact with other people in crowded places such as hotel halls, corridors or bars.

• The possibility of finding accommodations in lost and unfrequented areas.

People are not just looking to go to the same 20 or 30 cities. Now they want to get in cars and travel to nearby local communities. That means that travel, in a sense, is being redistributed to thousands of communities - Brian Chesky

• Home office, which allows you to live in another city (apartment).

This latest trend (home office) has accelerated exponentially thanks to the pandemic. It has seen a change in the dynamics of guest bookings. Currently 24%, and growing, are for stays longer than 28 days, which benefits Airbnb's business, providing much more recurring revenue.

When people travel, they stay longer. Twenty-four percent of our booked nights in the first quarter were for stays of 28 nights or more. People don't just travel on Airbnb, they now live on Airbnb. And these trends are not going away. The world will never go back to the way it was, and that means travel will never go back to the way it was - Brian Chesky

I wouldn't want to spend too much more time analyzing the industry, but I would like to refer to its size and the potential it can offer for Airbnb's growth. I consider it very important to invest in industries that have been around and will always be around.

Travel is one of the largest industries in the world and makes up a significant amount of the world's GDP. 1 in 10 new jobs was created in the travel industry before the pandemic. Its growth is greater than that of the advertising industry - Brian Chesky

Before moving on to the next section, I would like to refer to marketplace business models, what makes them successful and the reasons why I think Airbnb is practically perfect.

• High fragmentation: A marketplace needs multiple buyers and sellers to keep all parties satisfied. The buyer (guest) will always be able to satisfy his demand thanks to the multitude of sellers (hosts) offering their product. This generates a lot of trust and confidence on both sides.

• Playing the field: Those marketplaces that offer a service to which to be highly loyal will hardly continue using the application. I mean, if you are looking for a cleaning service for your home, you find one that you like, you will end up hiring it from behind and not through the marketplace, limiting the recurrence of income. Airbnb is in the tourism industry, one day you want to travel to France and the next month to the UK or the Canary Islands, you will always end up going back to Airbnb. Yes it is true that there are people who travel recurrently to the same place and can reach agreements behind.

We know that when hosts deactivate, it's often not permanent. It's because they are taking a break from hosting. And we know that many hosts intend to return to hosting. -Chesky

• High frequency: This last quarter of 2021 Airbnb reached the spectacular figure of more than 1 billion total hosts since it started operating, so there is no doubt about the use that is made.

• TAM: Airbnb currently has about 4 million hosts, the company's goal is to reach 1 billion in the next lustrums. This figure is perhaps overly optimistic, but it gives a true picture of the company's capacity for expansion. Moreover, as mentioned above, the travel industry is one of the largest in the world. Finally, Airbnb does not limit its business to simply hosting, it is the core of its business model, but it will gradually create new branches.

• Transactional: When transactions are made within the platform it provides a much higher take rate than if it were offline. By handling the transaction you can deduct directly to the customer their share of the revenue without having to send them an invoice afterwards.

We process 100% of guest payments on Airbnb, and that's very powerful. Individual hosts would not be able to host without us processing those payments for us. So, if you look at competitors that have substantially lower payment penetration, it's a definite pain point for people because it's not like they can do it themselves. - David Stephenson CFO

• Value and market expansion: The ability to create value is undeniable at Airbnb, but in addition to this it has managed to expand its market exponentially. Many people who never thought they could rent their home as a business have jumped on the Airbnb bandwagon.

Moats

Airbnb has important moats that will keep the competition away for many years, or at least will make it difficult for them to enter the business that Airbnb leads. This gives them a certain power pricing, which they increase especially with the offer of new services.

• Network effect: The most obvious of all. If a future guest wants to find an apartment, he/she will search among the 4 million hosts because he/she knows that he/she will not have problems to find accommodation, which he/she would have in another platform. From the other side, if a host wants to advertise his apartment and find customers, he knows that the platform to go to is Airbnb.

• Branding: When people want to look for an apartment in another destination, they use the phrase "Let's look for an Airbnb in London to stay". Associating the name of a product with a company confers a moat that is very difficult to penetrate (Coca-Cola, Sees Candy...). This is achieved thanks to the trust and confidence it conveys for both the host and the guest to use Airbnb's services explained above.

• Scale: As you grow you get stronger. Not only because of operational leverage, which allows you to increase your revenue at a much higher rate than your expenses, but also because it allows you to get more and more data from your users and provide them with better and better targeted services. One example of this is flexible accommodation, but in the future it could translate into real estate acquisitions in the most profitable areas, tailored insurance and other ideas that management comes up with.

