Airbnb Offers Investors a Unique Stay

Airbnb was conceptualized in August 2007 as an alternative to hotel lodging. We calculate it is now the largest player in the $150 billion alternative accommodation booking market with a high teens share, up from about 4% in 2014. We estimate that roughly half of the market's bookings occur online, with Airbnb holding around 35% online share today versus about 10% in 2014.

Ahead of its anticipated initial public offering in 2019-20, we see Airbnb's current market capitalization ranging between $53 billion ($180 per share) and $65 billion ($221 per share), using a peer-based as well as a discounted cash flow-derived exit multiple approach. This is 70%-110% higher than the $31 billion the company fetched at its most recent funding round in July 2017 and above the valuation of any hotel operator. Our valuation implies an enterprise value/2019 EBITDA multiple range of 28-32 times (with an assumption of $3 billion in net cash); this is a premium to the 18 times awarded on average to other companies with online marketplaces. We believe a premium is warranted based on several attractive features Airbnb offers investors, including (1) a powerful and rare network advantage that should drive continued share gains in a rapidly growing alternative accommodation market; (2) an opportunity to expand its network and addressable market into hotel, experiences, corporate, and transportation; and (3) strong profitability prospects driven by high consumer awareness, allowing the company to leverage top-line growth. We believe Airbnb's IPO should be on the radar screens for investors seeking exposure to a company positioned to gain share in the nearly $700 billion global online travel market, which we estimate will grow 9.4% annually on average over the next five years.

We believe Airbnb's success can be traced to four things: differentiated content, an improved user experience, the skill set of its three founders, and timing. When Airbnb launched, it offered differentiated content, as illustrated by its affordable shared rooms in urban markets versus full homes in vacation locations that were hosted on VRBO, while listing a wider array of unique content (treehouses, igloos, tepees, yurts) than Craigslist. It also improved the user experience over Craigslist, benefiting from the design and engineering expertise of its founders as well as the timing of technology advancements. Two of Airbnb's founders, Brian Chesky and Joe Gebbia, brought with them strong design backgrounds, while founder Nathan Blecharczyk was already a successful coder in his high school years, which enabled him to engineer the concepts developed by his cohorts. Importantly, technology advancement opened an opportunity to improve the user experience that existed in the online alternative accommodation space when Airbnb was established.

The timing was also right for the Airbnb concept from an economic and demographic standpoint. Coming out of the Great Recession, people were looking for cheaper travel options and ways to generate income, which room-sharing on Airbnb's platform offered. Also, millennials were seeking an alternative to the commoditized nature of many hotels, preferring to experience the local culture of a destination, which was provided by the neighborhood-hosted listings on Airbnb's network.

Today, Airbnb has amassed significant revenue--$2.6 billion last year, according to Bloomberg--and we believe it has an opportunity for attractive long-term growth in the $1.6 trillion global travel booking market. That said, Airbnb's core alternative accommodation industry faces room-sharing laws and safety challenges that could impede its trajectory.

The commoditized branded hotel room disrupted the travel industry for much of the second half of the 20th century, but more recently the trend has been toward more unique experiences like boutique hotels in the 1980s and accommodation platforms like Craigslist and VRBO in the mid-1990s. As Internet, cloud, and mobile technologies evolved, it unlocked the opportunity for a company like Airbnb to increase the accessibility of unique places to stay while also offering a different social interaction than a traditional hotel.

Today, the alternative accommodation market is large and growing. We estimate that around $150 billion in private accommodation bookings will occur this year, up from roughly $100 billion in 2014. Over the next five years, we see this vertical increasing bookings 10% annually on average, compared with the 11% averaged the past three years, to exceed $220 billion in 2022. Meanwhile, the percentage of alternative accommodation bookings occurring online should ramp to nearly 65% in 2022 from the high 40s rate we believe took place in 2017, representing nearly a high teens annual growth rate on average over the next five years.

We expect online growth of the alternative accommodation market to be supported by improved user experience and demand for unique experiences. The Airbnb, booking.com (owned by Booking Holdings BKNG ), and HomeAway (owned by Expedia EXPE ) platforms generate industry-leading traffic that allows them to continuously test and quickly implement changes to their websites that increasingly match the right space to the right person at the right time, leading to higher conversion rates.

Demand for alternative accommodations (and all of travel) should also be buoyed by the rapid growth in the global middle-income class. According to a study published in February, Brookings determined that 3.2 billion people were in the global middle-income class in 2016, or around 43% of the world's total population (according to World Bank data). The study predicted that 160 million individuals would join the middle-income class on average each year for the next five years, representing around 5% yearly growth, well above the roughly 1.2% global population increase witnessed the past few years (according to World Bank data). This would result in the majority of the world's citizens reaching this status for the first time ever in 2020.

