Last Updated on May 24, 2022 by Anjali Chourasiya
This article is authored by Harsh Vora, a proprietary investor and day trader with more than 10 yrs of experience in financial markets. He is interviewed on ET NOW and his columns are published in national financial newspapers like Live Mint, Money Control, and Business Standard.
The recent trend of the new-age technology companies including Nykaa, Zomato, Paytm, Policy Bazaar (and very soon OYO) getting listed in stock markets is symbolic. It signals a marked improvement in one of the rather uncomfortable contradictions we have been witnessing in recent Indian financial history. Over the past half a decade, the stock market and the economy seemed to have decoupled. Even as the impact of the pandemic-induced restrictions seem to take away jobs and income, the stock market seemed to care less. The Nifty 50 index, for instance, rose by almost 50% from the high touched in Jan 2020. i.e before the pandemic began.
Many of us still struggle to come to terms with the stock market’s continued bullishness. Well, there are multiple reasons that explain the disconnect, one of which is the fact that the stock market is forward-looking and that it discounts the next 20 yrs of earnings. A couple of years of the pandemic are unlikely to dent the market’s long-term outlook.
But equally convincing is the argument that a lot of new-age technology companies — say, in the food-delivery space, or shared mobility space, or e-commerce segment – account for a bulk of employment and economic growth. This growth, however, is not reflected in the stock market fully as many such companies still remain unlisted. To be sure, this is now changing. As already mentioned, we have seen a slew of new-age tech companies being listed. One such promising new-age company that’s launching its IPO soon is OYO (officially known as Oravel Stays).
Table of Contents
1. OYO’s background
OYO is a leading, new-age technology platform empowering the large yet highly fragmented global hospitality ecosystem, according to RedSeer. It has been focused on reshaping the short-stay accommodation space – that is, stays of up to 1 mth – since its incorporation in 2012.
OYO has developed a unique two-sided technology platform that is focused on comprehensively addressing the key pain points of the owners of hotels and homes (also called patrons in industry jargon) on one side and their customers (or travellers and guests who book accommodations through OYO’s platform) on the other side.
Their unique business model helps these patrons transform fragmented, unbranded and underutilized hospitality assets into branded, digitally-enabled storefronts with higher revenue generation potential and provides Customers with access to a broad range of high-quality storefronts at compelling price points. As on 31 March 2021, OYO has 1,57,344 storefronts across more than 35 countries listed on their platform.
OYO was founded by Ritesh Agarwal, one of the first resident Asians to be accepted to the Thiel Fellowship (started by Paypal founder Peter Thiel). Travelling across India at the age of 17 not sure of his age at this time, Ritesh stayed in more than 100 bed and breakfasts, guest houses, and hotels to realize there was a massive dearth of affordable and good-quality hotels in the unbranded budget hotel category, thus leading to the inception of the idea for OYO.
From that, it has now moved on to a full-stack tech platform, empowering small hotels and homeowners across the world.
2. IPO offer details
The IPO offer comprises a fresh issue by OYO and an offer for sale by the selling shareholders. The fresh issue will consist of Rs. 7,000 cr. and another Rs. 1,430 cr., which will be an offer for sale from the existing shareholders. So the total IPO size is expected to be Rs. 8,430 cr.The Rs. 8,430 cr.-worth OYO IPO comprises a fresh issue of Rs. 7,000 cr. and another Rs. 1,430 cr., which will be an offer for sale from the existing shareholders. Click To Tweet
What’s worth noting here is that Ritesh Agarwal, the company’s founder, is not selling any of his stake in the IPO and another major shareholder, that is Softbank, is only offloading a small stake. The IPO proceeds will be used for prepayment or repayment of some of the borrowings of OYO’s subsidiaries, for investing in the company’s growth initiatives, and for general corporate purposes.
3. Travel industry dynamics
There are two fundamental approaches to analyzing a company’s business potential.
One is to use the top-down approach or what we call the EIC or (economy, industry and then company) model. In this we start from the top, i.e, see how the overall economy is expected to perform, then study the industry, and then the company. And another approach, of course, is the bottom-up approach, where we study the company’s fundamentals first. In this article, we’ll stick to the EIC approach as this would give us a holistic view of OYO’s total addressable market and therefore its business potential.
