Airbnb and Apple, reacting to a crisis and focusing on shareholders' return
And the fantastic story of the most profitable breakfast in history!
Hello friends, I hope you’re all having a great week.
In this week’s post I wanted to take a break from the society/philosophical discussion of the last couple of weeks and do a quick deep-dive on a corporate story that I find quite interesting. I am realizing that I have this pattern of topics with some “abstract concept” posts (like last week’s post on new generations’ dynamics, or the previous one on how different cultures deal with success) and some more corporate strategy/business posts like the one on Zillow Offers. Let me know if you like the cadence, if you’d like to read something different or if you have any suggestion!
CORPORATE STRATEGY: ABOVE THE LINE AND BELOW THE LINE
A few months back I was listening to a podcast and the author made a very simple yet powerful statement. His argument was that in a corporation’s management there are mainly two large strategies to increase the value for your shareholders (and hence, ideally the share price): make changes on how the business is run in its fundamentals (aka “Above the Line”) or change the capital distribution strategy (aka “Below the Line). The term “line” here basically means the EBITDA or Net Profit line, as a manager you can basically either do something to increase your profit (i.e. grow the revenue, improve marginality, etc) or change how you distribute the value of your profit to your shareholders.
This is actually quite a basic concept, nothing new here. But as I thought about it, and pondered about the different examples cited, I found some quite inspiring lessons for anyone who has to do for work at any level with corporate strategy (this is basically everyone working in the private sector). The author of the comment originally used Meta as an example of (not great, in his opinion) below-the-line strategy and compared it with Apple. I actually would like to twist the comparison and take two positive examples: Airbnb and Apple.
I admit I have always been intrigued by companies turnaround stories, and after all who does not like an happy ending story? Post Covid there have been a number of “sbooms” (e.g. Zoom, Peloton, etc) that have had a lot of coverage, but I think that there have in parallel been a lot of great turnaround stories (e.g. Uber, Booking and maybe WeWork?) that could teach us a lot. This concept of turning a business around by working on its fundamentals and reviewing the inputs is at the end of the day the concept of “Going back to Alpha companies” that I wrote about in this post a few months back. I decided to talk about Airbnb because the time of the crisis (covid impact on traveling) had such a bad timing (the company was finalizing its long awaited IPO process) and the recovery was so great that it is in my opinion the poster case of how to react to a storm.
On the other hand I admit that, having zero experience on the public market investment side, I had dedicated very little time to thinking how Apple changed its approach to Below-The-Line strategy in the last years. I thus learned about what I renamed “the most profitable breakfast in history” between Tim Cook and the activist investor Carl Icahn, and I thought it was something worth sharing.
AIRBNB, FROM HEAVEN TO HELL AND BACK
Airbnb is a very interesting company in my opinion. It is the golden standard of the second generation of tech startup: born in a garage (or actually in this case, in an apartment!), one of the first applicants to the legendary incubator Y-Combinator, one of the first successful examples of the marketplace model (i.e. being a middle man between a buyer and a seller), an incredible financial success and a true disruptor. Airbnb was born in 2008, and 15 years later it has become a true household brand: recognized, loved (and sometimes hated) globally. The founding story is super interesting but I am positive everyone knows it and heard about the “cereal box” growth hack that got it started during the Obama 2008 presidential campaign. What actually interested me a lot is the story of how Airbnb reacted to Covid, raising from its ashes like the Phoenix.
At the end of 2019 Airbnb was on top of the world, it was growing very strongly (generating $5B in revenue, +33% YoY) and after several years of discussion finally announced it was working on its plans to go public. The tech sector was at the peak moment of a 10 years+ bull run and the valuation expected was super high ($50B+). The economy was booming, traveling was at its peak and digital had basically conquered the entire industry (remember the physical travel agencies?). Millions of people used Airbnb as a source of secondary or even primary income, and besides some hot discussions about the impact the company had on the quality of life in some cities and regulation debates, the brand was at its absolute peak.
I don’t think that anyone, founders included, was in any way ready for the storm that was mounting behind the corner. A quarter later, in March 2020, Covid hit and Airbnb revenue drop 72% year-over-year in Q2. Airbnb basically lost its entire revenue, and while most people agreed this was a temporary situation, and that traveling would have at some point come back in everyone’s life, no one had any idea of how long the emergency was going to last. This is when their CEO and one of the 3 co-founders, Brian Chesky and the Airbnb Board of Directors, showed the world the greatest turnaround in the last decade (Giovanni’s personal and humble award!).
