Hostelworld Group plc (LSE:HSW)

Ticker:                                 LSE:HSW

Market cap:                        £110m

EV:                                        £90m

Normalised EV/FCF:          5X (pre-tax)

 

Summary & Disclosure

I own a small personal position in HSW that I acquired a few weeks ago in the 110-112p range. I’m in two minds about this idea because turnarounds rarely turn and internet businesses can change extremely quickly. I also reckon there is a good chance things get worse before they get better (as revenues lag change/costs) so more nimble investors may get a more attractive entry point. I have not bought a full size position for this reason.

This is not an investment recommendation, do your own analysis and don’t rely on anything in this report. Also, be cognisant of the different currencies involved (reports in Euro, is listed in Pounds)

Anyway, have a read. I’d be interested in having discussions with people, because I don’t feel overly confident in this idea.

 

Elevator Pitch

I believe Hostelworld currently presents an attractive, asymmetric turnaround situation. Forced selling from Woodford Investment Management in 2018 and then Capital Group in 2019, combined with a deterioration in operational performance has resulted in the share price declining ~75% and trading at ~5X free cash flow while providing a 10% dividend yield.

Even assuming the business deteriorates at an accelerating rate (resulting in FCF halving) and applying a conservative 6X multiple, downside looks limited to ~75p (35% from current levels, 25% from proposed buy price). This creates a favourable risk/reward skew, because if the management team can show any signs of returning the business to top line growth, it would not be difficult to see the business being worth 250p (3:1 risk reward currently, vs >5:1 at 100p)

 

Business and Industry Overview

Hostelworld (originally Web Reservations International), founded in 1999 by Ray Nolan is an Online Travel Agency (OTA) specialising in the Hostel niche. It grew quickly and profitably, reaching €40m in revenue and €20m in EBITDA by 2009 when he sold it to Private Equity firm, Hellman & Friedman for in excess of €200m. In 2013, the company acquired its closest peer, HostelBookers.com, which took group revenues to ~€80m and EBITDA over €25m.

 

In 2015, the company was brought to the public markets in an IPO that valued the company at ~£177m (note Pounds not Euros), providing the capital to pay-down the substantial debt the company had accrued under PE ownership and for H&F to exit the majority of their stake.

 

Hostelworld’s platform is not dissimilar to that of other OTA’s such as Booking and Expedia, however, they have chosen to focus exclusively on the Hostel industry. In doing so, they have managed to carve out a profitable niche, where travellers are provided with a better selection of extensively peer reviewed Hostels, and Hostels are supplied with a more profitable average booker: because someone booking via Hostelworld is very aware they’re booking a Hostel they typically spend more on the Hostel’s higher margin ancillary services (bars, restaurant, tours, etc.). The new management team is working with a third-party data supplier to further tease out these profitability differences (between a Hostelworld traveller and one from Booking) to drive further exclusivity in their supply base.

 

This difference in customer base between Hostelworld and the larger OTA’s (Booking & Expedia) is evidenced by the average review score on like-for-like hostel’s being ~79% higher on Hostelworld vs. the others – indicating the average traveller enjoyed it more (because it was what they expected and wanted!).

 

The exclusive inventory can also be verified through spot testing availability for a random sample of hostels. The following was performed and provided by the company:HSW 1

Therefore, in 27% of the comparisons they made, Hostelworld had exclusive inventory.

 

My spot check did not return results as favourable, however, I was only looking for exclusive property availability: i.e. on a certain day, was a property available on Hostelworld, also available on Booking:

HSW 2

This is not a large enough sample size to draw much from, but it does seem like most of Hostelworld’s edge in exclusive inventory may be in South East Asia. It is worth noting that exclusivity was not a focus for the prior management team, but the new CEO realises this is a key edge and is focussed on driving more exclusive inventory.

 

The company looks to have a good brand, evidenced by their organic lead generation:

  • 43% of 2018 net bookings were via their app
  • Of the remaining 57% of bookings (source Alexa)
    • 48% arrived via search
    • 2% arrived via social media
    • 8% arrived via links
    • 42% arrived directly

Therefore, 67% of the net bookings were likely through direct/organic traffic (43% app bookings + 42% of remaining 57%). Further, in 2015 (add in repeat booking %)

 

This is further evidenced by their low relative marketing cost per booking, and the declining trend in recent years as they introduced their app:

HSW 3

 

Further market research provided by Hostelworld seems to support the conclusion that they do have a good brand:HSW 4

Source: [Customer Insights] Brand Loyalty Research: Aug 2018 (2CV); N=1848, split across the UK, ROI, US and Canada
Basis: 66% Hostelworld customer sample + 34% Boost Sample of panellists screened to meet the “Budget Backpackers” & “Independent Explorers” target segment criteria.

 

Industry

From the data provided by the company, combined with other research, it seems Hostels as an industry is a growth market (although difficult to strip out Hostels vs. tourism in general). Anecdotal data also provides some support that Hostels are growing, with many millennial travellers more focussed on “experiences” and travelling alone, which provides a tailwind for the industry.