In particular, China is expected to be a meaningful portion of global middle-class growth over the next several years. Brookings estimates that 350 million of the next 1 billion people to join this income level over the next six years will come from China. Importantly, Airbnb has a growing presence in the country with 120,000 active listings as of November 2017 (around 2%-3% of the company's total listings) and around 5 million Chinese guest arrivals (made up of roughly 3 million and 2 million domestic and outbound travelers, respectively) on the platform over a trailing 12-month period ending November 2017 (around 4% of Airbnb global traveler stays during that time). This equals the travelers from the country using the room-sharing network the previous eight years combined. Assuming an average daily rate in China that is 25% below the consolidated average for Airbnb results in the company getting around 3% of its total revenue from the country, which is already higher than the roughly 1% we estimate for Expedia but well below the 10% we calculate Booking Holdings receives.

One argument for the expansion of the peer-to-peer rental market is the positive economic impact on the surrounding neighborhood. Airbnb claims its travelers stay twice as long and spend twice as much as a typical visitor, with 42% of its guests' expenditures occurring in the neighborhood of the accommodation. Further, there is support that many Airbnb guests are incremental travelers, as nearly 80% of the company's travelers say they want to explore a specific neighborhood where traditional hotel accommodations might not be, with around three fourths of Airbnb listings outside main hotel districts.

Despite any incremental spending local businesses might enjoy from Airbnb lodging, the alternative accommodation market faces opposition concerned about the industry's impact on society (resident quality of life), safety (adhering to codes), and economics (cost of living). While Airbnb can and does provide a positive social connection, it also fosters an environment where strangers who might not be as respectful of the living quarters are in near proximity to full-time residents, resulting in an unintended lower resident quality of life. Safety is another real concern when rented units aren't verified as being up to code on such things as structure, fire, or carbon monoxide standards. But probably the biggest pushback on room-sharing is the negative cost of living impact it can have on inhabitants by allocating supply to tourists at the expense of residents.

Although Airbnb has come to rental term agreements with many cities, most all destinations have restrictions on room-sharing, and many areas are pushing for stricter laws or enforcement. These room-sharing regulations are a partial driver behind the 51% bookings growth we estimate Airbnb chalked up in 2017, which would be a marked deceleration from the 89% growth we believe occurred in 2016.

We don't anticipate the debate over room-sharing will disappear, and we expect the government's focus with persist, as is currently visible in cities like Paris, where the government is threatening to remove the vast majority of Airbnb content for not legally registering, and New York, where a multiyear legal battle between Airbnb and the city continues.

Network Effect Results in Narrow Moat
We believe that Airbnb, like Booking Holdings, Expedia, and TripAdvisor TRIP , has developed a two-sided marketplace network effect that it is able to properly monetize, thereby driving a narrow economic moat. Airbnb's network effect was established by attracting private accommodation owners to post their dwellings (supply side) on the company's platform, which in turn attracted more travelers (demand side), subsequently enticing more supply, creating a virtuous cycle that increases value for both new and existing users (hosts and guests).

Airbnb did have to launch its platform a few times to generate more interest, while resorting to aggressive marketing tactics like door-to-door communication and innovative engineering before reaching critical mass. Even when Airbnb launched its website for a third time in August 2008, it had only 800 listings with an undisclosed number of bookings. However, continued investment in the platform and word of mouth drove an inflection point where the network of hosts and guests entered into a virtuous cycle. By March 2009, the company had 2,500 listings with 10,000 users, and by the end of 2010 around 700,000 cumulative nights had been booked on Airbnb, reaching 1.6 million by May 2011. Today, Airbnb has over 5 million listings with around 250 million unique visitors and generated a leading 30% online booking share last year in the alternative accommodation market.

Still, we believe network advantages are currently stronger at the two largest online travel agencies, narrow-moat Booking and narrow-moat Expedia, and even at narrow-moat TripAdvisor, which is reflected in our exit multiples for the peer group. These companies have a more complete offering of travel content (supply) and higher levels of traffic (demand). That said, the Airbnb name has strong awareness in the marketplace, witnessed by the high amounts of traffic going direct to its website (62% versus 15%-42% for its peers) and number of countries where it is a top 10 travel app (its 82 countries trails only Booking's 113). We believe this will aid the company's continued expansion outside its core private accommodation vertical and into other segments, although with some limitations.