SPEED OF REACTION
In this interview one of Chesky’s co-founders breaks down how the strategy was conceptualized and executed. The first important factor was the speed of reaction: Airbnb wasted no time and went immediately in emergency mode on every single front. This is probably one of the most intuitive yet hardest to implement decisions. While in hindsight everyone agrees that a captain should take the helm and change course at the first signal of a storm, this is super hard to do when the ship is a company that has lived its entire life and based its entire culture on hyper-growth. Nobody at Airbnb, and arguably the larger tech sector, was ready to deal with crises: they were the masters of scale, not of down-scaling.
This is also what really makes the difference between Alpha and Beta companies. When you’re in a booming environment the only 3 things that matter are growth, growth and growth. When you go into crisis mode the 3 things that matter are growth, margin and run rate. It’s not that growth stops being important, but margin and run rate (i.e. how much cash you burn every month vs how much cash you have in the bank) become crucial too.
MAKE SURE THE BOAT DOES NOT SINK
The first action the management implemented was something that got me jumping on my chair when I read it: a company that was talking to go public at a $50B+ valuation, and that had raised a previous round at a $35B valuation, raised $1B of emergency loan financing at $18B valuation, half of the market cap of less than a year earlier!! I remember at the time thinking they had to be crazy or desperate to do such a move, while actually this proved to be a fantastic choice, also for the people that provided the funding. Airbnb’s management was taking care of the most important thing during a storm: make sure you have enough cash to remain in business until the storm ends. Survival, at almost any cost, is the most important choice you can make.
CUSTOMER CENTRIC, ESPECIALLY WHEN TIMES ARE HARD
The second move was to avoid losing focus on customers, and ensuring that the industry crisis was not passed to them. In Airbnb’s case this was actually even trickier than a lot of other companies: marketplaces have 2 sides of customers to take care of, sellers and buyers. In their case they decided to allocate the funds raised in the emergency round to:
Fully refund all the travelers that had booked traveling during lockdown periods, giving back the entire amounts paid. This sounds intuitive but I vividly remember how a family member had booked in the same period a hotel from a very large Hotel chain, and getting a refund proved to be impossible. After days of discussions with the customer service we managed to get a voucher (Italians only: I can’t avoid referring to the famous Verdone scene “Ah nonna, m’hanno fatto un buono. Che vor di?”). Airbnb instead gave every customer all the money back in cash without any discussion.
Pay the hosts for the nights booked and canceled during covid within the no-cancel window. Airbnb basically absorbed the whole loss of the canceled trips, and decided to treat hosts equally as central as guests by “getting some money in their pockets at a time when they had no income and many people rely on our service to pay the rent to make ends meet, to pay bills, to pay off their student loans and credit card bills”.
MAXIMIZE COST EFFICIENCIES
In a time of crisis, when revenues drop, obviously a key piece is to ensure that also costs decrease as much as possible. Starting from variable costs Airbnb did something that Chesky in retrospect described as “the dream of every Chief of Marketing”: they switched off all of the paid advertising. In his words: “we got to do the thing that every CMO has ever dreamed of doing, turning off a 100% of marketing and sees what happens. And nothing really happens”. Besides saving Airbnb a lot of cash in a time of need, this experience allowed them to experiment, learn and eventually improve dramatically the efficiency of their advertising spend when the crisis passed.
Similarly, but a lot more traumatically, Airbnb decided to decrease very materially their workforce by laying off 25% of their workforce (circa 1,900 employees). While this is always a very tough decision, I think that Airbnb’s handling of the RIF was a masterclass. Airbnb put a lot of attention on improving as much as possible the experience of laid off employees by offering health coverage, severance packages, etc (which were obviously a key concern for impacted people, especially in the US and especially during a pandemic when health coverage was people’s nr1 problem). But more importantly they invested in creating an “employee directory”: a website with the profile and contacts of all the people laid off, and marketed it very heavily to help laid off employees to get jobs in other companies. This proactive replacement service was quite unprecedented, and Airbnb made sure to be very vocal about it. Thanks to the fact that the tech industry was overall booming, most people got a new job before the severance packages expired. This has then become basically a market standard for any RIF.
TAKE THE OPPORTUNITY TO RETHINK THE BUSINESS
Finally Airbnb did a super interesting thing: they used the change in habits customers showed from the pandemic to re-think their business entirely. In the post-lockdown months people started traveling in a very different way: people tried to avoid crowded places like Hotel lobbies, elevators or gyms and pools. Travelers would rather stay in independent apartments. At the same time, since international travel was banned, a lot of people wanted to run away from city centers to more rural and larger houses often nearby their origin home.
