Second Major Success in the Sharing Economy -- Airbnb Wins a $25 Billion Valuation

The hospitality industry is $500 billion dollar business that promises comfortable stays, clean rooms, and luxury to those who can afford it. And one company is taking hotels out of the equation altogether.

Airbnb is a fast growing company, and there is no question why that is: with low fees, a great review system, and major investors bankrolling the business with each round of fundraising, this start-up has more than tripled its revenue in just two years to $900 million.

Does this mean it is time to call it quits for traditional operators of the past? A full transcript follows the video.

Sean O'Reilly: We're talking about Airbnb on this consumer goods edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly, joining you here from Fool headquarters in beautiful Alexandria, Virginia, just south of the nation's capital. I'm joined today by the incomparable Vincent Shen and the devilishly handsome Jake Silverstein. How are you guys?

Vincent Shen: Doing well, Sean.

Jake Silverstein: Doing well, Sean. Thank you for having me on the show.

O'Reilly: Thanks. You're our intern, and I wanted to make sure you're included. We'll get to this in a minute, but Jake actually has some experience with what we're talking about today, which is Airbnb.

Vince, what is the history of this company that is making the entire hotel industry nervous?

Shen: There's definitely a ton of buzz around this company right now. They are seen as part of the entire home-sharing shift, or industry that's disrupting all these other traditional businesses.

O'Reilly: Can I use it to rent out my couch?

Shen: I would say it's similar to the old "couch surfing," except that people are now coming from...

O'Reilly: Backpacking through Europe kind of thing?

Shen: Exactly. This is an opportunity that allows the residents of anything from a traditional apartment to a home to even something like a villa...

O'Reilly: A villa?

Shen: Or a castle as part of their...

O'Reilly: Jake, are you renting out a villa?

Silverstein: Not quite.

O'Reilly: Okay.

Shen: There's definitely a lot of variety in terms of their properties, and it was started by Brian Chesky and Joe Gebbia in 2008. They're from San Francisco, and I love the bootstrap origins that his company had because they couldn't afford the loft they lived in because it was San Francisco.

O'Reilly: Because it was San Francisco.

Shen: Exactly. It was very expensive, and they started, in their living room, with three inflatable mattresses, homemade breakfasts, and that's a bit of how the idea was born for them. They ended up going as far as selling themed cereal based on the 2008 presidential race in order to help raise money to get this company going. I think they raised $30 thousand to get things going for them.

It's definitely a really cool origin for this company that is now -- based on the most recent round of funding -- potentially worth $25 billion.

O'Reilly: That's why we're talking about this -- these valuations, and so on. It's a follow-up to the tech show I did a month ago with Dylan Lewis about the valuations that have been assigned to Snapchat and all these guys. Where is Airbnb right now? How many people is it finding places to stay? How big is it?

Shen: Sure. They currently boast about 1.5 million listings worldwide. That's a huge network of properties. They have hosted 40 million guests at this point in their lifetime -- at least the overall network has.

O'Reilly: Over 40 million served.

Shen: Now you can find them in 34,000 cities and over 190 countries. It's worldwide.

O'Reilly: I was surprised at how, compared to Uber that takes 10% to 20%, how reasonable their cut is.

Shen: Yeah. In terms of how the company actually makes its money, the hosts end up bearing a smaller brunt of it. The company takes a 3% cut of each booking, payment processing, and all the overhead things along those lines, whereas the guest will pay about a 6% to 12% fee for the booking. That's where the company itself is generating its revenue.

O'Reilly: It's still in the guest's interest because it is cheaper than a hotel or something?

Shen: Jake will be able to testify to this based on his experience... and I've done it. When I was in Denver, I used Airbnb, as well, and I found it to be a better option than some of the hotels in the area. What do you think, Jake?

Silverstein: Absolutely. I could have furthered my summer here as an intern working for the Fool.

O'Reilly: It was literally two months, right?

Silverstein: Yeah. Just about 7-1/2 weeks.

O'Reilly: You're a smiling face in the office for two months now.

Silverstein: It's been great. It was pretty difficult to find housing for a short stay like that, and I looked at Airbnb. I heard great reviews, and I wanted to be one of those around 40 million guests that Airbnb has. While it's not quite a villa, I've certainly had a great experience with using Airbnb.

The apartment is always ready, it's always clean, there's great housekeeping, it's a nice bed, and nice roommates, and it's always cool to meet new people coming through the Airbnb. It's definitely more affordable than having done a hotel for this time. I've only got good reviews.

O'Reilly: Did you look at other options like Craigslist, or anything?

Silverstein: I did, and what I like about Airbnb over Craigslist is it's a time-tested brand at this point. We know that you have a great review system. I looked and there were over 300 reviews, which is pretty amazing. Every person I read said they had a great time using Airbnb in the past. Great hosts, clean, safe, and those are things that you don't necessarily know going into a Craigslist listing. I felt very comfortable, and it's been a great experience. I probably will do it again.

O'Reilly: Awesome. Okay. Feel free to chime in here at any point you want, Jake. How do they make money? They've got the 3% royalty, the person that's doing the renting obviously pays a bit more. What kind of financials are we looking at? Currently, Airbnb is private.

