Tuesday, January 12, 2021

Marking Time: A new year, a fresh semester and its class time!

As we approach the turn of the calendar year, I have my own set of rituals that prepare me for the new year. Last week, was my data week, where I download and analyze data on all publicly traded companies, listed anywhere in the world, and I will post extensively on what the numbers look like after a most tumultuous year. I also start thinking about my passion, which is teaching, the spring semester to come, and the classes that I will be teaching, repeating a process that I have gone through every year since 1984, my first year as a teacher. And as always, I invite you come along for the ride. 

What I teach...

For a class to resonate and be remembered, it has to be more than a collection of topics, and with each of my classes there is a core narrative that animates and connects the class sessions. If you were to ask me what that narrative was for each of my classes, here is how I would respond.

  1. Corporate Finance: Corporate finance is the development of the first financial principles that govern how to run a business. It is that mission that makes corporate finance the ultimate big picture class, one that everyone (entrepreneurs, investors, analysts, business observers) should take. If it looks like I am over reaching, I start my corporate finance class with the simple proposition that any decision that involves money is a corporate finance decision, and by that definition everything that businesses do falls under its umbrella. To make this operational, I build my class around my big picture of corporate finance:

    I tie every session and every topic within each session to this big picture, and while I am willing to and often do abandon models and theories, I am loath to compromise on first principles. Thus, you and I can disagree about whether beta is a good measure of risk, but not on the principle that no matter what definition of risk you ultimately choose, riskier investments need higher hurdles than safer investments. I end the class with a corporate finance version of valuation, where I tie inputs into value (cash flows, growth and risk) to investment, financing and dividend decisions. 
  2. Valuation: It is unfortunate, but for most people, the vision that comes to mind when I say that I teach valuation is excel spreadsheets and high profile company names. Don't get me wrong! I find Excel to be a solid tool in my arsenal, but I am not only old enough to have valued companies with a ledger sheet and calculator but also wary of letting a tool drive my valuations. If you do take this class, you should recognize that I will almost never open and work with an excel spreadsheet in class (though I do have supplemental YouTube videos on using them in analysis) and my interest is in valuing just about anything, not just large public companies.

    In fact, there are three key themes that I emphasize through this class. 
    1. Price versus Value: The first is that we need to draw a contrast between valuing an investment and pricing it; the former is driven by fundamentals (cash flows, growth and risk) and the latter by demand and supply (with mood, momentum and liquidity often dominating fundamentals). While intrinsic valuation models try to assess value, pricing is built upon what others are willing to pay for similar investments; in the context of stocks, using a PE ratio and a peer group to attach a number to company is a pricing, not a valuation. 
    2. Value = Story + Numbers: The second is that a good valuation is a bridge between stories and numbers, where every number that you use in a valuation, whether it be expected growth, margin or discount rate, has to be built around a story about the company, and every story you tell about a company (its amazing management, its superior platform or loyal employees) has to show up in a number. I will confess that, as a natural number cruncher, it too me a while to learn this lesson, and I try to pass on how I moved up (and continue to try to do better) the learning curve.
    3. Face up to uncertainty, rather than avoid or deny it: Uncertainty is a feature of investing/ business, not a bug. One of my biggest issues with old-time value investing is that it viewed and continues to view uncertainty as something to be avoided as much as possible, and takes the view that you cannot value investments, where there is too much uncertainty. That view has led value investors to focus on mostly mature companies and kept them out of the game of investing in young and growing businesses. I take the point of view that uncertainty should not stop you from valuing companies, that your value estimates will have more error in them, but since the market also faces the same uncertainty, your best bargains may be in the midst of uncertainty. It is for that reason that I spend large portions of this class valuing difficult-to-value companies, in what I call the dark side of valuation.
  3. Investment Philosophies:  If my classes were children, this class would be my neglected one, since I have never taught it in person at NYU, but it is a class that was born out of an observation. There are only a few investors who have consistently beaten the market over time, and many of them are legendary, but people within this small group are extraordinarily diverse in terms of how they think about markets and investing. That tells me three things. The first and obvious one is that there are no easy ways to beat the market, and anyone who claims to have found one is either lying or heading for a letdown. The second is that the notion that there is only one pathway to investment nirvana is hubris, and that there must be different philosophies that can be successful. The third is that since many of these successful investors have been widely followed, just copying what they do must not work, or we would observe far more imitation Buffets and Simons,  who are successful. In this class, I try (and that is all I can do) to provide a full menu of investment philosophies, starting with technical analysis/charting, moving on to value and growth investing (in both public and private forms), and then on trading on public or private information. I close by looking at bookends of the philosophies by looking at arbitrage, where investors chase (and sometimes catch) the dream of guaranteed profits and indexing, where investors come to an acceptance that stock picking does not work.

    With each philosophy, I look at strategies that emerge, the historical backing for whether these strategies work and end by looking at the make up that you would need as an investor to be able to succeed with that philosophy. By the end of the class, my objective is not to sell you on the best philosophy but to provide you with a framework where you can find the philosophy that best fits you.
I also offer online classes in basic finance (present value, risk models and measures) and accounting (or at least my version of it) as background to my main classes. If you are at all interested in taking any of these classes, and are wondering about sequence, I modified the flow chart that I used in my September 2020 post to lead you through your choices:

Please recognize that this is just a very rough flow chart, and that you may find pathways through it that meet your needs better.

The Delivery Choices
If you decide to take a class or two, there are three platforms that you can pick from, and which one is best for you will depend both on your preferences and objectives:

1. Stern NYU classes: The first, and the one with the deepest roots, are the classes that I teach at the Stern School of Business at NYU to both MBAs and undergraduates. I normally teach these classes, in person, every spring, starting late January/early February and ending early in May.  This spring, I will be teaching three classes, a corporate finance class for MBAs and two identical valuation classes, one to MBAs and one to undergraduates, but with the virus still raging out of control, I will be teaching the classes on Zoom. The class times for the coming semester are below: 
    • Corporate Finance: Mondays & Wednesdays, 12.30 pm - 1.50 pm (New York time)
    • Valuation (MBA): Mondays & Wednesdays, 2.00 pm - 3.20 pm (New York time)
    • Valuation (Undergraduate): Mondays & Wednesdays, 3.30 pm - 4.45 pm (New York time)
All three classes start on February 1, 2021 and end on May 10, 2021. To sit on the live classes, you have to be a Stern student enrolled in the class, but I plan to record the classes and you can watch those recordings either on my website or on YouTube (where each class will have its own playlist), and access supplementary material (slides, post-class tests). 
2. My (free) online classes: The biggest challenge with following the NYU classes online is that they are not designed as online classes. The lectures are 75-80 minutes long, an eternity for an online experience, where time is measured in seconds, not minutes. I have created 12-15 minute versions of each session, preserving almost 80% of the content in the longer classes, and these online classes are also available on my website or on YouTube. If you do decide to take these classes, there are no hoops to jump through and no cost involved, but there is no credit for classes taken or certification. 
3. NYU certificate classes: If it is important to you that you get more structure, more touch and certification, there is a third option. NYU Stern has certificate versions of the online classes on their website. While the content of the free online and certificate classes are almost identical, you get more polished versions of the recorded sessions, once-every-two-weeks live zoom sessions where you can ask me questions and certificate at the end of the class, if you pass the exams/quizzes and complete the project requirements. The cost, though, is definitely not zero, and if you get sticker shock when you check what NYU charges, please remember that I have no control over or negotiation with you on this price.  
The links to all of these classes are at the end of this post.

