Although I’ve spent a good deal of my work life staying in glamorous hotels; I’ve also spent a good deal of my leisure time staying in much better value hostels round the world. If you stay in expensive hotels for work, it doesn’t really feel like a holiday if you spend your time off in the same way. I’ve made some great long term friends staying at hostels. Sometimes you get so lonely in hotels.
Besides I always thought hostels are a nice “lifestyle” business. You have to be there, but you can outsource all the hard work to other people. I thought it might be a good business for me to go into when I got fed up with the whole financial services industry. And the barriers to entry are low – it is easy to start a hostel. I have stayed in several places (Tartu in Estonia, Tbilisi in Georgia, Odessa in Ukraine) where entrepreneurial travellers rented a large apartment, put lots of bunk beds in, wifi, set up a webpage and booking system via hostelworld website.
I’ve lived all over the world. I’ve left every place.
If you don’t know hostelworld then I will describe it. You go on the website, type in the city you are going to visit and lots of different hostels come up. The useful thing is that there is a review database of 8 million post-stay customer reviews since 2005. You just see what people who recently stayed write, and how they rated the place. I’d trust these reviews more than hotels or restaurant reviews. It’s a simple concept. The sort of business that I wish that I’d started myself.
Then recently one of my successful friends who manages billions of pounds asked me what I thought of hostelworld. The company came to the London Stock Exchange in October last year. My friend explained that he thought it was a good IPO, listed at around 10x earnings (ie not expensive) and no debt. So he was happy to buy shares in the IPO.
I explained to him that I used the website frequently, I wasn’t going to buy the shares myself. Partly because when management wants to IPO a company, the tendency is for them to push things hard to make all the financial numbers look unsustainably good. Then having sold their company to stockmarket investors, they warn that the historic numbers were unsustainably good and the future looks less rosy. Hostelworld is by no means the only company to do this. So it is a good “heuristic” to avoid IPOs if you are in any doubt. This is sad, because the capital raising process relies on people who start successful businesses to have an exit and swap their shares for cash. Sadly many try to maximise the price that they get, leaving investors who are on the other side of that trade with a loss. It leaves a bitter taste for investors, who feel that the management time their sale to take advantage of the fact that insiders selling will always know the business better than outsiders.
In April hostelworld management expressed confidence in the long-term strategy and execution. They said trading was in line with expectations so far this year. Then bang. They announced in May:
- Group bookings are down compared to last year. AND
- Average booking value has been lower
Double whammy – lower bookings and lower average value of bookings.
Share price falls 30% on the day – below the IPO price.
Weirdly they blame this on all sorts of things “geo-political events” and “planned” changes to websites, changes in geographic mix, and more people booking using mobile phones, rather than using desktops.
I’m rather curious. So many excuses, that don’t quite add up – to me at least. In April everything was fine. Suddenly all these things are going wrong in one month. Possible but unlikely.
Instead my thoughts are that there might be a more fundamental risk. This is based on a couple of conversations with friends that work in hostels. There is a trend for people to use hostelworld to do their research into which hostel to stay at. But all hostels have a website of their own. Previously you might pay the hostel owners in cash after your stay, but the online booking system was so much easier if you used hostelworld. Payments technology now means that it is easy to book directly with the hostel – whereas 5-10 years ago this was a real hassle for anyone running the hostel.
To be fair to the company, they do mention this risk in their prospectus.
“The Group could also face increased direct competition from hostel chains and accommodation providers as a result of an increase in the number of hostel chains and franchises that offer direct online booking through their own websites and apps”
The other nugget I’ve heard. Customers don’t like the way hostelworld takes a booking “deposit”. At least hostelworld call it a deposit, but the fee is not refundable. Again the company explains this
“revenue is … collected by the Group directly from the customer in the form of a non-refundable deposit made at the time of booking, which is generally in the range of 12 per cent to 20 per cent of the total booking value.”
What is the difference between a non refundable deposit and a booking fee? It annoys people that they make money like this – or at least that hostelworld can take up to 20% of the total booking value and call it a “deposit”. It’s the sort of thing a bank would do, thinking that they are being clever charging a fee that they hope no one notices, but in the long run people do notice and it damages the brand. For comparison airBNB typically charge 6-12%.
I’m also a bit irritated by way management communicates their “brand strategy” with investors. They talk about marketing “investment” being 45% of revenues in 2015 (2014: 36%). What they actually mean is that they spend 45% of the money they make on marketing. Accounting rules mean that you can’t account for this an investment, you have to account for it as a cost.
Investment and cost – what’s the difference?
Investment v cost. Well it is really hard for accountants to tell. Companies spend money on all sorts of things, hoping they are creating a future income stream. But sometimes things are a cost, because it is uncertain what they get back. Sometimes this is an investment, because what they buy is more tangible. (eg is buying bunk beds for your hostel a cost or an investment? Accounting rules say that the beds are an investment, so they can go on the balance sheet, and be depreciated over time).
Software development costs, although they are intangible, can be treated in the same way as an investment. But marketing expenses can’t be. If instead of investing in more bunk beds for my hostel, I pay a friend to put up posters, I would have to account for this as a cost. Costs have to be expensed in the first year, written off and not kept on the balance sheet as an asset.
Perhaps this is unfair. Coca Cola spends billions of dollars on marketing, and that is why it is such a valuable company. The accountants treat the money Coca Cola spends on its brand as worthless, but at the same time Coca Cola is often cited as one of the most valuable brands in the world. So one reason Coke trades at such a high valuation is the accounting treatment.
If marketing spend was treated as an investment, and added to the balance sheet and expensed over time, the Coca Cola’s capital would be higher. Consequently the return on capital reported would fall. But actually it would be the same company, with the same economics. We can say that businesses that spend a large amount of money on marketing, year after year, probably have lots of hidden capital that does not appear on their balance sheet.
But I wonder about hostelworld. Do they have lots of hidden capital? I use the site, but it annoys me sometimes. And I don’t like management who play games with words. Messing around with the definition of “costs” and “investments”. “Booking fee” v “deposit”. That doesn’t sound like a great brand to me.
These are all heuristics. Not complicated models. But that is my investment process. I find my combination of heuristics tend to work, and sometimes such simple “rules of thumb” even work better than my friends who are professionals. Professional fund managers are diligent. I’m sure my friend built an excel spreadsheet model and met with management. But that doesn’t seem to have helped. Instead I would suggest heuristics are key.
“Beware of IPOs – even if there isn’t much debt, management may know that historic results are not sustainable.”
“Beware of management who play games with words.”
“Buy shares in what you know and like.”
I’ll continue to be a customer of hostelworld, but I’m interested to see if this really was a small blip, as implied by the management statement. Or if there is something more structural going on, like the risks mentioned in their IPO prospectus. The share price reaction suggests there might be deeper problems, but I don’t know. But rather than spend time tinkering with an excel spreadsheet model I would suggest trying the site and stay in a hostel. See what you think.