Shen: Yes. Thanks for chiming in there, Jake. A big thing I've generally seen that's allowed this company to be successful is how seamless they make everything for both the host and the guest. A lot of people compare Airbnb to HomeAway (AWAY.DL), which is actually a public company, which focuses more on professional vacation rental properties.

Something that sets it apart is that Airbnb tries to handle everything in-house. They will make this process as seamless as possible. They'll handle the payments, any disputes you have. There's definitely a unique variety of properties, and for first-time hosts, they'll even cover help with photography for whatever property you're listing.

O'Reilly: You're kidding! Wow.

Shen: That encourages people with places to potentially host new guests to join the network. The more properties there are, the stronger their value proposition is for this company. What that has allowed Airbnb to do is, this year, they're expected to generate about $900 million in revenue.

O'Reilly: And that's up from $250 last year.

Shen: In 2013.

O'Reilly: That's a 250% growth, something like that.

Shen: Yeah. It's insane that in the past two years, they've more than tripled their revenue. You can get a very obvious idea of how quickly it's growing, and why there is so much buzz around this company.

O'Reilly: Wanting to handle everything in-house seems to have a lot of costs associated with it, though, because they're not making a GAAP profit, currently.

Shen: The issue is part of what you said. I think the business model is sound. Obviously, right now they're really focused on that growth. You don't go from $250 to $900 million without expanding very aggressively. Not only where you are located geographically, but trying to push to take the property network as large as possible.

This year, they are expected to eat an operating loss of about $200 million. That's on top of $150 million last year. It's definitely not in the black quite yet, but in terms of that top-line growth, there are internal projections from the company where they expect to be generating $10 billion in revenue within five years -- by the year 2020.

O'Reilly: That's a lot of Jakes running around doing their internships in southern D.C.

Silverstein: Absolutely.

O'Reilly: What kind of hurdle could derail this? I don't see the hotel industry and Craigslist -- which doesn't have the ratings -- what kind of hurdles are there to this company making a profit, getting to $10 billion in revenues, becoming everything that early investors want it to be?

Shen: In terms of the overall opportunity, you see these numbers, and you think, "Is there really that potential to hit that $10 billion number that's forecasted?" If they hit that number, they expect to potentially make $3 billion in EBITDA.

The thing is, the size of the industry is huge. They might have 1.5 million rooms making them bigger than some pretty big, global hotel operators -- even Hyatt, Hilton, or Marriott. The hospitality research company MKG Group estimates there are about 20 million hotel rooms worldwide. It's still a pretty small fraction of that.

Not only that, the global hotel market is expected to be about a $500 billion industry.

O'Reilly: So they could take a small piece of that and still do really well.

Shen: And based on their growth, I think that their vision is certainly not to just take a small piece of that. They want a big piece of that.

O'Reilly: Okay. I keep bringing it back to Uber because I think the analogy is pretty sound there. it's basically a social networking type of connection. They don't own anything. Uber doesn't own the cars; Airbnb doesn't own the townhouses. A lot of cities have been putting Uber through the ringer, though. You hear about Paris, and all these things that taxi drivers have been doing. Has Airbnb run into any regulatory type hurdles?

Shen: It definitely hasn't been a perfectly smooth process, though I think they haven't run into quite as many issues as Uber has. In my mind, this often-cited major market that hasn't welcomed Airbnb with open arms is New York City. Certain people have hosted their apartment in the city have been fined because there are certain rules around...

O'Reilly: Permanent hotel, or something.

Shen: Yeah. Permanent versus temporary residences -- there's laws round that. Even in San Francisco, which has generally been seen to embrace the Airbnb model, have required people hosting properties to get liability insurance. There's a limited on how many days in the year they can rent out the property, the full unit.

O'Reilly: Without giving away too much information, Jake, had your host ever mentioned anything about insurance here in Alexandria?

Silverstein: He hasn't mentioned it. I think that's to his advantage to keep the guest a little bit in the dark.

O'Reilly: It's not like if you came into my home, I'd be like, "Just so you know, I have insurance." It might not come up in conversation, although it might be advertised on Airbnb's website or something. "Licensed and bonded." I don't know.

Do they have any direct competitors? You mentioned how HomeAway is more of vacation rentals, but that's obviously a competitor. Is there anyone else? Uber has Lyft. Where are they in the landscape?

Shen: I think, in the beginning, traditional hotel operators didn't really see this whole "share" economy as being as much of a threat as it turned out to be. Now, seeing this $25 billion valuation and this company obviously turning into a major competitor, even some of the hotel operators and other booking sites are joining the fray in this whole business model.

TripAdvisor recently launched a home-sharing service in Australia. Hyatt Hotels is part of a recent $40 million funding round for Onefinestay, which is another, smaller U.K. company that people referred to as the Airbnb for the rich. This caters more toward luxury properties and really high-end stays.

