A Study In Scarlet: Airbnb – Trap Or Opportunity?

Summary:

• ABNB has currently lost momentum with investors, pricing around the bottom quartile of its historical trading range since its IPO.
• Airbnb’s profitability and growth are currently strong, but regulatory pressures, competition, economic weakness, and potential disruption from AI pose risks to estimating future margins and growth rates.
• Despite these challenges, the Company’s dominant market share, efficient platform, smart management team, and moaty characteristics make it worth investigating, especially if the stock price declines a little further.
• Regulatory issues often bolster incumbents by raising entry barriers, and AI is more likely to create value rather than destroy it for Airbnb.

Introduction

Airbnb (NASDAQ:ABNB) is not a company that usually leaves people indifferent.

We all have had exposure to them in one way or another. Maybe through your LinkedIn feed via the “x” number of times you saw their seed round rejection letters from venture capitalists as a source of motivation, or Airbnb CEO Brian Chesky giving an aspirational speech on management or the power of persistence on your YouTube feed. Maybe through using their services to lodge in a foreign country with a local family (or without them as is the most recent trend), or maybe your annoyed that local rents in your neighbourhood are being pushed up by the supply of long-term rentals decreasing as more apartments become available for short-term vacation rentals, and you notice the consequential effect on the fabric of your local community.

Airbnb is a company that has changed the way people go on holiday, by recreating an old business model in the modern world at scale and applying its natural network effects to create a highly profitable company. However, different members of society are not agnostic to this business – be it brooding regulators in government trying to quell the rising number of community backlashes, inspired travellers, or profit-incentivised hosts.

Airbnb would normally sit on my “too hard pile” due to their proximity to regulators and the new regulation their business model (leveraging other people’s time and assets – people who are not professionals in the field – and Airbnb not directly offering the service) is inciting. This is similar to another large international platform company with a similar business model and also with regulatory issues that I have historically watched from afar – Uber (UBER). Whilst many technology stocks have outperformed tremendously since COVID, both Uber and Airbnb have been stuck within a relatively large trading range ($20 – $60 for Uber until recently, and $100 to $200 since Airbnb listed in 2020), most likely because of both companies continuous regulatory issues.

Airbnb has caught my attention as almost all analysts have been reducing their earnings estimates over the last couple of months, and the stock price has consequently suffered, reaching the bottom end of its historical trading range. Meanwhile, revenue growth in the recent quarter was in the low double digits, and the operating cash flow margin on sales was a very impressive 40%. Their vertical of vacation rentals seems to have a growth trajectory.

We are entering that period where a general perception of a weaker economy is leading to earning estimates reducing for consumer discretionary stocks. The cyclical element of such businesses provides an opportunity, as the volatility of the stock price of quality growth cyclicals is often much larger than the fluctuation in their intrinsic value.

Airbnb passes my profitability and growth filters today. The question is whether they will pass them in 5 years time? This article attempts to investigate the stability of the business, with the aim to evaluating whether today’s profitability is likely to be similar to tomorrow. Appreciating the level of stability can further assist in appreciating an appropriate valuation.

This article is a short study with sources attached to try and understand the business better. Please leave any comments below so we can all debate and enhance our knowledge.

What’s The Story?

The current situation with Airbnb can be summarised with a few core financial numbers:-

	2019	2022	2023	2024 Est	2027 Est
Sales ($ millions)	4,805	8,399	9,917	11,020	15,100
Employees	5,465	6,811	6,907
Sales / Employee	879,231	1,233,152	1,435,790
Operating Margin	-10.4%	22.5%	15.3%
OCF	0.2	3.4	3.9
OCF Margin	4.2%	40.5%	39.3%
Share Count	521.7	637.0	637.0
Debt	400	2,300	2,300
Cash	3,000	9,600	10,100
EPS	-2.59	2.79	7.24	4.14	6.36
P/E @ $117	n/a	41.9	16.2	28.3	18.4

Click to enlarge

In summary, the COVID pandemic during 2020 devastated the business. Management made the company considerably leaner, hence when demand started returning a strong operating leverage became visible. We see this clearly through cash generation and the operating margin in recent years.

