The move from pandemic to “casedemic” provides a once in a decade opportunity to own ‘lockdown’ shares – in this series we explore the public equity opportunities with significant upside. Hostelworld, the leading online travel agent within the hostel and backpacking niche, we believe has a 200% return potential on a 2 year view.
Setting the scene for this series – will “Lockdowns” persist and when does the world re-open?
The severe COVID pandemic in the UK and Europe is potentially over. We are now in a highly politicised and very sentiment driven period that some are describing as a ‘casedemic’ – with over emphasis on cases while the initial challenges we were trying to avoid of hospitalisation and deaths have significantly reduced. This happened 11 years ago with H1N1 (swine flu) where a second wave of rising cases did not impact the population (requiring a GP visit). In due course, the panic subsided.
If this dynamic continues for another 2 months we suspect the government policies and sustainability of lockdown policies across Europe will come under further questioning resulting in a significant reversal in the outlook for ‘lockdown’ shares. In this series, we will explore deep value UK and European situations that will benefit in such a scenario, but first some background.
2009 versus 2020
There is no shortage of analysis on COVID – is there anything else we discuss? Pandemics are brutal, viruses spread quickly resulting in hospitalisations and different age, demographic and health groups respond differently and the impact on the vulnerable in the initial wave is tragic. However the pandemic does pass and we have seen this before. People have short memories and we should think back to 2009 and swine flu. H1N1 (swine flu) started in Mexico before spreading to the UK in April 2009. In September and October that year there was a ‘second wave’ which then declined significantly in November 2009. By the following summer the WHO had declared the end of the pandemic, however cases had collapsed many months prior.
How does 2020 compare?
The major relief is the tragic days of March/April/May, with the significant increase in hospitalisations and deaths, are not present despite the current rise in cases. Looking at UK data, but this is replicated across Europe, there has been an increase in cases since July and August as testing capacity has ramped and population movement has increased. No surprise we are finding more cases and evidence of COVID in the population. However, the crippling pandemic is fading if one is willing to look through the headlines on cases. We are now in a highly politicized, judgemental and ‘case watching’ phase and have forgotten the initial policy purpose was about protecting lives and the hospital system. October will be very telling if 2 months of increases is not accompanied by hospitalisation or mortality.
If the UK and Europe has another 1 to 2 months of rising cases without a significant increase in hospital admissions or deaths, the ‘lockdown’ policies are going to come under significant scrutiny. What are we trying to solve for? Zero cases? This will never be the case and is a ridiculous concept. By 2016, H1N1 was just described as regular seasonal flu. Wait for the vaccine? We fail to see the logic. The H1N1 vaccine in the US for the last 3 years has only been 40% effective. The human immune system is more advanced than any single vaccine.
We believe Mitchells & Butlers can trade at book value again
Why do we see this decline in the impact of the viruses? There are a collection of factors including excess deaths normalising (the dry powder theory), t-cells, cross immunity (i.e immunity to other corona viruses, like the common cold). As a result, we see these patterns in pandemics of a steep rise in deaths and hospitalisation followed by a steep decline as the vulnerable in the population are impacted. This is known as the Gompertz Curve (we will let you google such). We hope we are right and that the tragic days of April and May in Europe do not repeat and that previous pandemic patterns hold.
What’s the conclusion?
Lockdown policies are simply not sustainable or justified if the severity of COVID does not increase in Q4 2020. If we are wrong, the implied valuation on the companies we will focus on more than compensates for a delay. On a 12 month view we have a once in a decade opportunity to buy beaten down travel, consumer, hospitality type names.
What shares should we consider? There are so many opportunities the Collective will bring you a multi-part series. We have considered names that have significant upside to longer term fair value and possess quality features like industry leader, good returns on equity (prior to lockdown), company director buying, cash flow and balance sheet strength to ride out this period of uncertainty and possibly allocate capital via acquisitions, investment, buybacks, dividends if appropriate. Some obvious sectors are travel, hospitality and leisure but there is no shortage of opportunities across global markets.
Enough background for now….let us get onto the investment ideas.
Post Lockdown the Millennials and the Zoomers are going to get out and explore – Hostelworld (HSW.L) has 200% upside on a 2 year view.
