2023 Week 7: Fed Is In Trouble

Subway is looking for buyers; Airbnb posted strong earning results as tourism bounces back; inflation has not cooled off

💡Did you know? With $5000, FedEx’s founder Fred Smith gambled in Vegas to save his company from the verge of bankruptcy. Fred won $27,000, buying time for the company to last a few more days, during which he raised additional money from investors. Today, FedEx is worth $50 billion.

Market Rundown

Subway: On Sale!

Source: CNN

📝Quick Recap

After 5 decades of ownership, the founding families are now selling Subway (initial estimates put the sandwich chain’s valuation at ~ $10 billion).

Why are they selling?

Well, the company has had its fair share of troubles over the past decade — increased competition, rising costs, decreasing sales, leadership scandals, and legal troubles.

The big question marks on everyone's mind: Who will purchase Subway?

Strategic buyers? Fast food restaurant operators (e.g., McDonald’s) are benefitting from rising inflation as consumers flock to cheaper restaurant alternatives. It is possible that they would take the opportunity to diversify their business. But there are a lot of different aspects that also need to be considered:

• Strategic fit — does Mcdonald’s want to own Subway? Maybe this type of purchase is better suited for holding companies with multiple brands under their belt (e.g., Yum Brands).

• Operation — does the acquirer have the operational know-how (e.g., logistics, franchise mgmt.) to run Subway successfully?

• Financials — how to finance such an acquisition (debt is quite expensive)? Also, is it a good time to spend money on an acquisition, or is it better to conserve cash when the economy is not doing well?

Financial buyers? Private equity (PE) firms are finding funds expensive to secure. They need to borrow funds at higher rates to fund acquisitions, decreasing returns potential per acquisition. So, it is unlikely that a PE firm will pounce on this opportunity unless they believe they can extract a lot of value from improving Subway’s operations.

With the interest rate hikes in 2021, leveraged buyout loan volume has declined since 2021. Private equity firms are shying away from taking high-interest-rate loans to finance deals (Source WSJ).

Even if a buyer comes by, where could they potentially realize their returns?

Increasing same-store sales: Subway saw its revenue peak in 2013 (~$12.3 billion). Since then, revenue has declined, reaching ~$9.4 billion in 2021.

• Revamp the menu: Subway’s menu is lackluster — I don’t recall a single new item being added to the menu over the past decade. Keeping the menu exciting is a great way to boost the number of new and returning customers — why do you think Mc Donalds and KFC invest millions into launching a new food item?

• Store makeover: Unlike McDonald’s, Subway does not sell an experience, which is a crucial factor in retaining customers. Think about it — you care about the food and the restaurant's general ambiance (not vice versa). Subway’s restaurants have an outdated feel to them, and it is just not a place families would spend time together. Hence, a general makeover is needed to encourage frequent visits. Additionally, there is plenty of room to play around with Subway’s store layout, such as placing drive-throughs, which would help improve same-store sales.

  

Reducing costs wherever possible: Subway has one of the largest restaurant chains globally. Yes, globally! The main idea here: retain profitable stores in key areas and shut down unprofitable stores, reducing operational costs where possible.

Airbnb: Swimming in Mula

📝Quick Recap

AirBnB reported upbeat Q4 results last Tuesday, beating analysts’ expectations. AirBnB accumulated $8.4 billion in revenue in 2022, a 40% increase since 2021. More importantly, the firm generated its first profits, totaling $1.9 billion.

What is the main driver behind these upbeat results?

After China finally opened up its borders, tourism is in full swing. (Source: CNN)

Travel restrictions eased up throughout 2022. Tourism is in full swing, and hospitality players are benefiting from this recovery after suffering significant losses during COVID.

Airbnb saw a 20% increase in nights booked in Q4 ‘2022 vs. Q4’2021, with cross-border night bookings increasing by nearly 50%! Analysts expect strong tailwinds in the tourism sector to boost Airbnb’s earnings well into 2023.

🧐Things to look out for as investors

Airbnb’s flywheel effect visualized (Source: Eric Jorgeson).

Airbnb has a fantastic business model. The firm's relentless focus on improving host and customers’ experience, minimizing user acquisition costs, and building a business with solid network efforts have transformed Airbnb into a hospitality titan.

However, as we progress well into the decade, investors would expect Airbnb to make a couple of moves to fortify its business further:

• Airbnb’s revenue is primarily concentrated in North America (~50%) and Europe (~30%). APAC only contributes ~10% of Airbnb’s total revenue, even though APAC is the largest market for global tourism (~45% of total tourism spending). In other words, Airbnb is still under-penetrated in the APAC. Hence, it is crucial to observe how Airbnb diversifies its revenue concentration risk and increases exposure into the APAC market as we head toward 2030.

• Airbnb is now focused on boosting transaction value and attracting hosts onto its platform, resulting in the firm charging lower take rates (aka commission charges to hosts and guests as a percentage of booking fee) than competitors. However, with any platform-based model, it is expected for the platform to gradually increase its take rates to boost profitability, during which it will be critical to monitor guest and host churn. Does Airbnb have the brand loyalty it takes to retain customers? Only time will tell.

Inflation: Not Cooling Off

📝Quick Recap

Source: NYTimes

The new inflation data showed that US consumer prices rose by 6.4% in January, which was lower than 6.7% in December. Additionally, annual core inflation, which excludes volatile food and energy prices, was above expectation at 5.6%, slightly down from 5.7% in December.

What does this mean?

Inflation is not going away anytime soon. Last year's interest rate hikes have not put sufficient downward pressure on inflation. The market expects the Fed to ramp up its interest rate hikes to keep inflation under control. As a result, yields on the US treasury reached as high as 3.75%.

🗒Weekly Headline Summary

Asia-Specific

1. Nissan's China EV game plan key to jump-starting stalled stock|NK

2. Star Banker’s Disappearance Unnerves China’s Business Elite|BB

3. ASML’s Big Bet on China Is Starting to Backfire Over Data Thefts|BB

4. Thailand Pins Hopes on Return of Long-Missed Chinese Tourists|WSJ

Beyond Asia

1. US Stocks Are Beating Everyone Else Once Again|BB

2. Auto Dealers See Mixed Signals|WSJ

3. Goldman Sachs, BofA expect three more U.S. rate hikes this year|RT

🤓What am I reading:

1. Putin’s War to Lop $190 Billion Off Russia's Economy in Delayed Reckoning

2. What CEOs Are Getting Wrong About the Future of Work—and How to Make It Right