Now that guests are telling us that they are much more flexible about where they travel, we can point demand to where we have supply. This is probably one of the most important things we have. That explains why when 90 million searches were used with the Flexible Dates feature, conversion rates went up brilliantly - Brian Chesky

Competition

There are so many competitors in the travel industry that it would be impossible to analyze them all - it's a highly fragmented market with different types of services. Two are the main players in the industry: Aribnb and Booking, but with different business models, the former focused on private accommodation and the latter focused on hotels. For reference, Booking's stock market performance since its launch has been spectacular.

Airbnb, is in a slightly different space than its competitors. They focus primarily on individual hosts. They comprise 90% of their 400 million hosts. And OTAs focus primarily on professional hosts.

Professional hosts also count. Since they include any site that provides a great experience and gives them high quality guests, I think individual hosts are less likely to want to appear on multiple platforms. They are the only custom platform designed specifically for an individual host.

With the latest acquisition made by the company, HotelTonight, Airbnb is likely to be a bigger headache for the competition, than the competition for Airbnb.

I'm very proud of the acquisition. I'm very happy to have made it. It's a great team, a great app. It's one of the most loved hotel booking apps in the world. And we were investing quite a bit in this product. The way we think about hotels is essentially the way we think about property managers on Airbnb. we don't want anyone coming to Airbnb to rent because they couldn't find a place to stay. That's why hotels are important. And, as we know, most hotels around the world have less than 50% occupancy, so we know they need demand, and Airbnb can certainly meet that demand. - Brian Chesky

Management

Throughout the thesis I have been explaining the company and the main culprit behind the company's success, Brian Chesky, founder, CEO and one of the company's largest shareholders, through 12 million Stock Options, about 4% of the total.

Honestly, stock option compensation, very popular among Start Ups since the 90's, is not my favorite method. If the calculation of that option is wrong, it can mean a significant cost and dilution in the company. I have done quite a bit of research on this method of compensation and Warren Buffett is not a big fan of it either.

One of the main characteristics of Airbnb is its culture, focused on excellence, curiosity, constant search for new ideas and above all focused on the host. Proof of this is that a large part of its employees are former hosts and guests.

Financially the company is very solid and will continue to be so. It has cash of nearly $8 billion and long-term debt (discounting capital leases) of $2 billion. Despite the pandemic, its IPO in 2020 and being a technology company only 12 years old, it generates FCF of $1.5 billion over the long run (calculated as Cash from operations - Capex).

This is achieved by its lightness of assets to grow and operate (servers, computers, offices, staff...), low marketing expenses (explained above) and high margins thanks to non-increasing fixed costs and reduction of variable costs.

In terms of margin targets, one of the things we are really proud of is the progress we have made in our profitability efficiency during 2020. We have made substantial reductions in our fixed costs. We won't have to add fixed costs again to support a business that will again approach 2019 levels and beyond. Then we saw a really big improvement in our variable cost efficiency in the profit and loss. And when you actually eliminate, in the fourth quarter, eliminate the one-time impact on stock-based compensation related to the IPO, our costs decrease in all of our P&L categories. - Brian Chesky

In terms of acquisitions the main one to date has been Hotel Tonight, explained earlier, within Brian Chesky's circle of competence and getting into the part of the market that Airbnb didn't control, hotels.

Valuation

Not everything can be positive in the Airbnb thesis. The prices at which it is currently trading are very demanding to enter it. It is logical, it is the leader in the sector, with a bright future, an extraordinary CEO, solid and with the capacity to generate a lot of FCF in the future.

It is complicated to make a valuation for X years because it is possible that they will continue issuing shares for some years in order to grow. Paying 20 times sales (at the time of the thesis) is really demanding, but the quality may be worth it. I estimate their growth over the next decade to be (conservatively) above 15% CAGR over the next decade, with gross margins above 70% and possibly start to have operating margins near or above 40% in not too long (Booking has them above 35%).

Conclusion

This is a leading company in its sector, with an extraordinary CEO and continuously looking for new ways to offer value to its customers. Its growth is very difficult to predict, but it seems that it will be extraordinary (Chesky wants to reach 1 billion hosts). The company's culture is focused on providing excellent, high quality service. Its moats are very strong and with the potential to widen over the years. The main drawback is its valuation and possible share issues in the next few years, which make it difficult to establish objective prices.

DISCLAIMER: This is not a buy or sell recommendation, everyone should do their own analysis.