What the market is no doubt currently pondering is:-

• Was this breakout in sales in recent years a temporary blip – a consequence of dramatically reduced demand during covid? Will normalised growth be considerably lower?

• Will regulatory pressures led to increased costs (lower margins), and potentially reduced supply of stock (lower growth) as cities and countries attempt to reduce the social consequences of city centres becoming littered with vacation rentals, which force families and city dwellers out as rents are pushed higher through a lower supply of long-term rentals

• Will increased competition from large incumbents (Booking, Expedia) and new entrants and business models (i.e. house sharing) force greater marketing costs, larger investments, and sweeter deals for hosts, putting pressure on margins?

• Will technology disruption via AI reduce the entry barriers for large technology companies to take market share in the online travel industry, increasing competition?

The above queries make an analyst wonder what is the normalised margin for the business moving forward? What are the normalised growth prospects for the company over the next few years?

Airbnb is a fascinating case study, as I have often asked myself why they did so much better than their older competitor VRBO (now owned by Expedia (EXPE)). My findings seem to indicate AirBnb pioneered the opportunity for hosts to rent out individual rooms within their homes, rather than the entire property. This provided more affordable accommodation, and allowed the stock of potential accommodation to increase dramatically, hence allowing the network effects to start bubbling over sooner as volume increased on its platform quicker. Airbnb was also smarter in selecting their locations and marketing them (i.e. where big events were being held), and in spending on technology to build a user-friendly platform (easier to search and book). Airbnb also put greater effort into building a community of hosts and consumers, building trust and hence sowing the seeds for building a powerful brand. They put more effort on getting hosts and users to add reviews, hence adding value to their platform for other users. Airbnb also had a different pricing structure – on their site it was free for a host to list, on VRBO there was an annual listing fee initially, hence the entry barriers to using VRBO were higher. Today, VRBO offers pay-per-booking and subscription.

Now VRBO has over 2 million properties listed in over 190 countries worldwide, and 48 million users. Airbnb has over 5+ million Airbnb hosts worldwide and 7.7+ million active listings on the platform. Let’s compare their sales evolution in recent years:-

Year	VRBO Sales	% Change	Airbnb Sales	% Change
2017	1,600		2,561
2018	2,010	26%	3,651	43%
2019	2,400	19%	4,805	32%
2020	1,550	-35%	3,378	-30%
2021	2,400	55%	5,991	77%
2022	2,790	16%	8,399	40%
2023	3,300	18%	9,917	18%

Click to enlarge

We can clearly see Airbnb has consistently grown faster than VRBO, except in 2023. Has VRBO learned some new tricks and reduced the gap to its larger competitor? Has differentiation between the players been reduced?

It’s worth mentioning we have been impressed by Expedia’s migration in recent years to a unified platform, which shares data, supply and loyalty (OneKey) across its brands. This change in strategy supports the company’s network advantage and will assist operating margin expansion – increasing the company’s moat – by giving platform users more content choice, the ability to accrue and use loyalty points across brands, and receive better targeted offerings. Sharing data across all brands – rather than having them siloed within individual brands that were previously competing against each other – should also allow a higher return on marketing spend. We may be seeing the benefits of this strategy based on VRBO’s recent results.

Another large competitor, Booking (BKNG), also has been enhancing its offering for its users, combining the opportunity to book flights, accommodation, restaurants and other services all within one platform. Booking has also increased its exposure to alternative accommodation to compete more aggressively with Airbnb, much as Expedia competes via its VRBO division.

It’s therefore no surprise that Airbnb has recently focused more on supporting its hosts, it doesn’t offer the depth of services that Expedia and Booking offers to guest; hence it is focusing on offering a better service to hosts. Note how listings have increased from 5 million in Q4’23 to 8 million in Q2’24! This is a large increase in supply, considerably larger than the increase in demand! This may help explain concerns about the so-called “Airbnbust“, which refers to a perceived reduction in bookings per listing due to increased competition on platforms like Airbnb. Life is complicated for Airbnb. They try to increase the number of hosts to make a more competitive platform, but they risk upsetting current hosts by making their rooms/properties less profitable!