COVID Lessons

When I start my teaching in early February, it will be my 58th semester teaching valuation and my 36th teaching corporate finance. Have I changed the way that I teach these classes over the last 36 years? Of course, but with two caveats. The first is the first principles or big pictures that you see for the classes are almost identical to those that I taught my very first semester, which should not surprise you, since that is what makes them first principles. The second is that the changes in content in most semesters has been incremental, building largely on the material from the previous one, with more timely data and a few augmentations. That said, since I believe that you should be able to value companies in the real world , each crisis that I have lived and taught through has left its imprint on classes, sometimes altering ways in which I approach estimating and sometimes altering the way I think about fundamentals. The dot com boom of the 1990s forced me to expand my valuation tools and models to cover younger companies, often with lots of potential and very little historical data. I am open about the fact that I learned to value young company through my struggles in valuing Amazon in 1998 and 1999. The dot com bust crystallized my views on the contrast between valuing and pricing an asset, and how behavioral finance can explain why the two diverge and what causes eventual convergence. The 2008 market crisis taught me that globalization had grayed the once bright lines between developed and emerged markets and the capacity for failures at some companies to spill over into other companies and sometimes the entire market. The last decade, with it influx of user based companies and technology platforms forced me to think seriously about how to value a user, subscriber or rider and extrapolate from there to company value. During 2020, as I watched companies and investors struggle with the after shocks of the economic shut down created by COVID, I wrote a series of fourteen posts (linked below) on what I was learning, unlearning and relearning about corporate finance and valuation. Unlike some market watchers, who have been quick to label the market as crazy, speculative or a bubble, I believe that the movements in market value across companies, regions and sectors have implications for how businesses should be run as well how investors price these companies:

COVID lessonBasisCorporate FinanceValuationInvestment Philosophies
The price of risk is dynamic and volatileBoth equity risk premiums & default spreads went on a wild ride in 2020Companies need hurdles rates (costs of equity & capital that change to reflect market levels.Discount rates in intrinsic valaution have to change to reflect current market conditions, and can be expected to change over time.Investors need to reassess their expected returns to reflect risk free rates & current ERP & default spreads.
Flexibility is an asset (and has value)Young firms with low capital intensity and more variable cost structures did much better during the crisis than their more capital intensive, high fixed cost counterparts.When investing, companies have to explicitly incorporate flexiblity into decision making, sometimes taking lower NPV, more flexible projects over high NPV, less flexible investments.Value has to incorporate the value of flexibility, explicitly through the use option pricing models or implicitly, when comparing pricing multiples across companies.Investment strategies that create concentrations in manufacturing and captial intensive companies need to be balanced with firms that have more flexible cost structures.
Debt can handcuff even large, established companies & put them at risk.In the early days of the crisis, established firms like Boeing found themselves in the crosshairs, partly because of their heavy debt loads.The assessment of how much to borrow has to factor in distress costs much more explicitly, and more value should be attached to keeping a safety buffer.Since it is very difficult, if not impossible, to incorporate failure risk in a DCF, more effort should be put into estimating the probability of failure and its consequences.Strategies that concentrate investments in companies with high failure risk (start ups and indebted firms) have to compensate by holding more cash or buying protection against market shocks.
In my valuation class, I will bring in some of the valuations that I did, both of the market (S&P 500) and individual companies during the crisis to illustrate how story telling was key to getting past the near-term uncertainty created by the shut down. In my investment philosophies class, I plan to talk about how the crisis shook my faith and what I had to do to find serenity. 

YouTube Video

Class Links

  1. Corporate Finance MBA class (Spring 2021): On my website and YouTube Playlist
  2. Valuation MBA class (Spring 2021):  On my website and YouTube Playlist
  3. Valuation Undergraduate class (Spring 2021):  On my website and YouTube Playlist
  4. Foundations of Finance Online class (Free): On my website and YouTube Playlist
  5. Accounting Online class (Free): On my website and YouTube Playlist
  6. Corporate Finance Online class (Free): On my website and YouTube Playlist
  7. Valuation Online (Free): : On my website and YouTube Playlist
  8. Investment Philosophies Online class (Free): : On my website and YouTube Playlist
  9. NYU Corporate Finance Certificate class (Definitely not free & offered only in fall 2021)
  10. NYU Valuation Certificate class (Definitely not free)
  11. NYU Investment Philosophies Certificate class (Definitely not free)

Viral Market Update Posts

Saturday, January 9, 2021

Data Update 1 for 2021: A (Data) Look Back at a Most Forgettable Year (2020)!

I spent the first week of 2021 in the same way that I have spent the first week of every year since 1995, collecting data on publicly traded companies and analyzing how they navigated the cross currents of the prior year, both in operating and market value terms. I knew that this year would be more challenging than most other years, for two reasons. The first was that the shut down of the global economy, initiated by the spreading of COVID early last year, had significant effects on the operations of  companies in different sectors, and across the world. The second was that, starting mid-year in 2020, equity markets and the real economy moved in different directions, with the former rising on the expectations a post-virus future, and the latter languishing, as most of the world continued to operate with significant constraints. In this post, I will start with a rationalization of why I do this data analysis every year, follow up with a description (geographic and sector) of the overall universe of companies that are in my analysis, list out the variables that I estimate and report, and conclude with a short caveat about 2020 data.

