Airbnb finds shelter, but at a high price
For all its economic wrath, the coronavirus pandemic has been kind to many technology companies. Share prices of behemoths like Facebook, Amazon, Google and Netflix are all up on the year. Smaller tech companies like Zoom – built around a future of “remote work” – have skyrocketed.
Airbnb is not one of the lucky tech companies. In part, that’s because Airbnb is not really a tech company, even if it’s a product of Silicon Valley. Airbnb is more of a company that uses technology to offer products and services (overnight lodging, tourism activities, etc.) that exist in the real, physical world. In that all-important sense, Airbnb is more similar to, say, Hilton or Marriot than it is to, say, Zoom or Facebook.
Of course, Airbnb is not alone among “tech companies” that sell products and services that exist in the physical world – such as Amazon. The coronavirus pandemic has been kind to Amazon’s delivery business, because (a) people still need essential goods, like groceries and household supplies, and (b) people don’t want to leave the safety of their homes. That latter trend is bad news for Airbnb, whose business is predicated on the condition that people not only want to leave their homes, but want to travel hundreds or thousands of miles to new locations. Covid-19 has decimated demand for travel in the short term and imperiled it in the medium to long term, thus threatening Airbnb’s entire business.
To the surprise of no one, Airbnb is now projecting its 2020 revenue to fall by at least 50%. As a still-private company, Airbnb has turned to – where else? – the private markets for emergency financing, announcing on April 6th that it raised $1 billion from two private equity firms, with a hefty 10% annual interest rate. Just one week later, Airbnb raised another $1 billion in the form of a pricey syndicated loan (reportedly snapped up by large investment firms like BlackRock, Fidelity Investments and T. Rowe Price).
It’s all a sudden and dramatic reversal in fortune for Airbnb, especially because 2020 was supposed to be a banner year for the San Fransisco-based startup. Just a few months ago, the company was plotting its public market debut at a reported $47B valuation. This was supposed to be the year Airbnb’s founders and early employees became billionaires and millionaires. Instead, 2020 is the year of the coronavirus pandemic, and Airbnb’s plans for an IPO are now on hold. To add insult to injury, Airbnb’s latest round of funding values the company at just $18B.
So, how did it all go wrong for Airbnb?
On the one hand, Airbnb can justifiably chalk up its situation to plain old bad luck. If Covid-19 had struck in 2021, sure, it would have crushed Airbnb’s bottom-line all the same. But by then, its investors, founders and early employees would have cashed out much of their equity in an IPO – instead, they’re stuck holding a bunch of private stock worth less than half it was three months ago. Plus, the perks of being a publicly financed company would’ve cushioned the financial blow. Airbnb wouldn’t need to take out $1B loans with 10% coupons if they were sitting on billions and billions of dollars of recently raised shareholder capital. They’d probably just suspend dividend payments, sell some more equity, and ride out the storm.
On the other hand, Airbnb has only itself to blame, because there are steps Airbnb could’ve taken to soften the blow of Covid-19. That’s right: Airbnb is, before our very eyes, transmogrifying into yet another cautionary tale for startups and venture capitalists alike.
In short, Airbnb is the new WeWork.
Let’s qualify that statement: I’m not saying the two businesses are even remotely comparable in terms of their business model or corporate governance. Even so, there are obvious similarities between the two that warrant our attention, and which lay bare the pitfalls of the prevailing VC funding model.
For one: Both Companies Ignored Profitability for Growth
WeWork was and is the king of loss-making. The co-working startup not only never made money – it never even tried to make money. Worse yet, it never even tried to appear as if it were trying to make money. Ahead of its doomed IPO, the company admitted in its S-1 filing, “We believe that our net loss may increase as a percentage of revenue in the near term and will continue to grow on an absolute basis.” As Business Insider described it, “WeWork's IPO thus looks less like a way to scale up the business by accessing the public markets and more like a financial lifeline without which the company would be in considerable difficulty.”
Airbnb, like WeWork, is a loss-making company, but unlike WeWork, Airbnb was once profitable: the company reportedly recorded a net loss of $322 million in the nine months through September 2019, but made $200 million in profit that same period one year earlier. In fact, the company first achieved profitability as early as H2 2016.
So what the hell happened in 2019?
A few things: Airbnb increased its marketing budget by 58%. It purchased another company for $400 million in cash and stock. It sank money into its Experiences product. In effect, Airbnb deliberately transformed itself into a loss-making company to get more customers and contractors (“hosts”) onto its platform, diversify its revenue, and build hype for its IPO.
Under normal circumstances, sacrificing profit for growth is a perfectly acceptable strategy in Silicon Valley. In the last five years, fewer than one in four technology companies were profitable at the time of their public market debuts. As long as your startup isn’t like WeWork and has a somewhat realistic path to profitability, then losing money for a few years isn’t a big deal.
Think about it this way: the loss-making, VC-backed startup is kind of like the consumer who loads up on credit card debt ahead of an end-of-year bonus. Sure, they’re pretty heavily leveraged right now, and maybe they spent some of their money on stupid or unnecessary things, but once that sweet bonus check clears (once the IPO happens), the consumer (Airbnb) can easily pay off its high-interest debt (the VCs finally cash out) and everyone goes home happy. (We’ll leave the growth-starved retail investor for another day).
