The unstoppable reign of Airbnb

Consumers are spending as if a recession is coming.

They are cutting back on everything from energy drinks to beauty products to fast food.

Even the wealthy are not spared. Luxury watch trading is way down. The parent of Louis Vuitton and Dior reported its slowest sales growth in a decade.

Only the most resilient shine in tough environments.

We can name some but their reputations as safe harbors make them expensive stocks to own.

We are interested when a business is resilient, growing, and cheap.

A potential candidate is Airbnb (ABNB), the king of short-term rentals.

Airbnb is the world’s largest lodging company. It does not own property. It instead provides listings in the form of short-term rentals from the super-cheap to affordable to private islands.

It provided 7.7 million listings in 2023. The top 10 largest hotel groups provided ~6 million rooms combined.

It generated $3.8 billion in free cash flow, ~$1.1 billion more than Marriott, the largest hotel group.

Size does not seem to matter during a consumer slowdown. ABNB plunged by 15% when 2Q revenues and profit missed estimates.

The stock is ~50% off its all-time high and is cheapest on a LTM P/E basis (~16x) since IPO.

For the first time since Airbnb became public, it is also significantly cheaper than Marriott/Hilton/IHG (23-46x P/E) and Expedia/Booking (25-27x P/E).

We think that Airbnb is so competitively advantaged against peers that higher cash flows and multiples are near-guaranteed.

One fertile ground for quality business models is two-sided marketplaces. They broker vendors and end-customers without owning inventory.

Not owning inventory means they are capital-light and generate high returns on capital.

But they are difficult and expensive to start. They have to get both vendors and end-customers to participate. They have to balance competing interests properly.

Once established, two-sided marketplaces display network effects and require little capital for acquiring more vendors and end-customers.

It all comes down to size and incentives. When Airbnb is the largest marketplace, vendors (ie hosts) and end-customers (ie guests) have little incentive to transact elsewhere.

The largest marketplaces has the most hosts and guests. Hosts have the best chance to find guests, and guest have the best chance to find appropriate properties and hosts.

Size does matter in two-sided marketplaces. The scaled marketplace contains network effects that grow and defend the business.

This explains the steep hill that Expedia and Booking has to climb to challenge Airbnb.

An effective challenger has to lure both vendors and end-customers away from Airbnb. Its task requires more capital as Airbnb becomes bigger.

Challengers abound, but capital constraints limit them from growing to a size that effectively challenges Airbnb.

On the topic of capital constraints, hotel peers should face even more trouble scaling. They are regulated and require much more capital than Airbnb-style properties to build and maintain.

Without scaled competitors challenging Airbnb, we can only think of poor management and regulations limiting its growth.

Growing complaints from end-customers about bad service and unreasonable fees have proliferated. Airbnbhell.com collects stories of poor experiences from hosts (ie vendors/landlords) and guests (ie end-customers) alike.

As horrifying as some stories are (here and here), we think that Airbnb management won’t be intimidated in pulling simple levers to screen out sub-standard hosts and renters.

As for regulations, many large cities, including New York City and London, ban Airbnb and other short-term rentals.

They argue that short-term rentals deplete the supply of properties to the point of raising rents and housing prices.

We agree with the social costs of short-term rentals. While we are ill-equipped to propose a solution, we can point out that the social costs are a direct result of the surging popularity of short-term rentals.

It is difficult to deny the market. Consumers - hosts and guests alike - eventually get what they want.

Look at Uber. Every cab driver hates it. But regulation has yet to kill it.

We prefer the odds of the market eventually getting what it wants, instead of that of a worldwide ban of short-term rentals.

For a large two-sided marketplace leader with resilient growth, Airbnb is cheap. It trades at ~17x FCF, though P/E is more reasonable at ~16x. Stock-based compensation and deferred income taxes depressed free cash flow.

These ought to normalize and have less effect on FCF over time. Headcount should grow as Airbnb expands further internationally. Short-term vacation rental is 25-30% of North America and Europe lodging and only 5% of Asia lodging. The growth of headcount and compensation should slow after Airbnb is established in international markets.

Despite being depressed by expenses and cautious consumers, FCF still grew 10% in 2023. This is a clear sign of resilient growth.

At its peak, Airbnb was more valuable than Marriott-Hilton-IHG combined. We think it won’t take long for Airbnb to do so again.