Remember that OYO operates in the broader travel and tourism industry, which accounts for a staggering 10% of global GDP. Not just that, but this industry is also growing faster than the growth in global GDP. In 5 yrs from 2014 to 2019, the global GDP grew at a CAGR of 3.4% while travel and tourism grew by almost double that rate at 6.1% and it is expected to grow at around that rate over the next 4 yrs too.OYO operates in the broader travel and tourism industry, which accounts for a staggering 10% of global GDP. Click To Tweet
The reasons for this may be obvious: We are seeing higher awareness among millennials about new travel destinations (thanks to social media), better access to new places, and also relatively better income levels. I believe there’s also another important factor at play, especially post the restrictions we witnessed during the past 2 yrs of the pandemic – which is a ‘behavioural and mindset shift in the way millennials perceive travelling’: This demography increasingly wishes to spend a larger portion of their income on travel, especially with the flexibility that remote working provides. A couple of my own friends recently decided to go on a one-month long workation to Goa, and thanks to the numerous affordable stay options available online, the couple is not spending more than they did in their hometown.
My point is, the travel industry may be undergoing a period of structural changes driven primarily by three fundamental factors: (1) better access to new places as the supply of new holiday homes increases. This is largely owing to the massive improvement in online discovery platforms – in fact, the onboarding of the unorganized sector to online platforms has led to increased availability of budget accommodations (2) greater options and ease of booking facilitated by a plethora of online service providers and (3) newer stay use cases such as staycation and workcation.The broader travel and tourism industry is growing faster than the growth in global GDP. In 5 yrs from 2014 to 2019, the global GDP grew at a CAGR of 3.4% while travel and tourism grew by almost double that rate at 6.1%. Click To Tweet
4. OYO business
In fact, speaking of staycation and workcation, the short-stay accommodation market, in which OYO operates, is the fastest-growing segment of the travel and tourism industry. Globally, this segment grew at 7.5% CAGR from 2015 to 2019. While the pandemic did dent demand temporarily, the industry is still expected to clock 6.6% CAGR from 2021 to 2025.
To summarize, the short-stay accommodation market has been growing faster than the broader travel and tourism industry, which in turn has been growing faster than the global GDP.Globally, the short-stay accommodation market, is the fastest-growing segment of the travel and tourism industry. Globally, this segment grew at 7.5% CAGR from 2015 to 2019. It is still expected to clock 6.6% CAGR from 2021 to 2025. Click To Tweet
Let’s also look at the growth rate of the short-stay accommodation segment in three key geographical markets in which OYO focuses heavily. These include India, SEA (with a strong foothold in Malaysia and Indonesia), and Europe. In India for instance, the short-stay accommodation market has been growing at 16.5% CAGR from 2015 to 2019 and is further expected to grow at 13% CAGR until 2025. Similarly, its growth in another key market SEA is expected to grow at 9.9%.In India, the short-stay accommodation market has been growing at 16.5% CAGR from 2015 to 2019 and is further expected to grow at 13% CAGR until 2025. Click To Tweet
Europe, however, remains the largest market in the short-stay accommodation category both in terms of value as well as volume, so it’s not surprising why OYO would want to gain a strong foothold in this geography. In fact, almost 76% of OYO’s revenues come from outside India. Only 24% comes from India. This, even as most of the company’s employees are located within India, thanks in large part to the full-stack technology platform built and deployed by OYO.~76% of OYO’s revenues come from outside India. Only 24% comes from India. Click To Tweet
Speaking of technology, it is important to note how OYO distinguishes itself from a lot of other online travel companies. You see, in the online travel segment, we have a bunch of disparate players that include online travel aggregators such as Booking.com or MakemyTrip that help you and me discover and book accommodations online. It includes channel managers such as RateGain (you may remember this company from its recent IPO launch) that handle the online distribution of rooms for hotels. It also includes hotel management systems and payment gateways such as PayPal or Paytm or PayU.
So earlier what happened is hotels had to hire the services of these different companies separately – one company to boost the visibility of their rooms to potential customers online, another to help them manage operations such as check-in and check-out services, and yet another to help manage digital payments. This was at best a patchwork of solutions to their problems.
What OYO does is provide these hotels, especially in the unorganized sector, the transition from offline to online through its own full-stack technology platform Co OYO and OYO OS, customer traffic through its own OYO app, website and corporate channel, accessibility to multiple OTAs such as MakeMyTrip, Booking.com, class-leading hotel management system, customer services and reviews – all under one umbrella. And in exchange for these services + for using OYO’s brand, the company’s patrons (which include independent hotel storefronts, hotels, and homestays) share a percentage of their revenue with OYO. Thus, OYO employs a revenue-sharing model in terms of which the company gets to keep anywhere from 20% to 35% of the gross booking value of rooms net of discounts and loyalty costs.