Data: A Pragmatist View

We live in the age of data worship, where investors, analysts and businesses all seem to have bought into the idea that big data has answers for every question and that collecting the data (or paying for it) will create positive payoffs. I am a skeptic and I have noted that to make money on big data, two conditions have to be met:

  1. If everyone has it, no one does: I believe that if everyone has a resource or easy access to that resource, it is difficult to make money off that resource. Applying that concept to data, the most valuable data is unique and exclusively available to its owner, and the further away you get from exclusivity, the less valuable data becomes. 
  2. Data is not dollars: Data is valuable only if it can be converted into a product or service, or improvements thereof, allowing a company to capture higher earnings and cash flows from those actions. Data that is interesting but that cannot be easily monetized through products or services is not as valuable.
All of the data that I use in my data analysis is in the public domain, and while I am lucky enough to have access to large (and expensive) databases like Bloomberg and S&P, there are tens of thousands of investors who have similar access. Put simply, I possess no exclusivity here, and staying consistent with my thesis, I don't expect to expect to make money by investing based upon this data. So, why bother? I believe that there are four purposes that are served:
  1. Gain perspective: One of the challenges of being a business or an investor is developing and maintaining perspective, i.e., a big picture view of what comprises normal, high or low. Consider, for instance, an investor who picks stocks based upon price to book ratios, who finds a stock trading at a price to book ratio of 1.5. To make a judgment on whether that stock is cheap or expensive, she would need to know what the distribution of price to book ratios is for companies in the sector that the company operates in, and perhaps in the market in which it is traded. 
  2. Clear tunnel vision: Investors are creatures of habit, staying in their preferred markets, and often within those markets, in their favored sectors. Equity research analysts are even more focused on handfuls of companies in their assigned industries. So what? By focusing so much attention on a small subset of companies, you risk developing tunnel vision, especially when doing peer group comparisons. Thus, an analyst who follows young technology companies may decide that paying ten times revenues for a company is a bargain, if all of the companies that he tracks trade at multiples greater than ten times revenues. Nothing is lost, and a great deal is gained, by stepping back from your corner of the market and looking at how stocks are priced across industries and markets.
  3. Expose BS: I know that everyone is entitled to their opinions, but they are not entitled to their facts. I am tired of market experts and analysts who make assertions, often based upon anecdotal evidence and plainly untrue, to advance a thesis or agenda. Are US companies more levered than they were a decade ago? Do US companies pay less in taxes than companies in other parts of the world? Are companies that buy back stocks more financially fragile than companies that do not? These are questions that beg to be addressed with data, not emotions or opinions. (I know.. I know... You would like those answers now, but stay tuned to the rest of my data updates and the data will speak for itself.)
  4. Challenge rules of thumb and conventional wisdom: Investing has always had rules of thumb on how and when to invest, ranging from using historical PE or CAPE ratios to decide if markets are over valued, to simplistic rules (eg. buy stocks that trade at less than book value or trade at PEG ratios less than one) for individual stocks. It is very likely that these rules of thumb were developed from data and observation, but at a different point in time. As markets and companies have moved on, many of them no longer work, but investors continue to use them. To illustrate, consider a practice in valuation, where analysts are trained to add a small cap premium to discount rates for smaller companies, on the intuition that they are riskier than larger companies. The small cap premium was uncovered in the the early 1980s, when researchers found that small cap stocks in the US earned significantly higher returns than large cap stocks, based upon data from 1926 to 1980. In the decades since, the small cap premium has disappeared in returns, but inertia and laziness have kept the practice of adding small cap premium alive.
In closing, I also want to dispense with the notion that data is objective and that numbers-focused people have no bias. If you have a bias or a preconception, it is amazing how quickly you can bend the data to reflect that bias or preconception. As an exercise, take a look at my updated industry averages for taxes paid by US companies in 2021. From past experience, I predict that numbers in this table will be quoted by journalists, economists and even politicians, with very different agendas, but the tax rate measure (since I report several different measures) that they quote will reflect their biases. Put simply, if you find my data quoted elsewhere, I would suggest that you visit the source and make your own judgments.

The Sample
The focus in markets is often on subsets of firms, usually with good reason. In general, larger firms (especially in market value terms) get more attention that smaller ones, because their movements in their value are more consequential for more investors Also, publicly traded firms generally garner more attention than privately owned businesses, partly because they are larger, but also because there are is more information disclosed and investment opportunity with the former. Finally, fair or not, companies in developed and more liquid markets are in the spotlight  more than their counterparts in emerging markets. That said, focusing on just large or developed market companies can create biased samples and skew assessments about market and operating performance. It is to avoid this that I started by looking at all publicly traded companies that were traded on January 1, 2021, and arrived at a sample of 46,579 firms, spread across 136 countries. 
While the universe of companies is diverse, with approximately half of all firms from emerging markets, it is more concentrated in market capitalization, with the US accounting for 40% of global market capitalization at the start of the year. Using the S&P categorization of global companies into sectors, the data universe looks as follows:
It should come as no surprise, especially given their performance over the last year, that the technology sector is the largest in terms of market capitalization. While some of the companies in this data trace their existence back decades, there is a healthy proportion of younger companies, many in emerging markets and new industries. 

Finally, it is worth noting that, notwithstanding the travails of last year, the number of firms in the data universe increased from 44,394 firms at the start of 2020 to 46,579 firms, a 4.9% increase over the year, as new listings outnumbered companies that defaulted during the course of the year. 

If there is a hole in my sample, it is the absence of privately owned businesses. One reason is that these businesses are not only not required to publicly disclose their financial details in most parts of the world, but often follow more malleable accounting standards, making the data less reliable and comparable. The other is that even in those parts of the world, where private company information is available, the data is limited and market price data is missing (since the companies are not traded). That said, it does mean that any broad conclusions (about profitability and revenues) that emerge from my data apply to public companies, and it may be dangerous to extrapolate to private businesses, especially in a year like 2020 where private businesses could have been affected more adversely by COVID shutdowns than public companies.

The Data
As more data has become publicly available, and access to the data becomes easier, the challenge that we face in investing and valuation is that we often have too much data, and information overload is a clear and present danger. In this section, I will list the data that I estimate and report, as well as explain how I consolidate company-level data into more usable group statistics. 

General Details
While there are advantages to looking across all firms, small and large, listed anywhere in the world, there are challenges that come from casting such a wide net. I have tried my best to keep them from overwhelming the analysis, and in the interests of openness, here are some of the details:
  1. Currency: One of the challenges of dealing with a global sample is that you are working with accounting and market numbers quoted in multiple currencies, and since you cannot aggregate or average across them, I will employ two techniques. First, all value numbers (like market capitalization, debt or revenues) that I aggregate or average will be converted into US dollars to ensure currency consistency. Second, most of the numbers that I report will be ratios, where the currencies are no longer an issue; a PE ratio for a Turkish company, with market cap and earnings denominated in Turkish Lira, can be compared to the PE ratio for a US company, with market cap and earnings denominated in US $. It is true that the Turkish company will face more risk because of its location, but that is an issue separate from currency.
  2. Missing Data: Information disclosure requirements vary across the world, and there are some data items that are available for some companies or some markets, and not for others. Rather than remove all firms with missing data, which will eliminate a large portion of my sample, I keep the firms in the sample and report only the variable/metric that is affected by the missing item as "NA". For instance, I have always computed the present value of lease commitments in future years and treated that value as debt, a practice that IFRS and GAAP have adopted in 2019, but that computation requires explicit disclosures of lease commitments in future years. That is standard practice in the United States, but not in many emerging markets, but rather than not do the computation for all companies or remove all companies with missing lease commitments, I compute lease debt for those companies that report commitments and report it as zero for those companies that do not, an imperfect solution but the least imperfect of the many choices.
  3. Accounting Differences: In addition to disclosure differences, there are also accounting differences in revenue recognition, expensing rules, depreciation methods and other details across markets. I work with the publicly available data, recognizing that net income for a Japanese company may be measured differently than earnings for an Indian company, and accept that this may skew the results. However, it is worth noting that accounting rules around the world have converged over the last four decades, and they share a lot more in common than they have as differences.
  4. Source Reliability and Errors: I obtain my raw data from S&P, Bloomberg and others, and I am grateful that I can do that, because I could never hand collect and input data on 40,000+ companies. They, in turn, obtain the data from computerized databases in different markets that collect public filings, and at every stage in this process, there is the possibility of errors. I do run some simple error checks to eliminate obvious mistakes, but I am sure that there are others that I miss. My defense is that, unless the mistake is on a very large scale, the impact it has on my group statistics is small, simply because of my sample size. In addition, there is also the possibility of accounting fraud in some companies, and there is little or nothing that can be done about them.
I am not trying to pass the buck or evade responsibility for any mistakes that persist but if you do find odd looking values for some variables that I report, especially for small samples, take them with a grain of salt.

