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The Sharing Economy: Tapping into New Investment Opportunities

Credit Suisse Friday, 02 September 2016.

credit suisse 020916 2The rise of the sharing economy is now a high-profile investment theme driven by the rapid growth of the internet. Established online giants could either face challenges, or benefit from this disruptive force.

Some business leaders in non-internet-based industries view a meeting with Google as if it was a "rendezvous with Joe Black" in reference to the movie of the same name, in which a media mogul meets Death in the form of a young man. Traditional industries may still be alive, but Google serves as a reminder that their time could soon be up. The sharing economy is another a disruptive force to existing industries, as it continues to record rapid growth. According to Crowd Companies, participation rates in sharing services has been on track to double in 2015. Industry researcher Nielsen reports that 68 percent of adults globally are willing to share or rent goods. Sharing is not a new idea, so why is it becoming such a disruptive force?

The main reason is that there has been a shift from physical to digital merchandise. The latter has gained considerable traction as the internet expands to mobile communication devices and other things. This makes it possible to coordinate peer-to-peer or business-to-people services in a more efficient and secure manner. Many internet-based sharing platforms and marketplaces such as Spotify and HomeAway have emerged, and the number of users is growing quickly. Companies to watch include non-listed venture-capital funded firms such as Uber, Blablacar and Airbnb, valued between 5 billion and more than 50 billion US dollars in the gray market.

Value Placed on Leverage Potential
Why is it that sharing firms appear to be so attractive and why do investors value them at much higher amounts than traditional rental companies? Industry researcher PricewaterhouseCoopers identifies five main sharing-economy sectors: peer-to-peer lending and crowdfunding, online staffing, peer-to-peer accommodation, car sharing, music and video streaming. It expects the sharing economy to grow to 335 billion US dollars in sales over a ten-year period. Half of this would be generated by the new sharing economy internet platform firms.

Investors are enthusiastic about such growth prospects. They also like the structure of internet platform firms and the scalability of their business models. Uber, Airbnb, as well as listed company Just Eat, merely serve as a hub to bring a large number of suppliers and users of services together at the click of a button. The cost of a transaction is close to zero. Investments are limited to the costs for building, providing and maintaining an IT platform, a mobile application and an easy-to-handle and secure payment system. Investments are relatively low, and represent manageable fixed costs. To reach break-even, the platform needs to reach a critical mass of transactions, for which firms usually charge a commission of 1-10 percent of the value of the product or services used. Once critical mass is achieved, every new user and transaction contributes to a rising margin. Thus investors should first look at the sustainability and potential size of a company's user base, and how often users access the platform when analyzing the value of a newcomer in this market.

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User Base of Sharing-Economy Internet Platform in Millions
Source: Company data, Credit Suisse

A Challenge to Established Internet Giants?
User base and engagement rates are also important for incumbent internet giants such as Facebook, Google, Amazon, LinkedIn or Priceline.com. In the past three years, the value of the listed internet-based companies cited earlier has increased by between 80 and 300 percent on growing sales of 20 to 30 percent per year. Are such growth rates now in jeopardy due to the rising success of sharing economy internet platform firms? Could these newcomers have a negative impact on the business of well-established companies? The users of the new internet platforms still engage much less than those who use platforms of more established companies. But if the newer platforms continue to grow, they will have the option to enter into new businesses, and to also compete with the internet giants. It is natural that Uber or Airbnb would want to look at other markets such as advertising and retail.

There are clearly potential negatives but also positives for established internet giants. If consumers rent more, it could have a dilutive impact on growth rates of commercial sales or searches. Amazon and Google, however, already act as sharing platforms and could expand to other sharing offerings as well. They could also acquire a successful new internet platform to expand their core business. The trend toward a sharing economy could have a very positive impact on social media firms such as Facebook and LinkedIn. They could monetize their database and provide identity and reputation profiles, as trust and reputation in sharing services are crucial. Both firms could play a big role via log-ins and connections for sharing businesses.

From an investor's point of view, the sharing economy should be positive for the internet sector, as it leads to increasing internet engagement. New and established internet platform firms continue to generate value, mostly at the expense of traditional sectors. Furthermore, valuations need to reflect newcomers' takeover appeal as well as the "option value", - their potential to enter into new businesses. These companies are a disruptive force to be reckoned with.

Written by Uwe Neumann for Credit Suisse

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