Share prices of travel-booking platform Airbnb (ABNB 0.60%) are down more than 50% from their all-time high, reached over one year ago.
Certain institutional investors expect Airbnb to turn things around over the next four years. Specifically, this "smart money" believes Airbnb stock can surpass $288.64 per share, representing more than 180% upside from where it trades right now. But here's why smart money might be wrong.
First, why $288.64 per share?
On March 2, 2021, Airbnb announced it was looking to raise $2 billion. Two days later, it priced convertible senior notes at a 0% interest rate with a conversion price of $288.64 per share.
In other words, Airbnb's lenders don't earn interest for loaning $2 billion. Rather, they get the option to convert this loan into $2 billion of Airbnb stock if the price is over $288.64 by December 2025 through March 2026, when the notes mature.
Prior to the present market downturn, the popularity of 0% convertible senior notes surged. As reported by The Wall Street Journal, JPMorgan Chase data shows companies sold a record $57 billion in these zero-coupon notes in 2020 and 2021 combined. Companies like Affirm Holdings, Snap, and Peloton Interactive all got in on the action with Airbnb.
This kind of debt product can be a win-win. For example, let's say Airbnb stock goes to $350 per share. If it hits this price, it's likely because it used the $2 billion to grow its business substantially. Therefore, it's a win for Airbnb. Moreover, if it hits $350 per share, the company's lenders can convert at $288.64 and instantly have over $60 per share in profit. Therefore, it's a win for the smart money.
However, if Airbnb stock doesn't hit the conversion price, this $2 billion loan needs to be paid back.
For cash-burning companies with bad balance sheets, paying back interest-free debt could be problematic. They'll be forced to pay off old debt with new debt that's more expensive because rates have skyrocketed in 2022. Fortunately for Airbnb, it's cash-flow positive and it has over $8 billion in cash, cash equivalents, and marketable securities as of the end of the first quarter of 2022. Therefore, its debt is manageable.
Can Airbnb stock really skyrocket over the next four years?
You might wonder why smart money made such a bold bet on Airbnb stock. Well, it wasn't so bold at the time. Airbnb's stock traded around $180 per share when the terms of the loan were set. Therefore, lenders were only looking for a 60% gain over five years, or about 10% compounded annually. And over the long history of the stock market, 10% annual returns are pretty average.
There's good reason to believe that Airbnb's business can have above-average performance. Consider that in Q1, there were over 100 million nights and experiences booked on Airbnb's platform, up 26% from pre-pandemic times in the same quarter three years ago. By comparison, gross booking value was up 73% over this time span.
Booking-value growth is exceeding overall transaction growth because people are paying more on average per Airbnb booking. And the implications of this trend are profound. Increasingly, consumers view Airbnb as a premium experience worthy of spending more money on. That's big.
There's more I could add to my bullish outlook. But in short, Airbnb is a premium brand in a growing space. Therefore, I expect its business to perform well. That said, it still might fall short of 180% upside over the next four years because of its valuation, not the business.
Since March 2021, Airbnb's price-to-sales (P/S) multiple has plunged from around 30 to about 10. This tends to happen when interest rates go up like they have. But there's no way to predict interest rates in 2025. Therefore, speculating on Airbnb's valuation in 2025 is challenging.
With over 635 million shares currently, Airbnb's market capitalization would be over $180 billion in 2025 if it reached $288 per share. Assuming the stock keeps a P/S of 10, it would need to be generating $18 billion in annual revenue by that time -- triple the $6 billion it generated in 2021. That seems unlikely to me.
Airbnb will announce financial results for the second quarter of 2022 on Tuesday, Aug. 2, when it expects to report year-over-year revenue growth of greater than 50%. If it can keep up this white-hot growth over the next four years, then perhaps it can indeed triple its revenue and hit the conversion price for its $2 billion debt.
However, even if it doesn't, I still expect Airbnb to grow enough to be a market-beating performer from here. And that's what matters most for investors.