Macro Data
I do not report much macroeconomic data for two reasons. The first is that I do not have a macro focus, and my interests in macro variables occur only in the context of corporate finance or valuation issues. The second is that there are great (and free) sources for macro economic data, ranging from the Federal Reserve (FRED) to the World Bank and I don’t see the point of replicating something that they already do well. The macro variables that I track on my site relate to the price of risk, a key input into valuation, in both equity and debt markets:
  1. US Equity Risk Premiums: The equity risk premium is the price of risk in equity markets. In my view, it is the most comprehensive measure (much more so than PE ratios or other pricing multiples) of how stocks are being priced, with a higher (lower) equity risk premium correlating with lower (higher) stock prices. The conventional approach to measuring this premium is looking at past returns on stocks and treasuries (or something close to riskfree) and measuring the difference in historical returns and I report the updated levels (through 2020) for historical premiums for stocks over treasuries in this dataset. I have argued that this approach is both backward looking and static, and have computed and reported forward-looking and dynamic equity risk premiums, based upon current stock price levels and expected future cash flows; you can find both the current level and past values in this dataset
  2. Country Risk Premiums: In a world where both investing and business is globalized, we need equity risk premiums for markets around the world, not only to value companies listed in those markets, but also to value companies that have operations in those countries. I will not delve into the details here, but I use the same approach that I have used for the last 30 years to estimate the additional risk premiums that I would charge for investing in other markets to get equity risk premiums for almost every country in the world in this dataset
  3. Bond Default Spreads: The bond default spread is the price of risk in corporate bond (lending) markets, and as with the equity risk premium, higher (lower) spreads go with lower (higher) corporate bond prices. In the same dataset where I compute historical equity risk premiums, I report historical returns on corporate bonds in two ratings classes (Moody’s Aaa and Baa ratings). I also report estimates of the default spreads based upon current yields on bonds in different ratings classes and the current riskfree rate.
I am not an interest rate prognosticator, but since today’s low rate environment seems to have made everyone a forecaster of interest rates, I do compute an intrinsic version of the US treasury rate and compare it to current levels in this dataset.

Micro Data
The focus of my data collection is understanding how companies are operating and how investors are pricing them. That said, you will not find individual company data on my site for two reasons. The first is that I bear a responsibility (ethical and legal) to my raw data providers to not undercut their businesses by giving away that data for free. The second is that you don’t need my site or any public site to get data on an individual company; if you want to get data on a company, there is no better way to do it than go to the source, which is the company’s annual or quarterly filings. To understand and use the data, here are some specifics that you may (or may not) find useful:
  1. Industry: Data can be consolidated by geography, industry or company size, and I use all three, to some extent or the other. My primary consolidation is by industry and I break down my sample of 46,579 firms into 94 industry groupings. To make this classification, I start with the industry classifications that are in my raw data, but create my own industry groups, again to prevent stepping on the toes of my data providers. I know that this description is opaque, but the best way to understand my industry groups is to go to this dataset, where I report the companies that I include in each industry. 
  2. Geography: There is one dataset where I look at companies broken down by country, and I report a number of different statistics for 136 countries. I would caution you to take this data with a grain of salt, since there are only a handful of listings in some country. I do report much more data for a broader geographical classification, where I classify firms into six broad geographical groupings: Note that while emerging markets is a very large and diverse group, I do report statistics for India and China, two of the bigger components, separately.
  3. Averaging: I hope it does not sound patronizing, but I want to explain how I compute group values (averages),  because it is not as obvious as it sounds. To illustrate why, consider the challenge of computing the PE ratio for companies in the software industry. You could compute the PE ratio for each company in the group and take a simple average, but that approach has two problems. First, it weights small firms as much as large firms, and outliers can cause the average to take on outlandish values. Second, it eliminates firms that have negative earnings (and thus have no PE ratios) from the sample, potentially creating biased samples. Using a weighted average PE ratio can counter the first problem and using a median can reduce the outlier effect, but neither approach can deal with the second problem (of sample bias). For most of my industry averaging, I use an aggregation approach, where I compute ratios using aggregated values; to compute the PE ratio for chemical companies, I add up the market capitalizations of all chemical companies and divide that number by the aggregate net income of all chemical companies (including money losers). This ensures that (a) all companies are counted, (b) the computed number is weighted since larger companies contribute more to the aggregate and (c) the risk of outliers is reduced, since it is less likely to occur in a large sample than for an individual firm.
  4. Current data: The focus of this data update is to report on how companies did in 2020, rather than to provide historical time series. Since I am updating the data in early January 2021, and the complete numbers for 2020 will not be available until March or April at the earliest, I will be using the trailing twelve month numbers for operating variables (like revenues and operating income) to compute ratios. For accounting numbers, that will effectively be the twelve months through September 30, 2020, that will be captured in the data. This practice of focusing on current data can cause the computed numbers to be volatile, but I do have the archived data going back in time (more than 20 years in the US, less for other parts of the world) at this link.
I confess that I have a primary constituency when I think of the variables that I would like to estimate, and that (selfishly) is me. Since my interests lie in corporate finance and valuation, the statistics that I compute are numbers that I will find useful when doing a corporate financial analysis or valuation of a company. Since I compute and report on dozens of variables, the best way of summarizing what you will find on my website in the following picture: 

With each variable, I report the industry averages by geography. With cost of capital, for instance, I report the cost of capital by industry for the US at this link, and datasets that can be downloaded by geography: Europe, Emerging Markets (China and India), Australia, NZ & Canada, Japan & Global).