We also think this network advantage should lead to excess economic returns for at least the next decade. We forecast Booking Holdings, Expedia, and TripAdvisor to average adjusted returns on invested capital of 131% over the next five years, showcasing the strong economic profits in online travel network effects, which we believe should also ensue for Airbnb.

Part of the reason ROICs are often robust is that marketplaces lack capital intensity and can be very scalable. Operators in other industries like airlines, auto manufacturers, telecommunications, hotel real estate investment trusts, and cruise lines require more investment to persist. Over the next five years, hotel REITs Host Hotels and Sunstone Hotels are expected to spend an average of 10.4% of sales on capital expenditures, while cruise operators Royal Caribbean, Norwegian, and Carnival are expected to spend 20%. The three online travel operators combined are expected to average only 4.3%.

While financials are limited for privately held Airbnb, we do believe that its business lacks capital intensity and that profitability is scaling as the platform grows, similar to what occurred at Booking Holdings as its network ramped. We see Booking Holdings as a reasonable comparable, given that both companies generate the majority of their bookings from international markets, using an agency model (middlemen collecting a commission on transactions) with similar take rates (averaging around 13%), and both are respective leaders in their accommodation markets (Airbnb in private accommodations and Booking in hotels) that continue to extend into other verticals.

A Lasting Network Advantage
Over the next five years, we see Airbnb maintaining its network advantage. While we see Airbnb's competitive positioning being enhanced by high awareness, which can aid horizontal expansion in its core alternative accommodation segment and vertical extension into the traditional hotel, experiences, corporate, and transportation markets, we expect competition across the travel landscape and heightened regulation in the room-sharing industry will detract from the company's network advantage.

Airbnb's network edge will be supported by its first-mover advantage and recent initiatives in the fast-growing $150 billion global alternative accommodation market (of which about 50% of transactions occur online). This will be mitigated by increased regulation and competition, resulting in more gradual online booking market share gains the next few years. By 2022, we see Airbnb's booking share reaching nearly 45% from 30% in 2017 and 15% in 2015.

We believe alternative accommodations will remain one of a handful of key growth drivers for the online travel industry, driven by growing online private accommodation content that is increasingly searchable. This is reflected in our forecast for 16.6% average annual alternative accommodation growth over the next five years, which is comfortably above the 9.4% growth we estimate for the global online travel booking market. Still, our forecast represents a deceleration from the 20%-plus average annual increase we believe occurred in the past three years, due to increased regulatory pressures.

City regulation of peer-to-peer lodging has increased in the past few years, reducing the number of Airbnb listings by limiting the number of licenses provided and removing multiple listings operated by commercial operators. Investors need to be aware of data that points to a large amount of Airbnb's supply being multi-unit listings (including renting separate rooms in the same unit) and entire homes/apartments (versus private or shared), which could be classified as illegal rentals in areas focused on controlling residential housing affordability by limiting or removing commercial operators on the alternative accommodation platform. Inside Airbnb analyzes listing data directly from Airbnb and has calculated the percentage of potentially illegal homes on the room-sharing platform. On average, around 60% and 40% of Airbnb's listings in its top cities are classified as entire homes/apartments and multi-unit listings, respectively, according to Inside Airbnb. This presents real risk to Airbnb's current network effect advantage, should cities continue to pass and enforce anti-room-sharing laws.

We also forecast Airbnb's alternative accommodation booking growth to decelerate as a result of the law of large numbers and competition from Booking Holdings, Expedia, and the hoteliers, although we expect recent Airbnb initiatives to support above-industry growth rates.

We estimate that Booking Holdings is already second behind Airbnb in the private accommodation market, having expanded its online share to roughly 20% last year from the midteens in 2015 driven by industry-leading supply and demand ((over 5 million alternative accommodation listings and around 450 million monthly visitors). We expect Booking to continue to see share gains at the expense of smaller competitors as it invests further in its non-hotel network with the goal to become the leader in the market. We estimate that its alternative accommodation booking growth rate can begin to eclipse Airbnb's in 2020, as Booking's investments and powerful network advantage take hold.

Expedia became the number-three player in the alternative accommodation market with its HomeAway acquisition in late 2015. Since that merger, we believe HomeAway has also been taking share from smaller competitors as it benefits from Expedia's incremental marketing and technology investments and leveraging of the network's 1.6 million alternative accommodation listings and roughly 600 million monthly visitors. We expect the HomeAway brand to see gradual share gains in the private lodging market the next few years, benefiting from new initiatives and incremental investment. HomeAway is expanding beyond the traditional full home in vacation locations and into urban content with the launch of its new Cities initiative in 2015, creating more direct competition with Airbnb. Still, we believe that Expedia's roughly 60% of total booking exposure to slower-growing U.S. markets (versus around 25% for both Airbnb and Booking Holdings) as well as a network advantage that isn't as strong as Booking Holdings' will result in HomeAway's bookings growth in alternative accommodations remaining just below Airbnb's.