Post lockdown there will be major demand for the young budget conscious traveller to explore, socialize and interact. By the new year, global youth will have been starved of ‘experiences’ for close to 12 months with significant disruption to their lives and often trapped at home. Pent up demand for a budget hostel and backpacking is significant once lockdowns dissipate.
An industry leader and online travel agency for this group of travellers is Hostelworld. It was founded in 1999 by Irish entrepreneur Ray Nolan and went through PE ownership and onto a Dublin/London listing. It is a platform like Booking.com and Expedia, however it specialises in this hostel niche and caters for a global customer base with an extensive inventory of hostels for booking.
This month, September 2020, Hostelworld released an interesting survey based on a survey of over 3,000 backpackers. The main points a) 52% are ready to travel within 6 months b) 55% expect international travel to be available in 2021 c) 56% of Americans were planning to travel domestically. Given restrictions domestic and short haul has represented 2/3rd of its booking for Americans, British, German and French nationals. However, they need flexibility given the uncertainty and Hostelworld has accommodated with non-refundable but flexible rate.
How has the company fared during lockdown?
- The impact of COVID has been disruptive as you would expect. H1 2020 revenue was 12mn euro versus 39mn euro in H1 2019 meaning a 19mn euro loss.
- The company has taken significant steps to reduce costs and conserve cash since mid-March and has cut operational expenditure by 20% between Q1 2020 and Q2 2020.
- Approximately 10% of hostels have closed down but there is still over 15,000 hostels available on their platform.
- Cash flow from operating activities from operating activities in H1 2020 (a brutal first half) was negative 2mn euro. Over the previous 5 years this would have been 10 to 15 mn euro in the first half.
A good quality business? Does it have the balance sheet to survive the turbulence?
- The exciting growth years for Hostelworld post IPO (2015) were up to 2018 where the company revenue line went from 50mn euro to 80mn euro. Between 2018 and 2019 growth was sideways but the company was profitable and cash generative.
- The company benefited from a capital raise in H1 of 15mn euro and has very little long term debt at 3.5mn euro (but, like a lot of businesses payables have grown to 17mn euro with employer contributions being a big driver).
- However, these obligations are more than covered versus 33mn euro cash on balance sheet at the end of June. This means the cash on balance sheet remains close to 50% of its market cap.
- The cash burn in H1 was controlled (thanks to a reversal in working capital and pushing out payables).
- This will mean the equity value is supported with a high net cash position.
The M&A angle
- Finally, we would note that OTAs (online agents) have seen significant consolidation and M&A historically. Many of the giants in the US (Expedia, Booking.com) and Europe (eDreams) have grown out of acquisition. For benchmark multiples in a consolidation scenario, consider the industry heavyweights such as Expedia trading at 3x EV/Revenue (2020) and Booking Holding (parent to booking.com) at 7x EV/Revenue (2020). A big dispersion, although note that Expedia and Hostelworld are more 15% to 20% return on equity businesses versus 50% at Booking Holdings. Would we be surprised to see a private equity group or industry player target a niche leader at the bottom of the cycle? Absolutely not. Hostelworld has been through PE ownership before and this could easily happen again.
What is Hostelworld worth?
- Lets look at revenue multiples as earnings have been decimated. Historically the company has traded around 2 to 3x Revenue (EV/trailing revenue).
- When the revenue growth rate was higher in 2015 to 2018 the market afforded it a multiple of 4x EV/Revenue.
- Analysts expect that by 2022 it will have recovered its 2019 revenue of 80mn euro. We believe the pent up demand to go backpacking will be significant.
- Let us be conservative and put Hostelworld at 2x trailing revenue for 2022, this would imply an enterprise value 160mn (2x revenue).
- If we add back net cash of 30mn this points to an implied share price of 1.7 euro versus 0.59 euro currently (note the liquidity is on the UK line, 55 pence).
Hostelworld is an industry leader, with cash on the balance sheet to deal with an extended lock down. We believe the shares offer 200% upside on a 2 year view. The youth will go travelling again and a travel lockdown will not continue indefinitely. Now is the time to start accumulating.
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