Editors note: This article was updated on Dec. 10 to update information about Airbnb IPO pricing and date.
When Airbnb (NASDAQ:ABNB) stock IPOs on Dec. 10, investors should be ready to scoop up shares. Airbnb priced its stock at $68, above both the $56-$60 per share investment bankers had expected until recently and the originally proposed $47/share, but it’s still far too low. Analysts expect the firm to grow 35% per year, earn $6 billion in revenues by 2022, and essentially retain its near-monopoly in the home-sharing industry.
I’m not often excited about large money-losing tech IPOs. Like Rocket Mortgage (NYSE:RKT), many of them specifically choose their IPO dates immediately after they’ve had their best quarters. That allows corporate insiders to sell out at high prices before regular investors realize what’s going on. (For what it’s worth, RKT stock is down 35% from its September highs)
The Airbnb stock IPO, however, looks completely different. The company has seen one of its worst years on record from coronavirus travel restrictions. Revenues cratered 72% in Q2, and the company laid off 25% of its staff to help keep the lights on.
Yet, the company is going public anyway. That’s why investors will win.
As the world recovers from the unspeakable harms of the 2020 coronavirus pandemic, Airbnb stock will jump from its $68 IPO price. Not only will its business recover in 2021. A generational shift in attitudes is pushing Airbnb mainstream. Today, many people already find renting someone else’s house overnight as natural as calling an Uber. A decade from now, almost everyone will. While a $130 price target might take several years to achieve, here are five reasons you don’t want to miss out on the Airbnb stock IPO this week.
Airbnb Stock IPO: What Does Airbnb Do?
Before we turn to Airbnb stock, it’s worthwhile to look at what the company does.
In 2007, two college friends, Brian Chesky and Joe Gebbia, had an idea. To help pay their San Francisco rent, they inflated three airbeds in their apartment and turned their apartment into a bed and breakfast. It was only a half-baked business idea at the time. But it was enough to land the company a place in the prestigious Y Combinator, a startup incubator founded by computer programmer Paul Graham.
The startup began by offering cheap alternatives to hotel travel. The New York Times politely referred to Airbnb guests as “adventure-hungry travelers” looking for “memorable traveling experiences.” In other words, it was glorified couch-surfing.
But growth came swiftly. And after several rounds of fundraising, the firm’s big break came in 2015 with its massive $1.5 billion Series E funding. The enormous cash influx allowed the company to scale and fight for legal regulations that exist today.
With the home-sharing firm now starting to rival traditional hotel chains, it’s time to look at the five reasons why the Airbnb stock IPO seems so undervalued.
1: Investment Bankers Priced Airbnb IPO too Cheaply
In December, Airbnb revealed that Q3 revenue had recovered to 82% of the prior year. Its investment bankers, however, didn’t seem impressed. Bookrunners for Airbnb’s IPO initially priced the company between $44 to $50 per share, or a $33 billion-$35 billion market capitalization. (It’s since been increased to $68 per share, for a $47 billion market cap).
Contrast that sentiment to March 2017. Three years ago, Airbnb found itself worth $31 billion in its Series F funding. At the time, the firm earned $2.6 billion in revenues and had a two-year forward-price-to-sales ratio of 8.5x. (I typically use DCF models to evaluate companies, but high-growth/zero-profit startups need different metrics). By 2019, revenue had increased to $4.8 billion.
Then came the coronavirus pandemic.
In the nine months of 2020, Airbnb’s revenue dropped to a $3.4 billion run rate as stay-at-home orders decimated its business. And even though sales should increase to $6 billion by 2022, the company’s $35 billion price tag still represents a 30% discount to its 2017 valuation (when compared to sales).
Such “short-termism” has always plagued Wall Street. Analysts tend to look at only recent quarters rather than longer-term outcomes. While the method works for established companies, it often misses companies like Airbnb that have substantial long-term growth.
2. Airbnb’s Strong Network Effects
Airbnb stock has another ace-in-the-hole: its high barriers to entry. That’s because the company’s network runs on a positive-feedback loop. The more hosts join the site, the better the customer experience. And as more customers use Airbnb, the more hosts join, and so on. When you want to maximize your apartment’s rental days, you’ll list on the site that draws the most visitors.
Even well-funded competitors have struggled to compete against Airbnb’s massive network. The world’s No. 2 player Vrbo, owned by travel giant Expedia (NASDAQ:EXPE), remains less than a third of Airbnb’s size by listings.
