The latest trading update from Hostelworld, 15th October, highlighted that the current restrictions are making it extremely difficult to operate as an online travel agent (OTA). Management highlighted in recent weeks a marked deterioration in bookings after an improvement in July/August. Their base case at the time of the June equity raise was that 2020 bookings would be 25% of 2019. They now expect the full year to be 20% to 22% of 2019. The share price has reacted according and is 10% lower than our first posting.
Does this change the investment case?
No, we still believe in the original investment thesis and that Hostelworld is well positioned to capture the recovery in travel, backpacking and ecotourism in 2021 and 2022. However, this latest episode should bring scrutiny onto how aggressive the business is being run for shareholders since they raised money in June (29th June 2020, £12mn raised at 72 pence per share).
A side by side with other OTA’s raises some questions.
This year, almost every company management has had to take a serious assessment of its cost base, no more so than the travel and hospitality industry. Has Hostelworld been as aggressive as other management teams to protect shareholder funds?
Hostelworld came into 2020 with SG&A (sales, general & admin expenses) at 80% of 2019 revenue, Expedia was 57%, Booking Holdings was 35% and Lastminute was 37%. This does not screen as lean versus competitors.
Since 2014 the revenue line of Hostelworld has been sideways, yet SG&A has gone up 20%. The 5 year revenue CAGR of Expedia, Booking Holdings LastMinute, eDreams are 16%, 13%, 19% and 3% respectively by comparison.
In addition, revenue per employee is a good metric to monitor in a tech business for efficiency. In this regard Hostelworld is lagging based on 2019 and pre COVID. eDreams is 440k euro per employee, LastMinute is 285k euro, Booking Holdings is $570k and Expedia $475k. HostelWorld is the lowest revenue per employee at 257k euro.
This year, everyone in the industry was dealt an unforecastable event. Hostelworld revenue is forecasted to decline 80% versus 2019 in 2020. At Expedia a 54% revenue decline is expected, Booking Holdings 50% and LastMinute 55%. How have the companies addressed their cost base in H1 to protect shareholders? Expedia reduced SG&A by 45% , Booking Holdings by 48%, Lastminute.com by 37%. Hostelworld by only 36% despite being forecasted to see the largest decline. It will be very telling to see how costs have been managed in Q3 and Q4.
If progress has not been made, we think this raises serious questions and something the new CFO should be focused on is cost management.
Do management have sufficient skin in the game?
The management commented that they are burning 1.9mn euro per month and have 22.5mn of cash i.e 12 months of cash burn covered. Our expectation in our original post was that this was sufficient cushion.
However, if H1 2021 remains uncertain their corporate broker, Numis, has speculated another raise. If this were to materialise then shareholders are going to become frustrated in our view. There is already an activist on the shareholder register, in Strategic Equity Capital.
The current management team have been in place since 2018. The CEO joined from Expedia in June 2018 and the other members of the management team have had a similar tenure. While they are incentivised via the LTIP, it was very telling that in the recent capital raise the amount of money put in by the management was minimal. The Chairman, Michael Cawley, ex Ryanair COO has a fraction of share ownership compared with his other holdings/board memberships in Ryanair, Kingspan and Flutter Entertainment (formerly Paddy Power). By comparison, at Expedia we have seen a board member acquire $1mn of stock in August of this year via an open market purchase.
Don’t forget industry M&A…
At such depressed share price levels, we would note that this is an industry that is prone to consolidation. Something the management team were keen to explore was acquisitions prior to COVID and reduced their capital allocation to dividend payments to facilitate such. It is difficult to see how such a scenario is now on the agenda. But could Hostelworld become a target in a more stable environment? The deal rationale is worth exploring.
As a starting point, an M&A or buyout model is worth detailing. Hostelworld screens very well in that regard. A back of the envelope analysis, if an industry player launched a takeover at 0.85euro (a 65% premium) would value the business at 8x consensus EBITDA 2021. Is that something that would appeal to shareholders? Does it make sense for the buyer? We ran the model, allowing for a slow recovery in 2021 and 2022 revenue (using revised consensus) and capitalising the investment value at 15x EBITDA in year 6, on our numbers this would clear an IRR hurdle of 25%. That is before an industry buyer gets further value from the cost synergies and this could be significant in this type of business. What are you buying? We would note that versus the current market cap of 58mn euro there is 90mn euro of intangible assets (excluding goodwill) on balance sheet. This screens very favourable versus peers and proprietary technology is something an acquirer would be very focused on. Furthermore, there is a very large installed base of users that are captive through the Hostelworld app investment and the company has made significant investments to expand this installed base in recent years. The brand and technology would be retained but the back end and cost efficiency could be managed by a larger and efficient industry player.
Our core thesis is that we are at peak uncertainty for the travel industry this winter. The issues facing the industry are not new and the European travel/airline share index has been range bound since April. We do believe there are more levers the management team should be pulling here to avoid a capital raise. Showing a higher level of cost discipline would be a starting point in terms of shareholder value protection.
The shares remain extremely cheap – we don’t know which week sentiment will shift for the travel industry but the market is priced for bad news into eternity in our view. Furthermore, in an industry that is seeing ongoing consolidation – Hostelworld’s number 1 position in hostel bookings, customer lists and technology assets could come into focus if the valuation remains this depressed – something that would be a lot more palatable to shareholders than another equity issue.
Lot’s more to follow….
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