A lesser known online travel agency (OTA) in comparison to my last article on Booking Holdings (BKNG), hostel-focused Hostelworld (OTCPK:HSWLF) faces numerous challenges that have resulted in its valuation collapsing from ~£400M in 2018 to ~£70M in August 2020. Their strategy to reinvigorate growth; dividend cuts; and present uncertainty in the travel and tourism sector has investors displeased. Yet, a solid balance sheet easing 2020 concerns, favourable sector tailwinds, and a current valuation pricing their new strategy for failure mean Hostelworld provides an alluring prospect against considerable competitive risks.
Figure 1: Hostelworld homepage. Source: hostelworld.com
When assessing Hostelworld’s (HSW) current woes, let’s mention the elephant in the room first. An updated version of a visualisation shown in my previous article shows tourism is recovering sooner than anticipated. Yet remember, booking volumes are typically seasonal.
Figure 2: YTD (Jan-Jul) recovery in online traffic of select accommodation providers. Source: Author’s calculations, based on data from similarweb.com
Inevitably, HSW will underperform generalist, large OTAs. Hostels’ typically young, adventurous travelers may prove un-budging, but limited social distancing measures will inhibit a rebound compared to hotels or house-shares. Across 1H 2020, traffic declined 73.16%. Despite 2H 2020 being likely better, this conservative figure is used in later assumptions.
Business woes/change in strategy
Figure 3: Recent underperformance of HSW. Source: Author, based on HSW financials.
COVID-19 follows a strategic shake-up in 2018, including a complete management overhaul. To shareholders’ disappointment, HSW is yet to reap rewards from its “roadmap for growth” – such initiatives rarely yield instant results. At least we finally understand their direction. Traditionally, OTAs provide a centralised platform, allowing hostel goers and hostel providers access to a fragmented market. HSW aims to expand inorganically into hostel management services.
As management states in their 2019 annual report:
“Taken together, Goki [who provide automated check-in/locking solutions] and Counter [who provide booking/payment management solutions] will help Hostelworld re-establish itself not only as an OTA/distributor with hostels, but also as a leading provider of low-cost hostel focussed technology solutions to the hostel industry”.
This strategy appears customer-centric. Hostel providers will appreciate fee reductions and efforts to improve the hostel experience – encouraging preferential listings. This is a good move, yet it does not address low switching costs for hostel goers. Q4 2019 and 2020 were earmarked as the beginning of HSW’s return to growth. Doubtless, this has been significantly derailed. Contrary, COVID-19 may provide an adoption tailwind for Backpack Online (Hostelworld’s management services unit), as hostels look to reduce costs and encourage traveller confidence.
Regardless, the ambiguity of their goals does not fill one with confidence of their execution. The “roadmap for growth” may be a good idea, but until there’s concrete evidence of its opportunity then it remains merely a ‘Call Option’ for investors.
Investors lose patience
This echoes investors’ frustrations as HSW has sank ~85%, which can be better understood through a historical lens. Hostelworld was controlled by private equity from 2009-2015. An established OTA is an alluring proposition for a PE firm, due to its consistent cash-flows. Hostelworld has cancelled its dividend policy. Thus, investors valuing HSW for its operating cash flows have left. A lack of top-line growth as well as shareholder remuneration explains a lack of demand for HSW equity.
Future Positive/Negative Catalysts
Reasons to be cheerful: Tailwinds
Despite its origins in early 20th century Germany, hostelling is still an emerging industry. Early hostels were never considered profitable until open-source booking management software and OTAs emerged – incidentally, Hostelworld pioneered both. Now, “you’re charging 4-star rates and you’re offering a 2-star service, which is what makes it so profitable”. Hostelling is expected to grow 7-8% annually; much higher than hotelling at 4.6% annually. This growth is attributed to burgeoning travel demand among young, ‘lifestyle’ travellers. Resultantly hoteliers, upstarts and investors have flocked. Hoteliers such as Marriott (MAR) and Accor (OTCPK:ACRFF) have expanded their “budget” offerings. Simultaneously hostel chains (a relatively new concept!), backed by private equity, have emerged. Hostels now compete with hotels, as the observable differences lessen. Large, generalist OTAs – a la BKNG – benefit most, by offering all options to frugal travellers. Due to their niche, HSW can never compete on scale. Differentiation is therefore the strategy of HSW and many operators.
Figure 4: GENERATOR provides a modern hostel experience. So-called “poshtels” have become popular with young travellers. Source: Generator London.
Reasons to be cautious: Competition
It should be noted HSW is the dominant hostel-focussed OTA, having acquired main rival HostelBookers in 2013. Despite this, HSW faces competition from many angles: namely large OTAs (BKNG, EXPE, etc.) and hostels’ own platforms. As mentioned, OTAs covering multiple accommodation types have an advantage over Hostelworld. When considering travellers’ preferences when booking, large OTAs “gives me more options”. “Saves money” is another top preference, which is best attained when booking direct. Further qualitative insight can be found on this r/solotravel thread. Quantitatively, bookings (Figure 2) have stagnated. A minor return to bookings growth in Q4 2019 cannot be given much credence, yet arguably an 85% decline in valuation is a tad extreme. Overall, it is difficult to pinpoint what advantage Hostelworld has. Low switching costs are concerning, particularly since many travelers appear to use Hostelworld to browse but book direct – supporting hostels and attaining cheaper prices. This train of thought vindicates their redirection.
Figure 5: QoQ bookings across HSW platforms. Source: HSW 2019 preliminary presentation.
Analysts identify competition as a key risk also. Failure to deliver their “roadmap for growth” will cause HSW to further succumb to competitive pressures. In 2020, HSW will likely survive, thanks to zero debt and a current ratio of 2.02 on current assets totaling €24M or ~35% of its current valuation (2019A figures). Cash burn for the 1st half of 2020 came in at €4.0M, which has been covered by equity raises and renegotiation of creditor agreements. Resultantly, cash equivalents have increased YoY to €32.9M from €25.4M (2020 Interim Results). Beyond 2020, however, is more uncertain.
Figure 6: Quick valuation based on P/S multiples in “Base” scenario. Source: Author’s calculations.
Revenue assumptions largely drive this DCF valuation. If HSW simply recovers 2019 revenues – based on 2019 P/S ratio – then investors would receive a 16.61% annual return. In a “Bear” scenario, CAGR is 9.41%. A significantly higher valuation could be seen in the “Bull” scenario, driven by higher revenue growth and a possible P/S re-rating.
Figure 7: Discounted Cash-Flow (“DCF”) valuation assumptions. Source: Author’s calculations.
Figure 8: Range of valuations of HSW, across scenarios and discount rates. Source: Author’s calculations.
Regardless of which scenario occurs, HSW trades in a range which aligns with the fundamentals. To minimise risk, HSW is attractive at a 21.45% return, below 58 GBp.
Figure 9: “Implied perpetual growth”, or the difference between applied and implied LT growth rates. Source: Author’s calculations.
To test the robustness of the DCF assumptions a final valuation, a comparison against implied LT and “LT growth rate”, presents a fair value of 56 GBp.
A minnow in the OTA-space, Hostelworld is undoubtedly a business with many challenges and unanswered questions. Recent director dealings are notable, though recovery of tailwinds within ‘Travel & Tourism’ are crucial. Here, a recovery is probable but turnaround of its gradually weakening competitive position is still dubious. Doubling-down on its niche position as a hostel services provider is appropriate but success here is also dubious. Yet, HSW trades at a valuation where, even if 2019As sales are never recovered or strategic ambitions are never realised, it presents an attractive opportunity for those will to take the risk.
Disclosure: I am/we are long HSWLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.