Nevertheless, Airbnb is strategically adapting to what their competitors are doing, and offering more products and solutions to hosts is one way of ensuring they remain differentiated from their large peers. One could argue, if you control the supply, the demand will eventually come to you. Making this strategy seem particularly wise.

However, we must note hosts can place their properties on a number of sites, there is no exclusivity agreement – there is no such thing as unique or locked exclusive supply. We saw the effects of this very clearly when the Chinese authorities removed the exclusivity agreements made by Alibaba (BABA) on its suppliers, where we expressed deep concern about this change in a comment in a Seeking Alpha article, and so far, have rightfully remained out of harm’s way by leaving that company alone as its economics have been permanently changed. Whilst there are some switching costs due to the record a host or guest can build up in a platform through reviews (hence the focus on Airbnb early on including reviews that VRBO did not realise had tremendous economic and intangible value). However if supply increases dramatically more than demand, and hosts feel diluted in an ever larger pond, the cost of switching is not needlessly high for a host to post their assets on another platform, especially if they feel results are getting visibly worse. They will have nothing to lose. This could determine profitability, as a price war could be unleashed if the market becomes irrational and the big players compete to host assets. Nevertheless, with three large players dominating the market, the more likely scenario is rationality will prevail, unless we see a drastic reduction in market growth, which could tempt platforms to get a little more volume to better amortise their fixed costs, or if the market is disrupted via a new technology (AI) or a new business model (house sharing?).

Market Data On The Big Three Players

We note Airbnb bookings have the shortest lead time relative to their large peers, with an average of 41 days ahead of the stay, while Booking and Vrbo draw longer lead times at 66 and 71 days, respectively. This can make Airbnb slightly more sensitive to the economic cycle.

Airbnb dominates the market, with 52% of global vacation rental inventory listed exclusively on its platform. Cumulatively, Airbnb lists 73% of global short-term rental properties (dominate in the USA). Booking holds 18% of global listings exclusively and lists 32% of global short-term rental properties in total. The platform has a strong presence in European countries, with the majority of its inventory located there. Vrbo has 8% of global listings exclusively and lists 23% of global short-term rental properties in total. It has a more global mix.

Airbnb has made progress in reducing host churn. After one year, 79% of hosts who joined in 2021 were still active in 2022, a 10% improvement compared to hosts who joined in 2018. After two years, 62% of hosts remain active, and after three years, around half of the hosts are still active.

Vrbo offers the most expensive short-term rental nights on average, with one night in a 2-bedroom vacation rental costing $324.

Vacation rentals are generally more affordable than hotels, but the gap is narrowing, particularly in markets like big cities where competition between hotels and 1-bedroom short-term rentals is the most intense. The average advertised nightly rate for a 1-bedroom short-term rental across key cities stands at $207, while hotels average at $225, making them 9% more expensive.

The share of professional inventory has increased by 9% since Q1 2021. In this context, “professional” refers to listings identified as being managed by vacation rental managers, short-term rental managers, or other management companies. We wonder as the stock of vacation rentals becomes more and more managed by professional players, if this industry is silently shifting more to a B2B rather than B2C business model, and this could lead to greater pressure on pricing, as such managers can threaten to move a greater volume of stock from one platform to another.

Disruption: AI?

If AI were to disrupt the online travel industry, we may find large technology players with scale advantages in adjacent fields like Google (GOOG), Meta, Amazon, or Alibaba enter the market more seriously, increasing dramatically the number of large players in the field and likely increase the level of competition. Google, for example, could provide easier access to websites of direct providers via Google Maps, and its search engines. Not a surprise, Airbnb is pushing for more direct traffic, to reduce its dependence on Google. We have already seen how Google has hurt Tripadvisor in the metasearch hotel business, though we note barriers to entry are higher in the online travel agency (OTA) booking arena, and we believe Google has no intention to become an OTA, but simply list properties and then pass them on to partners to make payment.