O'Reilly: That was one of my thoughts, because it seems like with Uber disrupting the taxi market, we're all used to getting in the back of a car with taxis where it's not our car. We're just sitting behind a car, and that's it. Uber lends itself to completely disrupting that; but with hotels and staying somewhere, there's a certain portion of the market that doesn't care about the price, and wants some place really nice. That actually sounds very interesting -- an alternative to a hotel.

Shen: The thing is, some of the friction of Airbnb gaining market share, starting to take away potential guests at traditional hotels; since it's so new, they're still trying to see what the actual impact is of Airbnb on this industry. There were some studies, and Airbnb releases their own research, as well, seeing its impact in terms of how much guests spend, how long they stay, the local economic impact where they are in places like Amsterdam, Berlin.

In Paris, it's one of the biggest cities for Airbnb in terms of number of properties, and though it's hosted about 2 million people through this service, hotel occupancy rates in the city have actually remained pretty steady -- around 80%. Is it really stealing those customers away from the hotel operators? Not necessarily. I think, over time, we'll see what that impact really is.

O'Reilly: Awesome. I can't wait to see and talk about these valuations here in a second.

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Moving on here, we are talking about valuation, and I don't want to say we're entering a bubble with all these social networking sites; but we're entering a bubble with all these social networking sties.

Airbnb just had a funding round. What did they get valued at?

Shen: In the past month, they raised about $1.5 billion. The puts their valuation at about $25.5 billion.

O'Reilly: That's a chunk of change.

Shen: Absolutely. We talked about how their revenue is expected to be $900 million this year.

O'Reilly: So they're being valued at 25x.

Shen: A little over 25x their sales. Put that into perspective. We have a list here of other companies that would be considered competitors, and some of them, like Priceline, have had pretty high growth.

O'Reilly: Sorry to take a step back, but we were talking about them earlier, and it seems -- you go to a Priceline.com, or any of the Expedias, or anything, and there's a hotel option there. In fact, a lot of airlines have the hotel option there. It seems like, if this really catches on, they would try to get a piece of that. Anyway, go on.

Shen: Sure. We have higher-growth companies like Priceline, and we'd mentioned HomeAway being a bit more of a direct competitor to Airbnb, though it caters to the professional vacation homes market. Priceline has a valuation of about $60 billion; it trades a little over 6x its 2015 expected revenues.

O'Reilly: So one-quarter.

Shen: HomeAway's is around 6x, whereas you look at the traditional hotel operators: Hilton is at 2.5x sales, Marriott is at 1.4x sales, Airbnb is almost 27x sales or more. I think people really are loving the growth that company is seeing. There's no denying that 90% annual growth rate for revenue bests everything by far. HomeAway is only at 20%. Even Priceline, which is an industry darling, is only 17%.

O'Reilly: Albeit considerably bigger. This is basically just being valued on market potential. That's kind of it, right?

Shen: Yeah. At the same time, I think these are not small numbers in terms of the revenue it's generating. Again, they're forecast for 2020 to be hitting $10 billion in revenue. That's huge. Based on the most recent funding round -- that $25 billion valuation -- Airbnb is No. 3 in terms of the biggest venture-backed start-ups. The only two huge-name companies ahead of it are Xiaomi and Uber.

In terms of the investors and that recent funding round, we're talking about really major institutions. P/E firms like General Atlantic, Tiger Global Management, Kleiner Perkins, and even the more traditional, finance companies like T. Rowe Price and Fidelity -- that $25 billion valuation is coming in only a little over a year after the company was valued during the last funding round at just $10 billion.

O'Reilly: Got it. There are three of us at the table, we're all going to give a buy, sell, or hold. If you could have gotten in on that latest funding round, Jake, since you are the intern ... if you could have gotten in on the $1.5 billion funding round with whatever amount of money, would you have bought in?

Silverstein: What would you have said, Sean?

O'Reilly: No way. You've got to go first. I would have.

Silverstein: Me, as well.

Shen: I think it's a buy for me. The potential there is huge, and I think, for people who are trying to find a way to get into it now -- obviously it's private, though a public debut is pretty likely in the future.

O'Reilly: Right. This has a Rule Breaker-y feel to it.

Shen: There are other companies that you can invest in as proxies. Some people have mentioned HomeAway, but also Etsy as part of this sharing economy, and those are two of the public companies now that, if you're riding the trend, they can be your way in before these really big ones like Uber and Airbnb actually go public.

O'Reilly: They have the advantage of being the first mover, and it's like how Facebook was the first social network. They're light years ahead of everybody else. Google, two days ago, just threw in the towel on Google+, which is supposed to be their Facebook alternative competitor. Being the first mover, which is what Airbnb is, has an inherent advantage to it.

Shen: The company has made its name synonymous with the whole idea.

O'Reilly: Which, I thought I could rent a plane with when I first heard about it. Very good. Well thanks everybody for your thoughts. Jake, thanks for being an intern and thanks for joining us today.

Silverstein: Thank you, Sean.

O'Reilly: If you are a loyal listener and have questions or comments we would love to hear from you. Just email us at [email protected]. Again, that's [email protected]. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Jake Silverstein and Vincent Shen, I'm Sean O'Reilly. Thanks for listening, and Fool on!