Wall Street often overlooks network effects — Facebook’s (NASDAQ:FB) shares languished at $18 when the company first listed. But with time, these strong effects proved their weight in gold.
3. Asset-Light Growth
But there’s a massive difference between Airbnb’s business model. Unlike the major hotel chains, Airbnb doesn’t own any of its properties listed (besides some minor forays into real estate investing). From a financial perspective, it’s a CFO’s dream-come-true. The company can snowball without having to sink money into expensive real estate.
Contrast that with cruise lines — an asset-heavy industry. Carnival Cruise Lines (NYSE:CCL) spent $5.4 billion to purchase property and equipment (PP&E). With that cash, the cruise line launched only four new ships in 2019 — the rest went into upkeeping its fleet. Even the traditional hotel chains have tried to shed assets for faster growth. Marriott now owns just 68 of its properties outright.
That makes Airbnb an unusual case in the world of hotel travel: each dollar invested can go to marketing or R&D instead of PP&E. That means its return on capital will look much more like software company Priceline’s (NASDAQ:BKNG) 156%, rather than Marriott’s 22%.
4. Insider Selling Will Create a Buying Opportunity
Airbnb’s IPO will have an unusual feature: fewer lockup restrictions. And that’s an excellent feature for investors.
It’s rare for tech IPOs to favor mom-and-pop investors. Usually, these firms enforce a six-month lockup period for rank-and-file employees. That reduces the number of available shares and drives up stock prices in the short-term. Companies like Snowflake (NYSE:SNOW) have benefited dramatically from these restrictions — its shares immediately doubled on its IPO day.
On the other hand, Airbnb will allow its employees to sell up to 15% of their shares when the company lists. The additional shares coming to market could help regular investors get in at a reasonable price.
But don’t wait long. The window will close fast as employees sell what shares they can.
5. Airbnb Is Becoming the ‘Uber’ of Hotels
Finally, investors need to step back and consider the long-term potential of Airbnb. To do that, let’s look at another industry: ride-sharing.
It’s easy to forget that app-based ride-shares were once considered somewhat unusual. After all, who would want to ride in a stranger’s car? Or worse yet, share it with another stranger?
Fast forward to 2020, and everything’s changed. Today, even corporations have embraced ride-sharing. Sixty-five thousand companies have already signed up for corporate programs, leaving traditional car rental companies like Hertz (OTCMKTS:HTZGQ) in the dust.
The hotel industry is seeing a similar shift. Airbnb today is no longer the couch-surfing startup of yesteryear. Today, you can rent high-end beach bungalows, ski cabins and luxury treehouses. Even businesses are starting to see Airbnb as an alternative to hotels. And that’s important. Even though business travel only makes up 20% of all travel, it’s a signal that Airbnb has become a socially acceptable way to travel.
Conclusion: What’s Airbnb Worth?
Sharpen your pencils — here’s where things get complicated. Airbnb expects massive growth through 2030, particularly as travel in emerging markets shifts to home-sharing. But how massive can the company get? It’s already “one of the largest providers of holiday accommodation in the world,” and growth obviously can’t go on forever.
Here’s the good news: even conservative estimates create a healthy picture.
Assume, for a moment, that Airbnb can increase revenues by 30% through 2028 and generate similar returns to Priceline. (Obviously, the OTA business has an entirely different fee structure, but the two software companies share enough similarities for an illustration.) With an average EBITDA of 33% and EV-to-EBITDA of 18x, Airbnb stock would be worth close to $172 billion by 2028. That means, with an 8.5% discount rate, the company is worth around $90 billion, or almost three times as much as its investment bankers have decided.
Of course, the truth is far more complicated. There’s little way to know where Airbnb’s EBITDA margins will land a decade from now, nor what exit multiple it will achieve. And even in the short-term, the company will see bumps along the way. In April, the company laid off 25% of its staff to keep the lights on amidst the pandemic, suggesting its business is more fragile than outsiders might believe. Also, its massive 75% gross margins are still eaten away by enormous overhead and marketing costs.
But look beyond the short-term, and a golden investment opportunity emerges. Airbnb could easily push $130 in the comping years as the company leapfrogs traditional hotel chains. The chance to invest in a fast-growing wide-moat industry for cheap doesn’t come around often. And when it does, make sure you’re ready to act.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.