Market Changes

The online travel industry has enjoyed not only the tailwind of a growing travel industry, but also a larger penetration of online sales. Online sales in 2022 now makes up 68% of all sales in travel & tourism. One could therefore consider that the largest contribution of this tailwind has passed, and that online players may have to contend with more industry level growth, +/- their change in market share.

However, certain verticals continue to grow faster, and vacation rentals continue to take a greater share of the market relative to hotels. This supports Airbnb.

The trend of direct purchase or through a marketplace is also supportive for these large online players. Marketplace purchases continue to take market share.

Regulation & Disruption

This is a big topic for Airbnb. However, regulatory issues are not new, and whilst they have made front page news for several years now, the business has managed to become bigger, and more profitable. We have seen a similar story with Uber, where SGA leverage with scale has been a source of increasing operating margin and profitability, whilst negative press and regulation issues have flared ever more loudly (anyone remember the tobacco industry?). We also saw a similar dynamic recently with Facebook (now Meta).

These companies have consistently applied the strategy of (1) embedding your product in the market quickly, (2) help consumers have free or lower cost products / solutions than what currently exists, (3) get users to find them indispensable, (4) then fight the regulators once you have massive market share and consumer dependence. It seems once you reach a critical mass in a vertical, regulation often helps more than it hinders you, as it increases the barriers to entry once you are the incumbent. This approach now seems to be a playbook for tech companies to rinse and repeat again and again.

Note how both Airbnb and Uber have a large and dominant market share in their fields, using the natural network effects platforms offer to attract more supply and demand on their ecosystem, and combining this with economies of scale to create a potent combination that cannot be easily penetrated by competitors playing the same game.

The game is likely to change only through regulation or disruption. Though the reality is in Western economies more regulation usually supports the larger players, as they more easily assimilate the increasing costs.

This leaves disruption, though we should note the big three players spend lavishly on R&D, and also on AI, and are not being headed by “cash cow” mentality CEOs. However AI could disrupt the industry, and could provide large-scale players like Google access to enter the market more easily. But Google, in particular, is a data company and is unlikely to want to deal with hosts directly. Furthermore, we should note there are many suppliers of large language models (LLM) – the in rage AI solution at the moment – be it Gemini, ChatGPT, Mistral, Anthropic, Perplexity etc., hence no single player appears to be able to hold the secrets of AI for themselves, meaning the ultimate beneficiaries are likely to be consumers (or suppliers like NVIDIA!!).

Under this pretext, one could argue the future for Airbnb looks relatively bright – regulation is likely to help more than hinder, they seem well tuned on to the risks of disruption, their industry vertical continues to take share, and historically, they are a leader in this vertical. Three dominant players are likely to behave rationally unless growth declines dramatically, or new entrants trigger an increasing rivalry between players. New entrants are likely to be the large technology players, and whilst they have scale and could pack a hearty punch, they do not seem keen on becoming OTAs. We do note VRBO seems to be more at par with Airbnb recently, and this could trigger increased competition, or perhaps a more rational differentiation so they don’t step on each other’s toes. Recently, this has been visible by the greater focus on hosts by Airbnb, and a continued focus on guests for Expedia and Booking.

Valuation

In the end, an investor must assess what the odds for success are by studying the price on offer.

Above we have highlighted a number of issues, and some ways to view those factors. For example, increasing competition can force higher investment, hence lower margins. The rental vacation market could become better penetrated by Booking and Expedia through their enhanced combined offerings on their platforms, enhancing their guest experience.

Airbnb is responding by housing more hosts on their site, and enhancing their on platform solutions for them. However, they have no exclusivity. If hosts feel they are not getting enough volume, they can list on different platforms simultaneously. Pricing may then become a variable to try and entice those hosts to remain faithful only to them. This may play to the advantage of the largest platform. However, in this case we are dealing with three large players, this is not an overly fragmented market.

Let’s play with some numbers and see the assumptions underlying the current valuation.

If margins decline from 40% of operating cash flow to say 34% (a 15% decline) over five years, what growth is needed for Airbnb to trade as an average US stock, i.e. 15x earnings (14x OCF) considering the current price?