So, “How is this beneficial to these independent hotels in the unorganized sector?”, you may wonder. Well, as per OYO’s prospectus, “within the first 12 weeks of joining OYO’s platform, an OYO-partnered hotel generated 1.5 to 1.9 times more revenue on average compared to the average revenue estimated at independent hotels of similar size in India, Indonesia, and Malaysia.” In Europe, they earned 2.4 times more revenue than previously.OYO's mobile app has been the third most downloaded travel app globally. Click To Tweet
While the cost of hiring different companies to render a slew of disparate services including online discovery, revenue and hotel management systems, customer service system, and more may cost about the same (20 to 35% of revenues of a hotel’s revenues), the increased revenue growth prospects, driven by OYO’s single-stack technology platform and the brand’s large footprint may make for an especially attractive value proposition for independent hotels in the rather fragmented and unorganized travel sector.
In fact, in the pre-COVID period, these advantages had driven same-day bookings for OYO to rise as much as 4 times that of organized hotel chains on average. OYO’s popularity among millennials is partly also reflected in the fact that its mobile app has been the third most downloaded travel app globally. OYO also enjoys a considerably sticky user base with 77.8% repeat customers. OYO Wizard, which is India’s second-largest customer loyalty program run by leading travel or food companies, had approx 92 lakh members in March 2021.
The pandemic however has impacted the entire travel and tourism segment heavily, which as we will discuss soon, is also reflected in OYO’s financials in 2021 as well.OYO enjoys a considerably sticky user base with 77.8% repeat customers. OYO Wizard, which is India’s second-largest customer loyalty program run by leading travel or food companies, had approx 92 lakh members in March 2021. Click To Tweet
5. Financials of OYO
With new-age technology companies, especially platforms such as OYO, a major part of their value comes from what we call ‘network effects’.
Initially, it is extremely tough for platforms to attract buyers and sellers. This leads to significant cash burn as companies spend heavily on acquiring new customers through say high marketing expenses. But once a company succeeds in gaining a meaningful number of users – both buyers and sellers – on its platform, then the incremental user growth happens rather rapidly. Buyers attract sellers, and more sellers in turn attract more buyers.
When this happens, the company may benefit in two ways: One, it may register exponential revenue growth. Two, since fixed costs such as rent or lease expenses, remain more or less the same even as revenues increase, the company’s profit per unit rises. This phenomenon is known as ‘operating leverage’, and is exemplified by Indiamart. In the image shown below, notice how Indiamart’s operating profit margin or EBITDA margin rose from -13% in 2018 to 55% in 2021. This is directly attributable to the benefits of operating leverage kicking in owing to network effects.
To gauge whether the new-age tech companies are realizing operating leverage, investors normally look at what is called ‘contribution profit’. This is nothing but revenues minus all variable costs – these are costs that rise when revenues grow and fall if revenues reduce. Since variable costs are directly related to revenues, higher revenues may not necessarily mean greater profit — as variable costs rise too. So we subtract these costs from revenues to arrive at contribution profit. As OYO gains more users – both hotels as well as travellers — on its platform its marketing expenses are expected to increase at a much slower pace, thus aiding profit.
So let’s look at what OYO’s contribution profit looked like in 2020.
As shown in this chart, in 2020 the company’s contribution profit net of all variable expenses and as a percentage of gross booking value was 5%. Note that this is calculated after deducting variable costs such as loyalty discount, minimum guarantee losses, storefront operating costs, and so forth from OYO’s share of the total gross booking value. So, if the total gross booking value was 100, then OYO’s share of that would be 34%. After deducting various variable costs, the contribution profit came down to 5%. That was in 2020.
But since then, OYO has restructured its costs, which led to a significant improvement in contribution profit. Now 99.9% of its storefronts don’t have fixed payout commitments or minimum guarantees. So as you may notice in this image below, in 2021 the MG losses or the losses that the company bore owing to minimum guarantees that it provided to storefronts earlier were completely wiped out. Other costs such as loyalty discounts or payment gateway charges were further reduced. These cost-cutting measures sharply improved OYO’s contribution profit to 18% of gross booking value in 2021.
Going forward, OYO may see further improvement in its contribution profit as it scales itself through adding more storefronts and improving gross booking value per storefront. To the company’s benefit, its share of the total addressable market in their core growth markets, which includes Europe, India, and South-East Asia, is less than 1%. So growth seems less of a concern.
6. Valuation of OYO
A major determinant of OYO’s IPO listing performance would depend on the valuation that the company sets for its IPO. While discounted cash flow analysis is beyond the scope of this article, we could get a rough and rudimentary idea by evaluating the price-to-sales ratio.