HSW 5

Total industry CAGR:      5%

OTA CAGR:                         8%

 

Turnaround strategy

  • Optimising sort order and introducing more dynamic pricing
    • They have not kept pace with the industry in introducing more flexibility into their sorting and pricing algorithms & the ability to share this with clients
  • Loyalty discounts
    • A big attraction for me as a booking.com user is the “Genius” discounts I receive
    • Hostelworld does not offer anything similar but is looking to introduce basically the same idea
  • Targeted marketing
    • Historically, a large chunk of their marketing budget has been on big brand promotions (i.e. hire someone famous and film an expensive commercial)
    • The new CEO realised this was not generating sufficient ROI’s and hired a new head of marketing with more experience in the data driven side
    • More focussed on customer lifetime value and acquisition cost
      • They realised that once a customer has downloaded the app, they book more and have a far higher repeat booking rate than non-app users
  • Focus on the app
    • Last year 43% of net bookings came via their app, which has increased YoY since they released it in 2015
    • The app provides much better economics for Hostelworld because they do not have to repeatedly acquire the customer
    • App users also tend to book more due to the convenience of having all of their bookings in one location and not needing to re-input data (names, payment numbers, etc.)
  • Ancillary services
    • They are developing the ability to sell tours and other related services (similar to what Airbnb introduced with “experiences”) to maximise the value they provide (and can extract) from the customer once they’ve been acquired
  • Use data to drive more exclusive inventory
    • Preliminary data from a third party source suggests that the average guest from Hostelworld spends materially more on ancilliary services during their stay
    • This is critical for Hostels because a bed is the lowest margin offering and they do not have as many occupancy issues as a Hotel

 

These changes should not require a material amount of incremental spend, because they already have a large IT/development team. Therefore, they simply need to redirect their energy.

 

Investment Thesis

  • Cheap valuation provides downside protection
    • Cash backing 20% of market cap
    • 10% dividend yield
    • 5X EV/free cash flow multiple
    • Long-term history of positive free cash flow generation since at least 2004

 

  • Potentially forced selling likely led to share price “over-reacting” to a slight slow down
    • Neil Woodford, who’s funds management company recently imploded, owned 25% of Hostelworld until the end of 2018
      • He began selling in April 2018, reducing down to ~10% via smallish trades, before a clearing transaction occurred on 30/11/18
      • Over this period, the stock declined by ~60% from 400p to 175p
      • He was likely somewhat of a forced seller as redemptions were pushing his fund through liquidity thresholds and this was at the more liquid end of the spectrum for his holdings
    • There is also a rumour that the fund manager who was responsible for the HSW investment at Capital Group was recently fired
      • They had been slowly selling since 2018 but recently sold their last 10% in a clearing trade
      • They recently sold their remaining stake
    • Therefore, there has been a lot of large selling pressure over the last two years that has likely amplified the pressure on the stock price

 

  • Growth may not eventuate, but business model provides fundamental downside protection
    • Revenues sufficiently diversified and organically generated that the business performance is unlikely to “fall off a cliff”

 

  • Turnaround strategy is not “heroic” and a few small tweaks could generate a significant uplift in growth
    • Industry is growing, therefore, if they can simply retain market share, they should return to growth

 

  • Accounting hides true earning power
    • Amortisation: post the acquisition of hostelbookers.com in 2013, the company has recorded substantial amortisation of acquired intangibles
      • This is not a true economic cost as the customers and value acquired does not need to be repurchased after X years
    • The introduction of a free cancellation policy means that some revenues (3% of gross revenues in 2018) do not reach the P&L as they have not delivered the service yet
      • This made the 2018 performance look worse than it actually was: gross revenue only down 2% but reported revenue down >5%
    • Brand consolidation has been an ongoing headwind, but should now be finished
      • They used to operate a multiple brand strategy. In recent years they’ve been slowly removing brands to focus on one, this has impacted revenues

 

  • Strategic value provides a potential catalyst & downside protection
    • OTA space has had a lot of acquisitions and consolidation in recent years
    • The turnover in the shareholder base has put the company in the hands of more active owners who may push for a sales process if the turnaround doesn’t lead to results

 

Valuation

HSW 8

 

Risks & Trip Wires

  • Dramatic shift in traveller’s destination to lower value countries
    • Typical commission in Asia for Hostelworld is €6 vs. €12 in Europe
  • Terrorism
    • Large terrorist events typically cause a meaningful drop in short-term visitation, however, this is unlikely to permanently impact the business (but represents short term earnings risk)
    • Any secular increase in terrorism would likely coincide with lower long-term tourism growth
  • Disintermediation
    • Google, super-apps, etc.
    • Somewhat limited by the fragmented supply side
  • Business performance could continue to deteriorate
    • Because there is an obvious lag between investments made today (in marketing and improving the product) and any potential uptick in growth, profits could continue to fall for another year or so
    • Also, the continued roll-out of free cancellation will lead to a build up in deferred revenue (and the associated hole in reported revenues)
  • Lost market share is due to something more sinister
    • As shown, the Hostel industry has been growing at 5-8% since 2014
    • HSW has only grown revenues at 2-3%
    • Therefore, they have been losing market share – most probably to Booking
    • If this has been caused by something other than lack of investment & focus, the terminal value of the business could be at risk

 

Appendix

HSW 6

 

HSW 7

 

HSW 9

 

HSW 10

One thought on “Hostelworld Group plc (LSE:HSW)

  1. Nice piece of work & balanced analysis. If the company ever does return to growth, given the size of the addressable market, a case to be made to justify a significantly higher valuation in the blue sky scenario is my only comment.

    Like

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