The below model indicates a conservative 6.5% p.a. growth in OCF, and a below historical average sales growth of 9.5% over these 5 years period gets to our current market price.

	2022	2023	2028	Growth	2028 Consensus Est
Sales	8.400	9.920	15.616	9.5%	16.600
OCF	3.430	3.880	5.309	6.5%
OCF Margin	40.8%	39.1%	34.0%
Valuation (14x OCF)	73	83	114
Stock Price	125	125	?
EPS	2,91	7,24	?		7,86
OCF/Share	5,24	5,93	8,12

Click to enlarge

This very crude model indicates some interesting points:-

• Consensus sales and earning estimates are aligned with this simple scenario, which assumes margin pressure and lower revenue growth (but still higher than nominal GDP growth over the next 5 years)

• Hence there is an opportunity for return if you believe:-

  • Margins will remain around 40% of OCF

  • If revenue growth will remain in the low double-digit space

  • If you believe the quality of the business deserves a higher than average earnings multiple

Let’s see what valuation comes out for a different set of assumptions over the next 5-year period :-

• If we assume revenue growth is 9.5% p.a.

• But OCF margins are around 38% (stay similar to current levels over the last 2 years)

• And the OCF multiple is 17, rather than 14

• We get a valuation of just over $150 (right in the middle of Airbnb’s trading range since IPO)

• This offers a 6.3% p.a. return for investors buying at the current $117.53 stock price

• If you purchase shares at $96.6 (a 15% decline on the current price), you get a 9.8% p.a. potential return on the above-mentioned assumptions

My conservative nature makes me struggle to pay more than 17x OCF considering their regulatory overhang, competitive threats and disruption risks. However, I also value their dominant market share, powerful and user-friendly platform, a smart management team, and their ability to generate network effects and economies of scale from that platform.

As a result, I note with the stock price around $100, I can assume some margin decline, a decline in growth rates, and still achieve a return close to 10% pa over the next 5 years.

I also believe post this 5-year period the business can maintain earnings per share growth above the 7% market average (they aggressively buy back stock, and are not overly aggressive on stock compensation), whilst generating a higher than average return on capital. Hence, even if the multiple doesn’t rise in the future, earnings should support modest stock price appreciation.

Conclusion

Airbnb has currently lost momentum with investors, trading around the bottom quartile of its trading range. A number of concerns have led the company to this position, including regulatory, competitive and disruption concerns. Airbnb generates high return on capital because of its asset light platform that offers network effects and economies of scale.

Moving forward, its vertical is likely to continue to enjoy growth above the average for the travel industry and the online travel industry. This places it well to continue its growth trajectory, though we assume revenue growth is likely to decline to around the 10% level over the next few years due to lower economic growth, and potential market share battles as large peers Booking and Expedia compete more aggressively with their ever improving offer for guests. Whilst some market share may change hands, we note this is a relatively concentrated market; hence rational behaviour is more likely, reducing the possibility of an all out price war.

Whilst our stomachs are concerned with regulatory issues, we must observe that technological forays into traditional or newly created markets rarely leads to large detrimental effects to profitability when regulators pounce. Often their recommendations support the incumbents by enhancing the barriers to entry, which effectively reduces competition by keeping new entrants out. It is no secret that large technology players welcome regulation for this reason.

AI is a much discussed topic, and its potential to disrupt many industries. We note the big three players in this market are not ignoring this threat, are tech-savvy (especially Airbnb), and that AI is becoming available to everyone via a large number of players, hence its value will not be limited to only a few players that will have a unique advantage. As a result, it is more likely to help create, rather than destroy, value for these companies.

A note AI may reduce the barriers to entry for a number of large technology players. The reality is that a number of them have already been involved in the online travel industry for some years, and they seem clear they don’t want to become OTAs. Instead, so far, they have focused on meta searches, where they have damaged some large incumbents in that field, such as TripAdvisor.

As a result, we see Airbnb as a relatively strong, healthy business, with attractive profitability and growth metrics, and a stability that may be stronger than current news flow would have us imagine. On further price declines, we would seriously consider to purchase shares.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in ABNB over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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