COVID Effects
I would normally not belabor the fact that my data is focused on the most recent year, but 2020 was an unusual year. Starting in February and extending for most of the rest of the year, the economic shutdown created turmoil in both financial markets an the real economy. While markets, for the most part, have recovered strongly, large segments of the real economy have not. Consequently, there are a couple of considerations if you use this year’s numbers:
  1. COVID effects: To capture how COVID has played out in different sectors and geographies, I computed the changes in aggregate market capitalization during 2020 broken down by sub periods (1/1/20 - 2/14, 2/14- 3/20, 3/20 - 9/1 and 9/1 - 12/31/20), reflecting the ups and downs in the overall market. I also looked at the change in revenues and operating income over the last twelve months (October 2019 - September 2020) compared to revenues in the year prior (October 2018 - September 2019). Since the worst effects of the crises were in the second and third quarters of 2020, this comparison should provide insight into how much damage was wrought by the viral shutdown. Just as a preview of how consequential the year was for stock prices, take a look at the median percentage change in market capitalization in the table below:

    I will come write more extensively about the COVID effects in a future post, but you can see the data for US companies, broken down by industry, by clicking here, ands you can also download the data for other geographies here: Europe, Emerging Markets (China and India), Australia, NZ & Canada, Japan & Global.
  2. Operating metrics: My computations for operating margins and accounting returns (returns on equity and capital) reflect the COVID effect on earnings in 2020, and not surprisingly, you will see that their values are much lower for the most damaged sectors (restaurants, airlines) than in prior years. If you are comparing across companies in these sectors, that may not be an issue, but if you are valuing companies and want to find a target value for margins or accounting returns, you will be better served using my archived values for these variables from 2019.
  3. Pricing metrics: I compute and report a range of pricing multiples from PE ratios to Enterprise Value (EV) to sales ratios, but as with the operating metrics, COVID has left its imprint on the numbers this year. As market capitalizations have quickly retraced their losses, but operating variables have not, the multiples reflect that disconnect. They are either not meaningful in some sectors, which are reporting aggregated losses, or at elevated levels in others (where the collective earnings are down significantly, but market values are not). Again, while this should not be an issue with cross company comparisons, there are two cautionary notes. The first is that investors who come in with strong preconceptions of what comprises cheap or expensive in pricing ratio terms or historic norms will find that everything looks exorbitantly priced. The other is that you will lose large segments of your peer groups if you stick with multiples like PE ratios for comparisons, since so many companies will be money losing.
Access and Use of Data
I know that the numbers (in terms of companies and variables) makes this data update sound like daunting work, but I will make a confession. I enjoy the process, even including the messy details, and it prepares me for the year to come. In fact, the time that this aggregated data saves me through the year, when I value and analyze companies, represents a huge multiple of the time I spend putting it together. Put simply, if you are tempted to anoint me for sainthood for sharing my data, you are overreaching because I would do it anyway, and sharing it costs nothing, while potentially benefiting you. If you decide to use the data, here are some things that I hope you will consider:
  1. Data access: The data is accessible on my website, if you click on data. The data for 2020 is available under current data, and data from previous years under archived data. If you do click on current data, you will see the data classified into groupings based upon how I see the world (corporate governance, risk, investment returns, debt, dividends and pricing). You can see the data online for US companies by clicking on the links next to the data item, but I would strongly recommend that you download the excel spreadsheets that contain the data instead. Not only will this let you access data for other geographical regions, but each excel spreadsheet includes descriptions of the variables reported in that dataset and many include short YouTube videos explaining the data.
  2. Data Use: I know that those who download my data use it in many different contexts. If you use it at their jobs as corporate finance or equity analysts, I am glad to take some of that burden off you, and I hope that you find more enjoyable uses for the time you save. If you use my data to buttress an argument or debunk someone else’s, I wish you the best, as long as you don’t make it personal. If you use is it to back your case in legal settings, go ahead, but please do not involve me formally. I believe that courts are a graveyard for good valuation practices and while I do not begrudge you, I have no interest in playing that game.
  3. Data Questions: If you have a question about how a variable is computed, please check the website first, since the question has probably been answered already, but if you cannot find that answer, you know how to find me, and I will try to address your issues. As I mentioned earlier, the excel spreadsheets that contain the data include the descriptions of how I compute the variables.
  4. Suggestions and Complaints: Before you send off angry or impassioned emails to my team, about my data, you should know that this team has only one member and it is me. I am not a full time data service, and I cannot provide customized data solutions. If you find a mistake in a computation or a typo, please do let me know, and I will fix the error, perhaps not as quickly as you would like me to, but I will.
In sum, I hope you find the data that I provide useful. In the next month, I will add about a dozen posts on what I see in the data, but I will do so with the recognition that change is the only constant and that assuming that things always revert back to historic norms is not an investment philosophy.

YouTube Video

Data Updates for 2021
  1. Data Update 1: A (Data) Look Back at a Most Forgettable Year!

Wednesday, December 2, 2020

The Sharing Economy come home: The IPO of Airbnb!

On Monday, November 16, Airbnb filed it’s preliminary prospectus with the SEC, starting the clock on its long awaited initial public offering. On the same day, rising COVID cases caused more shut downs and restrictions around the world, creating a clear disconnect. Why would a company that derives its value from short term rentals by people who travel want to go public, when a out-of-control virus is causing its business to shut down? In this post, I will argue that there are good reasons for Airbnb's IPO timing, and make my first attempt at valuing this latest entrant into public markets.

Setting the Table

As with any valuation, the first step in valuing Airbnb is trying to understand its history and its business model, including how it has navigated the economic consequences of the COVID. In this section, I will start with a  brief history of the company, move on to reviewing its financials leading into 2020, and then look at how it has performed in 2020. I will end the section by looking at information disclosed in the recent prospectus filing that provides insights into the company’s journey to its initial public offering.

Timeline of Airbnb

Airbnb's roots go back to 2007, when during an industrial design conference in San Francisco, Brian Chesky and Joe Gebbia realized that there were opportunities for homeowners to rent their homes to visitors, and created a company called AirBed & Breakfast. Joined in 2008, by Nathan Blecharczyk, a Harvard graduate and technical architect, AirbedandBreakfast.com was born and later renamed Airbnb. In subsequent years, the company grew, with multiple rounds of funding from venture capital. Along the way, investors in the company rapidly escalated their pricing of the company from $1 billion in 2011 to $10 billion in 2014 to more than $30 billion in 2016. The time line below captures some (but not all) of the highlights in Airbnb’s history:

While the company has been able to hit new milestones of growth each year, there are two challenges that it has faced along the way, that need to be incorporated into any valuation you attach to the company today. 
  1. Legal Challenges: The company has faced multiple challenges from cities that feel that its business model violates local zoning laws and regulations, and evades taxes. While you can attribute some of this pushback to hotel company lobbying and the inertia of the status quo, there is no doubt that Airbnb, like Uber, pushes regulatory and legal limits, taking action first and asking for permission later. While Airbnb has found a way to co-exist with laws in different cities, the restrictions they face vary widely across the world, with some locations (like New York) imposing much more stringent rules than others.
  2. Acquisitions: As the number of hosts and guests on Airbnb have climbed over the years, the company has invested in building a more robust platform for its rentals. While some of that money has been spent on internal improvements, much of it has been spent acquiring more than two dozen companies, most of them small, technology businesses. 