Why price to sales? Well, because like most major new-age tech companies, OYO is also loss-making. So using price to earnings, does not make sense as the denominator would be negative.
The DRHP does not mention the shares or the price at which OYO will launch its IPO. But we can do a back-of-the-envelope calculation based on investment deals the company sealed very recently.In August 2021, Microsoft had invested $ 5 mn. or Rs. 37.5 cr. in OYO at a valuation of roughly $ 10 bn. or Rs. 75,000 cr. Click To Tweet
Given OYO’s revenues of Rs. 3,962 cr. in 2021, the company’s price to sales ratio would come to about 19. This would be considerably lower than the listing valuation that companies such as Zomato or Paytm or even profitable Nykaa listed. All of these are listed at a price to sales of greater than 30. Note that this is despite the fact that projecting future revenues for most of these new-age companies is tougher than the traditional businesses. Note also that OYO’s major competitor Airbnb is trading at a price to sales of 31 considering FY 2021’s revenues. Its TTM price to sales, however, is 21 which is also the median level of its price to sales ratio since getting listed.Based on OYO’s 2021 revenues, its price to sales ratio would be about 19, lower than that of other listed new-age companies like Zomato, Paytm or even profitable Nykaa. These are listed at a price to sales of greater than 30. Click To Tweet
If OYO decides to list at a more expensive valuation, then the attractiveness of the IPO would reduce especially considering the fact that the travel and tourism industry has seasonal risk factors and also the fear of Omicron variant causing lockdowns across the world has not yet subsided.
7. Risks of OYO
Let’s also discuss one of the most important factors an investor must study before investing in an IPO, which is the risks involved. Normally during an IPO, a company lists a fairly comprehensive list of risks it faces in the DRHP and discussing all these risk factors enumerated (or not) in the DRHP would be beyond the scope of this article. What we’ll do, however, is briefly discuss the major ones.
The first and foremost risk is the fact that the company is loss-making at the net level as discussed earlier, and operating cash flows have also been negative, though a public statement by the company mentions that the losses are down to approx Rs. 450 cr. per annum in FY 2022. If the pandemic worsens and lockdowns increase, then revenue could see another sharp dip, necessitating using cash flows or even additional debt to fund the ongoing operations.
To be sure, the company’s capital structure or the debt to equity mix looks quite decent. As of July 2021, that is pre-IPO, the company had a debt of about Rs. 4,980 cr. on total assets of Rs. 8,751 cr. So almost half of its assets are funded by debt at the pre-IPO level. But the post-IPO structure, that is, after raising fresh equity capital from the market, would roughly look like Rs. 2,500 cr. of debt and a balance sheet of approx Rs. 13,500 cr.
Another risk is the vulnerability of OYO’s brand value to negative publicity on media reports, social media posts, blogs, and other forums. In the recent past, for instance, several industry associations registered protests against OYO, alleging practices of deep discounting, price parity and denial of market access. You will find several of these reports online. Why could this be concerning to investors? Well, note that two of the largest asset items on OYO’s balance sheet are Goodwill and other intangible items, which majorly comprise brand equity. In fact, the brand equity is reported on the balance sheet at Rs. 1,094 cr., which is almost 12.5% of OYO’s total assets.
So one can gauge how heavily negative publicity could impact OYO’s balance sheet. Another figure that stands out from the balance sheet is the goodwill amount of Rs. 2,216 cr., which is double that of the figure for brand equity and comprises as much as 20% of OYO’s total assets. While a higher proportion of intangible assets is expected from new-age digital companies, almost 30% of intangibles seem a tad too high. Remember that a significant amount of subjectivity is involved in the computation of intangibles, including goodwill and brand equity.OYO’s brand equity is Rs. 1,094 cr., which is almost 12.5% of its total assets. Click To Tweet
That said, a large component of this goodwill is attributable to the acquisition of the @Leisure Group in FY 2020 which is a part of OYO’s European Vacation Homes business which has continued to demonstrate a very shallow dip in GBV per storefront despite COVID. Hence the possibility of a large impairment here seems low at this stage, but it may help to keep this risk in mind.
And finally, keep an eye out for the valuation at which the company decides to list. As discussed earlier, a higher valuation could mean less money left on the table for IPO investors. I have also not discussed forensic accounting or related party transactions as that would fall beyond the scope of this article – though I urge you to study them, as well as other important risk factors from the DRHP, before you undertake an investment action.