Hoteliers are also increasingly investing in the alternative accommodation market, although we see this as a lower competitive threat to Airbnb than Booking Holdings or Expedia because traditional lodging operators don't have the network advantages that the large online travel agencies do.

Airbnb is making important investments of its own that we believe will mitigate increased competition from Booking Holdings and Expedia. It has launched luxury, quality, and loyalty initiatives that support its network advantage and our belief that Airbnb will expand its alternative accommodation share over the next few years.

Airbnb extended into luxury properties in 2017, when it acquired Luxury Retreats and its 2,800 unique homes, which rented out for an average of $2,000 per night and offered concierge services. While we are constructive on Airbnb's expansion into higher-end units, we don't think it will prove to be a major contributor to the company's financials because scaling this segment can prove challenging, given the limited amount of unique high-end homes that hosts are willing to rent.

We see Airbnb's Plus initiative, which launched in February and focuses on the overall quality of listings, as a more meaningful driver of the company's network advantage and growth opportunity in alternative accommodations. Plus listings need to pass a 100-point inspection, already have guest ratings of 4.8 or higher (out of 5), and receive professional photography. These listings receive higher placement on Airbnb searches, which should help drive conversion and ultimately the user experience.

We also think that a differentiated loyalty program (currently testing) can expand Airbnb's network advantage and support growth over the long term. Airbnb is planning to launch Superguest, which could offer discounts and last-minute bookings on lodging and experiences, provide airport pickup and lounge services, and offer benefits like access to a local gym. In our view, such services for loyalty points would differentiate Airbnb from programs offered by hoteliers and others that predominantly focus on discounted lodging or free Wi-Fi, helping the company stand out in an increasingly competitive industry. Airbnb also plans to offer loyalty to its Superhosts, giving these members better placement on the website, priority support, custom URLs, early access to products, and photography, as long as the listing has at least a 4.8 rating (out of 5) with 10 or more bookings a year and zero cancellations. The Superhost program should foster quality stays for guest, thereby aiding the overall network advantage of Airbnb's platform.

So despite heightened regulation and competition driving decelerating alternative lodging booking growth for Airbnb, we believe the company's first-mover advantage and initiatives will allow it to take share from smaller competitors and withstand encroachment from other online accommodation operators and hoteliers, although at a slower rate than in years past.

Communal Culture Has Limits as Well as Opportunities
We believe Airbnb's expansion into traditional lodging will be limited, given the company's mission statement and culture that centers on community and belonging. As a result, we don't believe the entire $500 billion traditional hotel booking market will be addressable to Airbnb as it is for Booking Holdings, Expedia, and TripAdvisor, because both the company and its users seek out unique travel experiences. This frames our view that hotel bookings on Airbnb can approach 10% of the company's total by 2022, accounting for only $6.5 billion in bookings. By comparison, Booking Holdings leads the industry with an estimated $110 billion of traditional lodging bookings in that year.

Still, Airbnb can grow in this market by listing boutique hotels that offer differentiated stays with a connection to the culture. Defining the boutique hotel opportunity is challenging because these lodgings make up an unknown portion of the world's branded chains and independent hotels. But in a global hotel market with 16.3 million rooms (according to Wyndham Destinations), even being able to address one tenth of that over time can add incremental growth to a current Airbnb base of roughly 5 million private accommodation listings. Airbnb has partnered with Siteminder to allow any of the 28,000 hotels using that platform to list on the room-sharing network. Also, Airbnb now allows hosts to define and guests to search by a category labeled “boutique” on its platform. It appears that Airbnb has had initial success getting supply on its network, with around 24,000 boutique hotels signed by the end of February, according to the company's hotel program manager, Cameron Houser.

We think the $150 billion experiences (tours and attractions) booking market is set to outpace our total online travel market growth forecast of 9.4% over the next five years (based on commentary from TripAdvisor). We believe Airbnb's communal marketplace and company mission statement of belonging everywhere adheres extremely well to this market, allowing the platform to extend its network advantage and leading to the vertical representing 5% of the company's total bookings by 2022. Although TripAdvisor is the clear leader in the experiences market, we see plenty of room for Airbnb to compete in a fragmented landscape where online penetration was still only in the high teens last year, well below total online travel penetration of above 40%.