Business Model

Airbnb's primary business model connects hosts who own houses and apartments with guests who want to rent them for short term stays, while providing a secure and easy-to-use platform for search, reservations, communications and payments. That said, though, it is worth peeking under the hood to see how this business model plays out as revenues and earnings. In the picture below, I look at the Airbnb business model, both in its original form (which still holds for hosts renting their own houses or apartments) and professional hosts (who own multiple units or even operate small hotels), a model it introduced recently and is still transitioning into:

In both versions of the model, Airbnb's revenues come from fees collected on rentals, with both the host and the guest paying in the individual host version, but only the host paying in the professional host version. In 2016, Airbnb extended the model, allowing hosts to offer experiences to their guests, for a fee, with Airbnb keeping 20% of the payment. While the concept was heavily promoted, it has been slow to take off, with only $10 million in sales in 2017, but Airbnb has not given up, hiring Catherine Powell, a Disney theme park executive in 2020, to revamp the business.

The Financials, leading into 2020

The proof of a business is in the numbers, and Airbnb, in addition to posting impressive numbers on hosts, listings and guest nights, has also seen financial results from that growth. In the graph below, I look at gross bookings (the total amount spent by guests on their rentals), revenues to Airbnb from these booking (in dollar values and as a percent of gross bookings) and operating profitability, in dollar and percentage terms:

Source: Airbnb Prospectus (November 16, 2020)

Taking a closer look at the numbers, here are some preliminary features that stand out:

  1. Growth is high, but the rate is declining: It may seem churlish too take issue with a company that has grown its revenues more than five fold over a five-year period, but as the company's base gets bigger, its growth rate, not surprisingly, is also declining. By the start of 2020, Airbnb had already become one of the largest players in its market of vacation and travel rentals, a sign of success, but also a crimp on future growth.
  2. Airbnb's revenue share has stayed stable: As gross bookings have increased, Airbnb's share of these bookings has remained stable, ranging from 12-13% of overall revenues. Note that the shift to the new business model for professional hosts (where Airbnb keeps 14% of the transaction revenue) is relatively recent, and it will take some time for that change to play out in the numbers. In addition, growth in the experiences business will also push this metric upwards, since Airbnb keeps a 20% share of those revenues.
  3. The company is edging towards profitability: To Airbnb's credit, it is closer to profitability than many of its high profile sharing-economy predecessors (such as Uber and Lyft) and the fact that it was able to report positive operating profits, albeit fleetingly in 2018, without playing the adjusted earnings game (where companies add back stock based compensation and other items to their bottom line to claim fictional profitability) puts them ahead of the pack.

In summary, coming into 2020, Airbnb was delivering a combination of growth driven by disruption and a pathway to profitability that made them a prime candidate for a public offering.

The COVID effect

I don’t think anyone expected 2020 to be the year that it was, and even in hindsight, it has been full of unwelcome surprises for individuals and businesses. While there were news stories about the virus for the first few weeks of 2020, they centered either on China or passengers on cruise ships that had been exposed to the virus. Once the virus made its presence felt elsewhere, in February and March, countries responded with partial and full economic shut downs that hurt all businesses. The travel business was particularly exposed, as people curtailed flying and traveling to distant destinations, and Airbnb was hurt badly in 2020, as can be seen in the graphs below:

Source: Airbnb Prospectus

The graph to the left looks at the effect of COVID on gross bookings and cancellations (in millions of nights), with the net bookings representing the difference. Note that cancellations exceeded bookings in March and April, at the height of the global shutdown, but have come back surprisingly well in the months after. In the graph to the right, you can see the effects on the financials, in a comparison of first nine months of 2019 to the first nine months of 2020, with gross bookings dropping 39% and operating losses almost tripling over the period.

The Prospectus Revelations

If Airbnb had broached the idea of a public offering in March and April, where the numbers were not just dire but potential catastrophic, it is likely that they would have been laughed out of the market. There are two factors that may have led Airbnb to reassess their prospects and file for a public offering now. 

  • It’s relative:  The first is that it was not just Airbnb that felt the pain from the economic shut down. As we will see in the next section, the hotel and travel booking businesses were damaged even more than Airbnb, because of their large asset bases and debt levels. In relative terms, Airbnb might emerge stronger from the COVID crisis, than it was, going into it. 
  • Rebound:The second is that business returned stronger than most had anticipated in 2020, with third quarter numbers coming in above expectations, and markets rebounded even more strongly with stocks recouping all of their early losses. When Airbnb filed its prospectus with the SEC on November 16, I don't think that there were many who were surprised at the timing. 
While Airbnb's general financial performance has been mostly public for the last few years, the prospectus provides more detail as well as guidance on governance and the terms of the offering.

  1. Pathway to Profitability: Digging through Airbnb's financials over the last five years, and breaking down the expenses, here is what we see:
    Source: Airbnb Prospectus (Nov 16)

    Note that, at least through the most recent years, there is little evidence of economies of scale, since the direct operating costs have stayed at between 40-42% of revenues and the other costs have, for the most part, been rising. In 2019, the company also reported a substantial restructuring charge that presumably was one-time and extraordinary, but that item bears watching, since it has become a convenient vehicle for companies to hide ongoing operating expenses.
  2. Use of Proceeds: While the details are still being worked out, it is rumored that Airbnb is looking to raise about $3 billion in proceeds on the offering date, and that while some of the proceeds will be used to retire existing debt, most of it will be held by the company to cover future investment needs.
  3. Share classes: In keeping with the practices of tech companies that have gone public in recent years, Airbnb has shares with different voting rights: class A shares with one voting right per share, class B shares with 20 voting rights per share, and class C & class H shares with no voting rights per share. Not surprisingly, the class B shares will be held by founders and other insiders, allowing them control of the company, even if they own well below 50% of all shares outstanding. It is the class A shares that will be available to shareholders who buy on the offering day, and will remain the most liquid of the share classes thereafter. It is not clear why there are class C shares, other than to give founders, who already have control, even more control in future years, if they feel threatened. 
  4. An ESG twist: It should come as no surprise that in an age where companies are valued on their "goodness", Airbnb is signaling it's intent to be socially responsible, with Brian Chesky making explicit the corporate values for the company, including "having an infinite time horizon" and "serving all of our customers". In addition, the proceeds from the non-voting class H shares will be set aside is an endowment to serve Airbnb hosts, though it is not clear whether the primary intent is to give hosts a stake in the company’s success, or to help them out during periods of need. I remain skeptical about ESG, but will hold off on passing judgment on whether this is just a public relations ploy.