Airbnb capitalized on these changes in demand and designed a marketing campaign to allow people to “Go near!”, and started seeing people’s behavior changing: travelers were looking for more flexible alternatives to search and book places. They took inspiration to design a new feature that eventually became the core of the experience: flexible dates traveling (e.g. “I want to go in the country side one weekend in March, I don’t really care when”). This basically changed entirely how the experience was designed and how people interacted with the app.
HOW DID IT END?
Airbnb’s turnover is such a good story mainly because of the happy ending: by Q3 2020 revenue had bounced back to $1.3B, de facto recovering the lost ground during the Covid months. Airbnb had come out of the storm stronger, more capital efficient and with a stronger brand reputation thanks to the way they handled customers and investors during such a dramatic time.
In December 2020 Airbnb finally went public at a ~$40B valuation, the stock more than doubled on the first trading day to $100B. The crazy part: this was only 9 months after revenue plummeted! Today, Airbnb's market cap is ~$77B. Last quarter, the company reported $2.9B in revenue (+29% y/y) with net income of $1.2B and FCF of $960M. All three were record highs.
THE MOST PROFITABLE BREAKFAST IN HISTORY
Conversely to what I wrote about Airbnb what makes this Apple case an interesting story is that it did not involve changing the business model, reviewing margin structure or boosting revenue. But one of the arguably most important factors of the biggest value creation in the history of capitalism (Apple market cap went from $400B in 2016 to $2.7T at its peak in 2022) was on how to allocate the profits the business was generating back to shareholders.
In 2016 Apple was basically one of the most successful companies in history, iPhones are without a doubt the product of the century (from a return on capital stand-point, at least) and across all the business lines the company was generating a mountain of cash. This cash generated by Apple’s profit was sitting on their balance sheet in many forms. And that’s when the story of the breakfast unfolds: apparently Carl Icahn, who is one of the most famous activist investors in the US, had a breakfast with Apple’s CEO Tim Cook and the CFO Luca Maestri. I obviously have no idea whether this is an urban legend or if the breakfast really happened, but let’s all believe it did for the sake of how the story flows!
In this breakfast Icahn apparently told Cook: “I have absolute respect for the results you’re producing and have no input on how to change the way you manage your business. I, however, have some ideas on how you manage Apple “below the line”: what you do with the profit you generate”. What he suggested was fairly simple but yet not very intuitive. While the entire press and “main street” criticism to Apple was that they were not investing enough in disruptive R&D, that they were in marginal innovation cycle and after the iPad nothing really cool had been invented, Icahn provided a very easy solution: focus on the profits, distribute cash to shareholders through dividends and share buybacks. He was positive the markets would have rewarded them and history actually proved him right:
This strategy might seem trivial, and actually share buybacks have historically had a very bad image in tech: they are somehow perceived as the last resort of your money when you don’t know what to do with it. Icah’s perspective was actually different, and the author of the comment in the podcast used the analogy to what Meta is doing right now with their AR/VR investment to make his point.
Meta is taking a very different strategy vs Apple: instead of distributing its healthy profits to shareholders, they decided to invest very heavily into developing a new category of products. While Apple used roughly $396B in their cash to buy back stocks, Meta is investing a fortune into their Virtual Reality R&D. The stocks reacted in a very different way, while there’s some alignment until Sep’22, Meta fell off a cliff when it became clear the magnitude of investment Meta intended to make in VR: “in the last two years Meta spent $25B and they said that they're gonna spend, you know, meaningfully more in 2023 and then sustain that investment for a while. Total investment will be roughly $25B in 2023 then they'll sustain that, what that means is that over 12 or 13 year life of reality labs as we've seen it, these guys will have spent a quarter of a trillion dollars”.
Just for the sake of perspective: for the entire iPhone R&D costs Apple spent $3.6B, and then sustained follow-up investments with the demand that previous generations were receiving. The Manhattan project would cost $23B in today's dollars to create the atomic bomb. Tesla in its entire life, spent $25B to get free cash flow profitability. And they also took this incremental approach: start with a model and use proceed from the sales to fund next versions.
I do not want to derail the conversation and go deeper on the story of Meta Virtual Reality labs but I think it’s going to be interesting to follow the story and see whether Mark Zuckerberg was actually right and VR is going to be a huge new market or whether he should have gone to breakfast with Icahn too!! :)
Wish you all a great week,
Giovanni
Reading time 14’ - writing time 60’ (written on a flight) - post image generated by Stable Diffusion AI (prompt: “design the phoenix reborn from its ashes”)