We think Airbnb can gain traction in the corporate booking market, which we estimate at around $1.1 trillion, as its partnerships and initiatives reduce the back-office and safety concerns of many global firms, aiding its network advantage and growth opportunity. The company has announced several major partnerships in the past few years. For instance, travel expense management operator Concur recognized Airbnb as a corporate travel provider in 2014, allowing the company's back-office systems using the provider to accept bookings from the room-sharing platform. In the following year, Airbnb launched its Business Travel Ready initiative, offering homes that have gone through a review process of meeting standard requirements, which should reduce the safety concerns companies associate with Airbnb. In 2016, the large travel management companies American Express Global Business Travel, BCD Travel, and Carlson Wagonlit partnered with Airbnb, allowing companies that use this channel to book through the alternative accommodation platform. These relationships have resulted in around 10% of all trips on Airbnb being for work in 2017, with business trips having tripled on the platform in 2016, according to the company. Further, Airbnb reported in April 2017 that employees from over 250,000 companies worldwide were using the platform. Given limited disclosures, we do not provide a forecast specifically for Airbnb corporate bookings, but we note that business trips are reflected in our overall accommodation estimates for the company.

The global air and ground transportation markets are large at around $600 billion and $100 billion, respectively, but the consolidation and efficiency of the industry offers only low-single-digit take rates (compared with teens and 20% for lodging and experiences, respectively). We wouldn't expect transportation attached rates on Airbnb lodging bookings to be more than a single-digit level, since the company can't offer any differentiated experience. Also, travelers love to shop around for the best deal, especially in a commoditized environment like transportation. We expect just 1%-2% of Airbnb's total revenue to come from the segment in 2022, following an anticipated launch into these markets in 2019.

Solid Stewardship
While Airbnb's founders have excelled at design, engineering, and surrounding themselves with strong mentoring, their lack of business expertise has at times caused potentially avoidable bumps in the road. That said, we are confident that the existing team can extend the company's reach into its core alternative accommodation market and other verticals such as boutique hotels, experiences, transportation, and corporate, supporting its network advantage.

Airbnb's three founders all bring valuable skill sets that have worked well together, supported by the fact that all three remain with the company today and that it reached a $31 billion valuation based on a July 2017 funding. CEO Brian Chesky is a passionate, natural leader who has excelled at identifying key mentors who have helped guide strategy during Airbnb's extraordinary rise. He also has strong designer skills, having graduated from the Rhode Island School of Design. This background proved valuable in building a quality user experience during the early years of the company.

Joe Gebbia is another of Airbnb's founders with a design background from the Rhode Island School of Design. His designer skills were key in developing the company's website during the early years. Additionally, Gebbia has strong creative ability that aids the company in building out its network in a differentiated fashion. He is now chief product officer.

Nate Blecharczyk was also vital to the company's success. While Chesky and Gebbia thought of the creative design, Blecharczyk glued it all together and developed Airbnb's platform infrastructure. Blecharczyk was an accomplished engineer by the time he was in high school, when he made more than $1 million selling software. In addition to building Airbnb's backbone infrastructure, Blecharczyk was able to code links to Craigslist and Google AdWords that offered Airbnb free or low-cost advertising at a time when funding was nonexistent. Today, he is chief strategy officer and chairman of the China operations.

While Airbnb's founders offer strong design, solid engineering, and a passionate work ethic, they have had to learn business skills along the way, leading to some reactive versus proactive decisions that caused some unnecessary rough patches. For instance, Y Combinator business training in early 2009 helped guide the young entrepreneurs to reach out to the platform's users--arguably something they could have been doing more of initially. Also, one could argue that the founders lacked a full understanding of the market environment. Having an up-front understanding of affordability issues that often frame anti-room-sharing laws could have allowed Airbnb to partner with local governments and develop legislation that is more favorable to the accommodations platform operator. One could also argue that Airbnb has been too reactive regarding safety policies. For example, the company did not offer guarantees and insurance around property and personal harm until a few unfortunate instances went viral; this is surprising, given that the main concern most investors had when Airbnb was seeking funding pertained to safety. Additionally, while Airbnb does not discriminate, some people using the service do, and the company didn't frame policy around this issue until published studies (of which the company was aware for years) went viral. Still, we commend the success of the founders and company, and we acknowledge that staying in front of all issues when a company ramps up to a $31 billion valuation in less than 10 years is challenging.

Finally, Airbnb is currently searching for a CFO after Laurence Tosi left in February to work full time at his investment fund, Weston Capital Partners. We believe that Tosi's background at Blackstone and Merrill Lynch was set to provide valuable insight into the IPO process, and we think it will be important for Airbnb to find a replacement with experience in the private and/or public equity markets. We will monitor the search and hiring of this important role.