The Hospitality Business

To value Airbnb, we need to start with an assessment of the market that it is targeting and then understand the competition that the company faces. In this section, I will start with a look at the market size and then examine the hotel and booking companies that comprise its competition.

The Market (TAM)

There are two ways in which I can describe Airbnb's total addressable market. One is to look the hotel business globally, which generated in excess of $600 billion in revenues in 2019, with the following characteristics:

The hotel business is large, but its growth has slowed over the last five years, and it remains concentrated, with the top five hotel chains accounting for a larger and larger portion of the overall market every year since 2014. While the US remains the largest market, geographically, Asia is the center of growth, with China leading the way. 

There are some who believe that the conventional hotel market understates the potential market for a sharing economy company like Airbnb, since it can increase the supply of rental units without major new investment, and perhaps induce new entrants into the business. After all, the ride sharing companies have doubled or even tripled the size of the car service business in the last decade, using this template. It should come as no surprise that Airbnb believes that its total addressable market is much bigger than the hotel business. In 2011, in its infancy as a company, Airbnb estimated that its total addressable market at the 1.9 billion trips that were booked in 2010, and its share of that market at 10.6 million trips, as can be seen in this graph from the company in an early VC pitch:

In its prospectus, driven partially by its past success, and partly by the need to justify a large market cap, Airbnb has expanded its estimate of market potential to $3.4 trillion, as evidenced in this excerpt from the prospectus:

We have a substantial market opportunity in the growing travel market and experience economy. We estimate our serviceable addressable market (“SAM”) today to be $1.5 trillion, including $1.2 trillion for short-term stays and $239 billion for experiences. We estimate our total addressable market (“TAM”) to be $3.4 trillion, including $1.8 trillion for short-term stays, $210 billion for long-term stays, and $1.4 trillion for experiences.

In my view, Airbnb's targetable market falls somewhere in the middle, clearly higher than just the hotel business of $600 billion, but below Airbnb's upper end estimate of $2 trillion for this business. That is because there are parts of the world, where the Airbnb model will be less successful than it has been in the United States, either because of consumer behavior or regulatory restrictions. Given how much trouble Airbnb has had in the experiences business, I think Airbnb’s estimate of $1.4 trillion for that business is more fictional than even aspirational.

The Players

To make a judgment on Airbnb's future, we need to understand two peer groups. The first is the hotel business, since it is the business that is most at risk of being disrupted by the Airbnb model. The other is the online travel booking business, where there are large players like Expedia and Booking.com which have, at least for segments of their business, made their money by acting, like Airbnb, as intermediaries or brokers connecting guests with hospitality offerers. 

1. The Hotel Business

The hotel business is both large and diverse, composed of hotels that range the spectrum from luxury to budget. To get a measure of the business, I have listed the 25 largest publicly traded hotel companies (in market capitalization) in the world below, with Marriott topping the list, with revenues of about $21 billion in 2019:

The conventional hotel business is an asset-heavy business, with a significant real estate component to its value, and while some hotel companies have stayed with that model, others have moved on to a more capital-light model, where the real estate is owned by a separate entity (both in terms of ownership and control) and the hotel companies operates primarily as an operator. Marriot, for instance, follows the latter model, with the Marriott REIT owning the real estate, and Marriott collecting operating revenues from running the hotels. In addition, the global economic shutdown precipitated by COVID has wreaked havoc on hotel company revenues and profits, with revenues down about a third (in annualized terms) in the last 12 months, relative to 2019. 

2. The Travel Booking Business

While the hotel business is the one being disrupted the most by Airbnb, it is the travel booking business that is closest to the Airbnb business model. That business is also dominated by large players, with Expedia and Booking.com being the biggest. In the table below, I look at the revenues and operating income at these companies in 2019 and the last 12 months:

While Expedia and Booking.com both generate revenues from operating as middlemen between travelers and hospitality providers, just like Airbnb does, there are two key differences:

  1. Other businesses: Both Expedia and Booking.com also operate in other businesses that drive revenues and margins. First, they generate revenues by buying blocks of hotel rooms at a discount from hotels, and then reselling them at a higher price, in what they call the "merchant" business. Second, they also derive revenues from online advertising by hotels and travel providers. Expedia gets a much larger share (47%) of its revenues from the merchant business than Booking.com (25%), which may explain its lower margins.
  2. Status Quo vs Disruption: Both Expedia and Booking.com were designed to make money off the status quo in the hospitality business, and derived all of their revenues until recently from existing hotels and airlines. In reaction to Airbnb's success, both companies have tried to expand into the home and apartment rental businesses, but these listings still represent a small fraction of overall revenues.

The Valuation

To value Airbnb, I will follow a familiar script, at least for me. I will start by telling my Airbnb story, based upon the market it is in and its competition, current and potential, and then use this story as a launching pad for my valuation of the company. I will complete the valuation by looking at its sensitivity to key value drivers and bring in uncertainty into the equation.

Story and Numbers

I believe that Airbnb will continue to grow, while finding a pathway to profitability. Airbnb's growth in gross bookings will come not only from disrupting and taking market share from the hotel business, bad news for conventional hotel companies and travel providers who serves them, but also from continued expansion of non-conventional hospitality providers (home and apartment owners). As it grows, Airbnb's share of those gross bookings is likely to plateau at close to current levels, but its operating margins will continue to improve towards travel booking industry levels, as product development, marketing and G&A costs decrease, not in dollar terms, but as a percent of revenues. While Airbnb is enthusiastic about the experiences business, it is likely to remain a tangential business, contributing only marginally to revenues and profitability. Since Airbnb has a light debt load and is closer to profitability than most of the sharing-economy companies that have gone public in recent years, I will assume that their risk will approach that of the travel business, and that the risk of failure is low. In terms of inputs, this story translates into the following:

  1. The COVID After-effects: The comeback from COVID will be slow in 2021, with Airbnb seeing revenues return, albeit to less than 2019 levels, while continuing to lose money (with operating margins of -10%).
  2. Growth in Gross Bookings: In 2019, Airbnb’s gross bookings grew 29.25%, lower than the growth rate in prior years, reflecting its increasing scale. After its recovery from COVID in 2021, gross bookings will continue to grow at a compounded annual growth rate of 25% between 2022 and 2025, and growth will drop down over the following years. In 2031, I expect Airbnb’s gross bookings to climb above $150 billion, about 60% higher than Booking.com’s gross bookings in 2019 and 40% higher than Expedia's gross bookings in that year.
  3. Revenues as percent of Bookings: Over the next decade, revenues as a percent of gross bookings will increase only mildly from current levels (12%-13) to 14%, sustained by the new host model for professional hosts and the supplemental benefits from Experiences business. 
  4. Target Operating Margin: This will be a key component of Airbnb’s story, and I will assume that the operating margins will improve over the next decade to 25%, lower than Booking.com’s 2019 operating margin of 35.48%, but higher than the margins for Expedia or the hotel business.
  5. Sales to Invested Capital: While Airbnb has a capital-light model, it’s platform requires new investments in either product development and acquisitions. In 2020, Airbnb's sales to invested capital was 1.82, but the invested capital was negative in the prior year, making it unreliable, and  Booking.com had a sales to invested capital of 1.91 in 2019. I assume that Airbnb will be able to generate $2.00 of revenues per dollar of invested capital in the next decade.
  6. Cost of Capital & Failure Risk: For the cost of capital, I will assume that Airbnb’s cost of capital will be 6.50%, close to the cost of capital of hotel companies, to start the valuation, but over time, it will rise to 7.23%, reflecting an expected increase in the treasury bond rate from current levels to 2% in 2031. While Airbnb has flirted with profitability and has little debt, it still remains a young, money losing company, and I will assume a 10% chance of failure.
  7. Share Count: Getting the share count for a company on the verge of going public is always tricky, as preferred shares get converted to common shares, options and warrants are outstanding and additional shares are issued on the offering date. For Airbnb, there is the added complication of a 2 for 1 stock split which occurred only a few weeks prior to the offering. For the moment, therefore, the share count is still a number that is in progress, but the next update on the prospectus should provide more clarity. (Right after I posted this, Airbnb updated their prospectus to reflect a more accurate share count. The value per share should now be closer to the right value)
With these inputs, my valuation of Airbnb is captured in the picture below:
Download spreadsheet

The value that I derive for Airbnb, with my story and inputs, is about $36 billion, with $3 billion in expected proceeds from the IPO augmenting the value and netting out the value of options outstanding. The per share value based upon the latest share count is about $54/share.

Value Drivers and Dealing with Uncertainty
There are two key drivers of Airbnb’s value. The first is the growth rate in gross bookings and the resulting expected dollar value in 2031, with value increasing with expected gross bookings. The other is the target operating margin, in 2031, with higher margins translating into higher value. In the table below, I list out the value of equity in Airbnb for variants of gross booking growth and operating margins:

Rather than view this table as anything goes, I would use it to make break even assessments, given what Airbnb trades at. For instance, if the market capitalization of Airbnb today is $60 billion, you would need it to deliver gross billings of $200 billion in 2031, with an operating margin of close to 35%. There is ample room for disagreement on Airbnb’s value, since there are plausible combinations of revenue growth and margins that deliver very different equity values. To more explicitly capture the effect of this uncertainty, I replace my point estimates of gross bookings growth, target margin and cost of capital with distributions, run simulations and capture the consequences in a value distribution:

Download spreadsheet

In short, there is nothing sacrosanct about my value judgment for Airbnb and if you disagree with me, even strongly, I understand your point of view. In fact, it is these differences that allow for buyers and sellers to co-exist in the market.

Previewing the IPO

While we can debate what Airbnb’s value truly is, an IPO is a pricing game. Put simply, rather than operate under the delusion that it is value that drive decisions, it is healthier to recognize that bankers price IPOs, not value them, for the offering, that much of the trading on the offering day and the weeks thereafter is driven by traders, trying to gauge mood and momentum. In this section, I will look at the contours of this pricing game for Airbnb, and implications for investors who may be more concerned about value.

An IPO is a Pricing Game
To price an IPO, traders look at two places for guidance. The first is the VC pricing of the company in the rounds leading into the public offering. The second is the market pricing of publicly traded companies in the peer groups, companies that investors will compare the company to, in setting prices. 
1. Venture Capital Pricing:  As mentioned earlier, Airbnb has raised more than two dozen rounds of venture capital over its lifetime, and has been reprised multiple times. In the graph below, I look at the trend lines in Airbnb’s pricing, based upon VC assessments:

The pricing attached to Airbnb climbed dramatically in the first few years, reaching $31 billion in 2016, but then settled into a period of stagnation. In April 2020, at the height of the COVID crisis, the company raised more capital from VC investors, who reduced its pricing to $26 billion. 
2. Peer Group Pricing: To price Airbnb, relative to publicly traded companies, I have computed pricing multiples for hotel and booking companies in the table below:

Applying any of these multiples to Airbnb’s current operating metrics (revenues, EBITDA or net income) will yield valuations that are too low, because the company is still growing and finessing its business model. To get a more realistic pricing, I apply the multiples to Airbnb’s expected values for these metrics in 2025, and then discounting the future values back to today.

In summary, these numbers yield a much higher pricing for Airbnb’s equity, if it is priced similarly to Booking.com, and a much lower pricing, if Expedia is used as the comparable.

Investment Judgments

In the coming weeks, Airbnb will update its prospectus to reflect more details on its IPO, and bankers will set an offering price per share, based primarily on the feedback that they get from potential investors to different  I may be jumping the gun here, but given how well the market has treated capital-light and technology companies this year, I would not be surprised if the market attaches a pricing of all above my estimated value for Airbnb's equity. As a market participant, you have three ways of participating in the Airbnb sweepstakes:

  1. Get in on the offering: Given the propensity of bankers to under price offerings, and given how the market has been behaving in the last few months, you can try to get a share of the shares at the offering price. This game gets easier to play if you are on the preferred client list at Morgan Stanley or Goldman Sachs, and are allowed access to the offering, but much more difficult, if you are not. Even if you do get in on the offering, there is no guaranteed payoff, because bankers do sometimes over price IPOs, as they did a few times in 2019.
  2. Play the trading game: In the trading game, value is a minor factor, at best, in whether you succeed. Your success will depend upon gauging the market mood and momentum on Airbnb and getting ahead of it and paying attention to what I call incremental information, small news stories that may have little or even no effect on value but can be consequential for momentum. 
  3. Be an investor: If you are truly a value investor, you should not be ruling out Airbnb just because it is money-losing or a young company facing multiple uncertainties. Instead, you should value Airbnb yourself, and draw up decision rules well ahead of the offering. Since I have my estimated  value for Airbnb at $36 billion, I will go first, using the valuation results, by decile, that come from my simulation: 
  • If equity is priced at <$28 billion (20% percentile): A bargain
  • If equity is priced between $28 & $33 (40th percentile) billion: A solid buy
  • If equity is priced between $33 (40th percentile) & $38 billion (60thpercentile): A fair value
  • If equity is priced between $38 (60th percentile) & $44 billion (80thpercentile): Too richly priced
  • If equity is priced > $44 billion: Over valued

As I have argued in prior posts, it is not my preference to sell short on stocks like Airbnb, even if I believe the they are significantly over priced, given how much more powerful momentum is than any fundamentals in driving stock prices.