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December 9, 2020

Finance – Airbnb IPO

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Airbnb is set to IPO, listing on the Nasdaq ($ABNB) at an expected price of $56 – $60 per share for a valuation of roughly $42 Billion USD, raising around $3 Billion in fresh equity capital.

We have written extensively about the Airbnb story, its groundbreaking business model, and the creation of a new category in both travel and experiences.

With the recent S1 Filing (required for public listing in the US), Airbnb has opened the kimono – so to speak – and laid out plenty of salient data points about its business model and expectations around future growth.

Despite the shockwave sent through the travel sector as a result of the COVID19 pandemic, the travel sector itself still looks quite positive from a long-term perspective.

We have a substantial market opportunity in the growing travel market and experience economy. We estimate our serviceable addressable market (“SAM”) today to be $1.5 trillion, including $1.2 trillion for short-term stays and $239 billion for experiences. We estimate our total addressable market (“TAM”) to be $3.4 trillion, including $1.8 trillion for short-term stays, $210 billion for long-term stays, and $1.4 trillion for experiences.

S1 PAGE 7

The question is what can be expected from Airbnb as they list publicly?

The Airbnb Business Model

In the very early days, we did a Business Model Canvas to explain the core of the Airbnb business model.

The initial innovation – from a business model perspective – was that they charged the Guest a fairly substantial commission (6- 12%) and the Host a relatively meagre commission (3%) on the total amount of the booking. The net margin (~15%) per booking gave them a huge advantage over incumbents in the space, but it also incentivized hosts.

S1 Page 129

Early-days Airbnb looked much different to today’s Airbnb, as you were fully reliant on the trust of the host. Keep in mind, however, that a lot of customers (on both sides of the platform) were using Couchsurfing in this era, a platform with no financial incentive and no trust mechanisms (reviews, etc.). Airbnb was like Couchsurfing with a business model, and since then the company has exploded to become a preeminent platform in the short-term rentals category.

Airbnb really boomed in the 2010 – 2015 period, which was partially spurred on by huge amounts of VC capital, something that at the time was seen as a huge risk. A post from VC Paige Craig in mid-2015 (lamenting the chance he had to invest in Airbnb) showed that there was nothing glamorous or sexy about the company’s growth trajectory in its early days.

“Luckily for me, I didn’t put much emphasis on their metrics. If you looked at the Airbedandbreakfast.com numbers as of September 20, 2008 you would have seen a sharp drop off (around 50%) in users, reservations, and revenue from August to September.” VC Paige Craig

My $1Billion Lesson

The now infamous story of the founders selling cereal to survive serves as a reminder of how lean this company really was in its early days.

But once they hit critical mass – in roughly mid 2010 – they exploded in growth over the next five years. As the Funding Map shows below, the explosion in growth was accomplished by investing HUGE amounts of money into expansion, especially into the European markets (ie. the epicentre of travel) in order to acquire a critical mass of hosts while the market was young.

Their strategy centred on Host acquisition and building their brand reputation within the ‘travel community’ in their core markets. This was not, however, a strategy built on paid advertising. It was a tactical strategy that focused on organic, word-of-mouth marketing, which in turn drove more trust (via reviews, etc.). This effectively made the switching costs very high and created a disincentive for hosts to wing it across multiple platforms. This helped pave the way for experiences as it were.

Strong referral/word of mouth dynamics: Airbnb user-acquisition funnel breaks down as follows –  65% is Word of Mouth, 26% Referrals, 9% Paid

Investors in the $25 Billion round in 2015 were essentially betting on a double by IPO time (based on financial projections released at the time).

Assuming a listing valuation of ~$42 Billion USD, we can see that it has not, in fact, doubled since then and that the gains for investors from 2015 are marginally good, but possibly not as good as expected back in 2015. Why?

When looking at the business model innovation from a mid to long-term perspective, it was obvious that there were some cracks in the foundation.

By late 2016, when our post on Business Model Innovation was written, it was obvious that the company’s stretch for growth was having a significant negative impact on many cities’ social fabric. Airbnb had illegal landlord problems in many jurisdictions, which was further compounded by their lack of disclosure. Essentially, they went from a company whose core was built around hosting, to a company that was getting into the ghost hotel business.

