One of the biggest initial public offerings (IPOs) from the last year was Airbnb (NASDAQ:ABNB). The well-known Silicon Valley darling went public in Dec. 2020 and saw its stock soar in the first few months of trading. Though its shares have given up some of those gains, Airbnb still enjoys a market cap of nearly $110 billion, making it one of the largest companies in the world.
A big reason investors are optimistic about Airbnb is the potential for a travel boom around the globe as the COVID-19 virus (hopefully) fades into history, which should be beneficial to the entire travel industry.
Against this bullish backdrop, can Airbnb live up to high investor expectations?
Pandemic recovery underway
As you might expect, Airbnb had a rough first half of 2020 with the world temporarily shutting down due to the COVID-19 pandemic. In 2021, its business has recovered nicely, as evidenced by its strong second-quarter earnings report. During that period, nights and experiences booked hit 83.1 million, up 197% year over year and down only 1% from the same quarter of 2019. Revenue looked even stronger, up 299% year over year to $1.33 billion (and up 10% on a two-year basis).
Free cash flow was $784 million in the period, which is impressive at first glance. However, Airbnb sees a seasonally high influx of booked rooms in the first half of the year, which results in a short-term surge of cash from customers. Free-cash-flow margin will even out over a full year to a lower level.
With $7.43 billion in cash and only $1.98 billion in long-term debt, Airbnb has a strong war chest to invest for growth over the coming quarters and years. Since the start of the COVID-19 pandemic, Airbnb has streamlined its operations, and the company is focusing on a few key initiatives like attracting as many hosts as possible, improving the guest journey, and enhancing customer service.
This means that most of Airbnb's growth, at least for the next few years, should come from an increase in nights and experiences booked on the platform.
Remaining opportunity for growth
With travel restrictions still in place in many areas around the globe, Airbnb should get a nice tailwind as the threat of COVID-19 eases in the coming months. There are also some trends Airbnb has talked about that indicate travelers are leaning more toward Airbnb-style rentals due to the pandemic.
Growth in nights booked in non-urban areas was much stronger than in urban regions in the second quarter. Unlike most hotels, which have to cater to areas with more travelers, Airbnb can evolve with the tastes and trends of its customers, even if they want to travel to more remote locations. This is one of the key advantages of its decentralized platform.
Flexibility on trip length is another advantage, and this has been a huge growth driver in the last few quarters. In the second quarter, management said "stays of 28 days or more remained our fastest-growing category by trip length," indicating there are more people living or taking extended trips through Airbnb with the rise of remote work. These power users not only provide a great opportunity for the core platform, but Airbnb will eventually be able to upsell them with other products and services that further lock them into its ecosystem.
Investors need to expect more
Airbnb's business looks to be recovering nicely from the COVID-19 shutdowns. However, with a market cap of $110 billion, investors need to expect an acceleration in growth over the next two to three years for this valuation to make any sense.
If we look at Airbnb competitor Booking Holdings, which runs a similar business model to Airbnb but with a focus on hotels, the stock traded at a price-to-sales ratio (P/S) between six and eight prior to the pandemic, and it produced an EBIT (earnings before interest and taxes) margin of 30% to 35%.
With around $5.7 billion in revenue expected in 2021, Airbnb trades at a P/S of 19. With similar unit economics, it is likely Airbnb will have close to the same profit margin as Booking Holdings at scale. This tells me investors are pricing in multiple years of robust sales growth at Airbnb's current valuation.
Are these expectations too high? I'm not sure. But if you're an Airbnb shareholder or an investor thinking of buying the stock at current levels, you'll want to see revenue grow rapidly in the next few years -- hitting an annual rate of $10 billion or even $15 billion -- if this investment is going to work out over the long term.