Sonder is now a speculative buy

The SPAC bubble has burst, and in many cases, investors who invested in such names have lost almost everything. Hospitality startup Sonder ($SOND) is one of these names. Investors who bought the stock shortly after it went public have lost nearly 95% of their invested capital – a total disaster.

Despite the market rally this year, Sonder stock hasn't rebounded. Instead, it has fallen 56% year-to-date as the company has given up on achieving its first cash-flow-positive quarter this year due to macro headwinds, including high interest rates and consumer weakness.

At about $0.50 per share, Sonder is officially a penny stock, meaning that it'll be extremely volatile for the foreseeable future, and its performance won't be entirely driven by company fundamentals. However, the stock is a buy – a speculative buy – because the company has been steadily improving its cash burn rate, and growth has been strong. On top of that, the continued strength of the US and global economy will benefit Sonder, and given that the stock trades near all-time lows, it can surprise investors to the upside. Let's take a deeper look.

Strong Economy Can Help Sonder Sustain High-Growth Rates

Sonder's fundamental performance depends on the strength of the overall economy because travel is a discretionary expense for both businesses and individuals. This means that the resilience of the US economy, which is Sonder's main market, will help the company sustain its high growth rates.

Sonder operates a rent-to-rent business model, leasing apartment complexes that it then converts into short-term rentals. The company's goal is to build a global brand that goes head-to-head with hospitality giants such as Hilton ($HLT), Marriott ($MAR), and Hyatt ($H). While there are no barriers to entry in the short-term rentals market, meaning that competition will be stiff, Sonder can differentiate itself by focusing on building a strong brand. A strong brand is a competitive advantage in the vacation rental industry because it instills confidence in customers regarding the quality of the services and the overall experience.

In Q1, Sonder surpassed 10K live units, up 35% y/y. The company continues to expand rapidly as the demand remains robust and bookings are strong. The Q1 occupancy rate came in at 80%, compared to 73% in the year-ago quarter. This clearly shows that Sonder is doing a good job keeping its apartments almost fully booked even though it is expanding rapidly. At the same time, it improves its profitability by utilizing its thousands of contracted apartments instead of signing new contracts that would put pressure on cash flows.

Slow But Steady Progress Towards Positive Cash Flows  

Sonder used to focus exclusively on growth, ignoring profitability. This is how it has grown its apartment portfolio to over 10K in less than 10 years. But as a public company, it has changed its strategy because the cash burn has been unsustainable given the tightening monetary environment.

Now, Sonder is prioritizing profitability without sacrificing growth, and it is doing a good job. In Q1, its revenue grew 50% y/y to $121 million, thanks to a 30% increase in bookable nights and a 15% y/y increase in RevPAR (Revenue Per Available Room) to $134. RevPAR is a metric used in the hospitality industry to measure hotel performance. It's calculated by multiplying a hotel's average daily room rate (ADR) by its occupancy rate.

Given that the company is growing rapidly, RevPAR can increase in the future as newer apartments mature and reach their full potential. This means that besides unit growth, RevPAR can also be an important revenue driver.

As we saw above, Sonder is currently growing by converting contracted units to live units instead of burning cash to sign more leases. As you can see below, the number of contracted units was flat quarter-over-quarter in Q1 and was down significantly compared to the same period in 2022. This is part of the company's plan to grow more efficiently. It has terminated some contracts that are expensive for the current environment and has prioritized the conversion of contracted units to live units. Sonder currently has nearly 8K contracted units, meaning that it can essentially double its revenue by utilizing its existing portfolio.

The company is still burning cash because of all the contracted units that are not live yet, but the progress toward positive cash flows is clear. In Q1, the operating cash flow margin improved to -29% from -63% in the year-ago quarter, which is a significant improvement driven by disciplined spending and growth strategy. For example, non-property level operating expenses fell 20% y/y in Q1, even though revenue jumped 50% over the same period. This shows that the company was not financially disciplined in the past, as a 50% increase in revenue and a 20% decrease in operating expenses mean that a big portion of these expenses were unnecessary.

The current trajectory of the cash flow margins is very encouraging because it's consistent, and the company's guidance suggests that margins will continue to improve in the coming quarters. As you can see below, for the second half of 2023, Sonder expects cash burn to improve to -$40 million at the midpoint of the expected range, from -$69 million in the same period in 2022.

The company seems to be on the right path because of its decision to slow its growth of contract units that negatively impact cash flows until they get converted into live units. If the economy and, as a result, the demand for vacation rentals remain strong, Sonder can continue to utilize its portfolio of contracted units to drive growth, which will further improve its cash flow metrics and help it become cash flow positive in 2024. But if we see softening demand for vacation rentals in the coming quarters, Sonder's cash flow progress will be delayed, and the company may need to raise funding to sustain its cash-burning operations.

What Else

Sonder is currently trading in penny stock territory because the company is burning cash, and it is still not clear when it'll achieve its first cash-flow-positive quarter. The stock is risky and speculative under $1 per share, but if the positive progress continues, investors will reward the company, sending its stock much higher. Given that expectations are too low, it's easy for the company to surprise to the upside, making $SOND stock a speculative buy.

I've no positions in the stocks mentioned.

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.