Part of this transition can be explained by the pressure to grow. Part can be explained by their business model, which gave professional hosts an incentive to get as many high-priced properties on the platform as possible. Another element is the fact that they were competing against hotel chains ie. a room is a room. But no matter how you look at it, trust began to erode on both sides of the platform, and Airbnb was forced to counter with an extensive PR campaign to defend its reputation, especially in cities like New York.

This group makes up about 17% of all Airbnb hosts, but they pull in nearly 40% of the revenue in the cities examined, or roughly $500 million of the $1.3 billion in revenues Airbnb earned in this time period.”

Airbnb – Business Model Innovation

Then in early 2017 came the launch of the highly-anticipated Airbnb Experiences and with it a new business model. In this model, the company would take 20% commission from the Experience Host.

The unit economics of this model required a huge volume to succeed. Given the initial excitement and investment into Experiences, it has not lived up to expectations. But there was clearly a longer-term vision to bundle together the travel experience, and that will play a role in the company’s strategy going forward.

All in all, we can see that Airbnb’s core business model is hosted travel. Viewing their business model innovation, strategy shifts, and adversity over the last decade helps paint a picture as to why they are so focused on Hosts and the ‘travel experience’ as they lay out their strategy in the S1.

Our Hosts

Who are our hosts?

Airbnb’s hosts are the foundation of our community and business. It is their individuality that makes Airbnb unique. From schoolteachers to artists, our hosts span more than 220 countries and regions and approximately 100,000 cities, and 55% of our hosts are women. As of September 30, 2020, we had over 4 million hosts around the world, with 86% of hosts located outside of the United States.

Business Model Analytics

Looking at Page 10 of the S1, we can immediately see how COVID19 has impacted their bookings, down roughly 20% YoY (year over year) in the last 4 months (June – September).

S1 Page 10

However, on Page 11 we can see that their nightly rate (Gross Booking Value – GBV) has increased materially over that same period YoY.

S1 Page 11

This reflects the strength of Airbnb’s core business model and the adaptability of the host community itself. One can infer (due to the pandemic) that Whole Home listings (rather than Shared) drove most of this trend, as Whole Homes obviously drive higher nightly rates than Shared homes. But Airbnb also has, arguably, the best stock of these homes anywhere in the world. Friends and families wanting to travel in the summer months would have likely been looking to Airbnb first, even if those same groups would have normally stayed in a hotel. Having the entire space to oneself (or group) is obviously a key attribute in a pandemic.

They go on to state, on Page 12, that Domestic Travel, Short-distance Travel, Travel outside of Top 20 Cities, and Long-term Stay (> 28 days) were their strongest categories amid the ‘rebound’ months.

From a macro perspective, these trends show the resiliency of the company’s core business model. Even when the global travel industry is effectively shutdown, they were able to rebound and show strength in a few underlying categories; however, the big question is will they become a profitable company over the long-term?

We have incurred net losses in each year since inception, and we may not be able to achieve profitability. We incurred net losses of $70.0 million, $16.9 million, $674.3 million, and $696.9 million for the years ended December 31, 2017, 2018, and 2019, and nine months ended September 30, 2020, respectively. Our accumulated deficit was $1.4 billion and $2.1 billion as of December 31, 2019 and September 30, 2020, respectively.

S1 Page 13

With growth being negatively impacted, the assumption of additional debt, and a murky outlook for the future of travel, achieving long-term profitability will require jumping over some significant hurdles.

Financial Outlook

None of the below should be construed as advice. The information is presented for analytical purposes only. All data taken from Airbnb S1 unless otherwise linked.

Airbnb’s top-line revenue has taken a significant hit in 2020 ( down ~31.9%). On a margin basis, however, they are spending significantly less on ‘Sales and marketing’ compared to the same period a year ago, which is a good signal from a financial perspective. The competition in the industry is obviously fierce, and CAC (Customer Acquisition Cost) will historically increase progressively as markets mature. One can thus infer that a lot of the 2020 growth has been driven by existing customers. Additionally, the company laid off ~25% of its workforce in Q2 2020 (see restructuring charge). If revenues were to continue rebounding, and Sales and Marketing costs are kept in check, there could be a path to profitability in the future.

S1 Page 21

Perhaps the most relevant metric for the company is host listings, at least at this juncture in time. As the # of active listings has not materially changed, and the company has no liability related to leases or owning buildings (compared to hotels for example), they have full slack in their supply to absorb any boom in demand. The question is whether or not that demand will manifest, by when, and what will need to happen in between?