But these are not normal circumstances. Silicon Valley’s sustain-losses-to-achieve-scale mantra rests on the assumption that a loss-making company’s business model is not imperiled by exogenous, once-in-a-century events like Covid-19. That’s typically a safe assumption, but every once in a while, disasters exit the realm of the hypothetical and actually do strike – it’s why companies spend millions of dollars on crisis preparation. It’s why companies can and should be prepared to weather disasters. That holds especially true for large companies like Airbnb that can sock away cash if they so choose. It’s doubly true for undiversified companies like Airbnb whose revenue is tied to a single industry.
By all appearances, Airbnb was unprepared for a huge disaster like novel coronavirus shutting down the global economy – and like, fair enough, most of us were unprepared for that doozy. And sure, Airbnb has $3B in cash on hand, which sounds like a lot of money. But actually, it’s not that much money when your sole source of revenue dries up and you have thousands of people on your payroll, thousands of more contractors (“hosts) breathing down your neck, and a bunch of panicked investors. Evidently, $3B isn’t enough money to avoid emergency financing with punishing interest rates and debt-to-equity instruments.
WeWork woke up Silicon Valley to the dangers of unprofitability and destroyed the myth that a startup can become ‘too big to fail’. Airbnb is a much sounder company than WeWork, which makes it an even more dire version of that warning.
Which brings us to our second WeWork-Airbnb parallel: Using VC financing to ‘delay the inevitable.’
WeWork, by raising a staggering $19.5B in funding over 16 rounds, was, to use a common phrase, delaying the inevitable: a public reckoning over all that was wrong with its business.
Venture capitalists, led by SoftBank’s $100B fund (which alone invested $9B), were WeWork’s ultimate enablers. Bottomless VC capital allowed the office-sharing startup to binge on acquisitions – 21 companies in total – and quixotic ventures like WeGrow, a venture to ‘disrupt’ primary education. These side businesses were supposed to ameliorate (or distract from) the cash hemorrhaging taking place in WeWork’s core business, which consists of entering into long-term office space leases and then selling short-term leases.
As a private company, WeWork was able to hide all these pesky details about cash flow and revenue. It was also able to conceal its shoddy corporate governance and borderline financial fraud, like the fact its CEO was leasing his own properties to WeWork at a handsome profit, or the provision that the CEO’s wife would determine his successor should he ever die or become disabled. Venture capital effectively allowed WeWork to evade the base level of scrutiny that comes with being a publicly traded company, all the while its founders cashed out much of their private stock before the house of cards came crashing down and thousands of employees were laid off.
Airbnb is clearly no WeWork, but that doesn’t mean Airbnb hasn’t relied on venture capital to prop up its company valuation and delay the inevitable (its IPO).
Indeed, Airbnb was reportedly an IPO candidate as early as 2017. Instead, that year Airbnb raised another $1 billion of private capital in a Series F funding round, despite already being the second most valuable private company behind Uber, with an eye-popping $30B valuation. Cash-rich investors and wide-eyed executives saw Airbnb still had considerable runway for pre-IPO growth. Not only was the company doing well, but broader economic conditions were fantastic: the so-called “Trump Trade” was kicking into high gear; consumer confidence was high; the woes of 2008 and 2009 were far in the rearview mirror. Why go public for $30B when we can go public for $40B or $50B in a few years? investors and executives mused. Fast forward to 2020: the still-private Airbnb’s current valuation is $18B, which is a whopping $12B less than its $30B valuation of three years ago (a lifetime in Silicon Valley).
Again, much of Airbnb’s financial dilemma is down to plain old bad luck, a fact that I don’t want to understate. But even so, Airbnb was a bit greedy in how it ran its treasury, and how it kept delaying the sensible next step for financing (an IPO).
Whether Airbnb can weather the coronavirus, only time will tell, but one thing’s certain: Airbnb has already joined WeWork in the pantheon of “what not to do” startups.
A lush Airbnb ad, from a simpler time…
In other deal news, two quick stories:
Coronavirus Poses M&A Headwinds:
“The House’s antitrust chairman is pushing for a moratorium on mergers until the pandemic ends, warning that a "buying spree" by well-heeled companies and investors could wipe out competition from smaller players amid the cratering economy” (Politico).
It’s unlikely such a regulation will come into law, but it’s an important reminder that no sector of the economy is immune from Covid-19 or the virus-inspired restructuring of the economy. Even without government intervention, M&A activity is already down 33% worldwide year-over-year.
Oil Hits Private Equity:
“Blackstone Group Inc.’s first-quarter results were hit hard by the coronavirus-led market selloff. The [private equity] firm posted a net loss of $1.07 billion, or $1.58 a share, for the first quarter.” The firm’s poor quarter was “primarily driven by the effect of plunging oil prices on its energy holdings” (WSJ).
Blackstone is hardly the only PE firm reeling from the collapse in demand for oil. PE firms have poured money into the oil & gas sector, raising nearly $80 billion in funds focused on shale production in the last five years alone.
John Hyatt, the author of What’s the Deal, is a writer and public relations professional. You may connect with him on LinkedIn or follow him on Twitter.