We have not seen a material change in the number of active listings on our platform between December 2019 and September 2020

s1 Page 32

As part of the fallout from the pandemic, the company took out a second $1 Billion USD term loan:

The Wall Street Journal reported that a source familiar with the transaction said the five-year loan comes with a 7.5 percent interest rate.

Tech Crunch

That is in addition to the $1 Billion USD in debt and equity that they raised a week before that in order to replace their existing loan with banks:

Airbnb hasn’t disclosed the terms of its deal with Silver Lake and Sixth Street Partners. People familiar with the matter have said that the transaction was comprised of second lien debt, along with warrants for about 1% of the company’s equity. The warrants give Airbnb an $18 billion valuation, one of the people said. That compares with a value earlier of $31 billion.

Monday’s deal carried an 11% to 12% interest rate, the people said. The investment doesn’t entitle the investors to a seat on Airbnb’s board of directors, one of the people said.

Bloomberg

No doubt, it was costly for Airbnb to add this ~$2 Billion in liquidity to its Balance Sheet. Indebtedness is stated as a key risk in the S1:

Our debt obligations contain restrictions that impact our business and expose us to risks that could materially adversely affect our liquidity and financial condition. If we require additional funding to support our business, this additional funding may not be available on reasonable terms, or at all. We have outstanding long-term indebtedness with a principal amount of $1,997.5 million as of September 30, 2020.

s1 Page 50

Given the principal itself (a small percentage of which can be converted to warrants) and attached interest rate, the risks related to this debt may be offset by equity raised in the IPO (debt and equity covenants are discussed in-depth on page 171), as the company is expected to raise approximately $3 Billion in equity capital this week; however, that doesn’t mean that the corresponding interest payments won’t have a significant effect on their P&L in the years ahead.

The good news is that the company has shown its ability to generate Free Cashflow (FCF) in the past and present.

S1 Page 135

The question is what will drive those FCFs in the future, given the emergent environment of lockdowns, travel restrictions, and economic collapse in the some regions.

S1 Page 146

As with a lot of the economy right now, the recovery could be expected to be bumpy and heavily regional. 2019 data shows a ‘Revenue by Region’ balance between EMEA and North America (40% and 41% respectively), while the Asia Pacific represents only 12%. Will these trends persist? Unlikely, given that Asia seems destined to recover more quickly than Europe. Seeing growth in some regions, while expecting a decline in others, is just one reason it makes it hard to predict how the recovery in travel will look one or two years down the line.

The strength of Airbnb lies in its platform dominance in the segment, its business model, and the fact that the segment itself is huge.

We have seen empires built in the last decade on the Nasdaq in particular by businesses who have a similar profile. But the macro environment has shifted exponentially in the last 9 months and few know what to expect in the upcoming years. To say that travel companies will be challenged is an understatement, and Airbnb needs to grow its FCFs enough to pay off its debt and convince investors that the long-term growth story is still intact.

We have a substantial market opportunity in the growing travel market and experience economy. We estimate our serviceable addressable market (“SAM”) today to be $1.5 trillion, including $1.2 trillion for short-term stays and $239 billion for experiences. We estimate our total addressable market (“TAM”) to be $3.4 trillion, including $1.8 trillion for short-term stays, $210 billion for long-term stays, and $1.4 trillion for experiences.

S1 Page 7

There is no doubt that the generational shift towards Gen Y and Gen Z will be a strong tailwind for Airbnb, as we know that those consumers will become progressively more likely to choose platforms like Airbnb over hotels. Furthermore, the ‘long-term stays’ market and ‘experiences’ market give them additional opportunities. But if the global economy falls into a prolonged recession in many regions then travel will not bounce back any time soon, and younger consumers are likely to be the most affected income-wise. In that vein, this is likely a long game where the ultimate winners in the space will be worth 10X more than they currently are 5 – 10 years down the line, but many will fall by the wayside. Where Airbnb fits on that continuum is TBD (to be determined), as it is a highly competitive market with many other well-capitalized players.

Overall, Airbnb is a story of market disruption and innovation, one that inspires entrepreneurs and innovators alike. On IPO day, many early staff and investors will cash out their chips and celebrate the journey, while new retail investors will jump on board hoping to earn a return in a difficult macro climate. Let’s see how the $ABNB stock story plays out in the years ahead.

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