Last week, hospitality unicorn OYO raised $1Bn to fuel its growth in the Asian market and beyond. 

OYO, started in 2013 by college dropout Ritesh Agarwal, has become one of the most famous (and infamous) startups in India.

Mr. Agarwal, having dropped out of college at 18 and winning the Thiel Fellowship at 19, became a poster boy of the rags to riches Indian success story. From a small town in Odisha to being the 25-year-old CEO of one of the most well-funded startups in the world, is a great story for the Indian media.

Along the way, such "quick and early success" also had a lot of legitimate doubters. In 2015, Mint published a detailed account of the dark underbelly of the company's history. In 2016, an entrepreneur wrote a viral post on how OYO is the equivalent of a Ponzi scheme.

Mr. Agarwal responded in earnest, but the bad press didn't stop.

From mismanagement of rooms, to criminal activity - OYO has had to battle doubters, perpetually like a house of cards. Investors in the company, though, have never doubted the potential of the company and have put in $1.5Bn for the company to scale rapidly over 5 years.

Softbank's Son has had a strong liking for the company, and funded it despite multiple pivots, and continued losses.

So what is OYO rooms really?

The company started off as Oravel stays, an AirBnB me-too.

It quickly pivoted to a marketplace of budget hotels, then a managed marketplace of budget hotels and now even has premium hotels and co-working spaces. CB Insight's Anand Sanwal called this the Ponzi Scheme of ambition for Uber, but OYO isn't stopping.

The company set its sights on the Indian budget market first, valued at ~$7Bn, then the Chinese market ($35 Bn) and then the SEA market ($15Bn). It is, therefore, a $62Bn overall market, of which OYO's addressable market is 25% (its take rate) or $12Bn.

The company, though, could very well gun for the entire $200Bn budget hotel market in the world, a tall ambition. Let's work with the $12Bn number, and focus on the Asian market for now.

Premium travellers are already catered to, with budget travellers ($25-$80/night) not really well served. The pain point that the company is solving for is the fact that budget hotels are "mom and pop" establishments, with little standardization and predictability.

Travellers don't know what they are getting to (quite literally), and this was inspired by Mr. Agarwal's difficulty in travelling. Fragmented, disorganized and opaque - the industry is the recipe for "disruption". Uber did it for transport, AirBnB did it for travel, Facebook did it for advertising.

The trouble is, these are not the right comparisons at all.

OYO is more McDonalds than any of the above, a franchise model that needs to stick to quality. The comparison is even more apt - McDonald's is actually a real estate company (leasing would actually be a great business for OYO).

Franchises live and breath by their brand, one poor experience taints the entire brand.  Uber, AirBnB and Facebook do not take "responsibility" for the work of "independent contractors", OYO has to.

The market that OYO operates (and is trying to disrupt) is also complex.

The very fact that it is opaque and non-standard makes OYO a victim of scam-iness, these hotel operators have over-promised and under-delivered for years (e.g. here). Changing them through SoPs is going to be hard, while McDonalds usually gives its franchises for fresh stores - with operators having demonstrated good history.

Moreover, one bad burger may not make for a lost customer, but being locked in for one bad night makes you more likely to lose a customer.

Clearly, there are considerable obstacles - but there's no value addition if there is no challenge. OYO had to purge hotels, make them "tech driven", do audits, be data driven. All this has a cost, and it is clearly not small. Given this, how has OYO done overall?

OYO has grown from 4,000 rooms in 2015, to 80,000 in 2016 and is at 200,000+ today. The company boasts of 125,000 rooms in India, and 87,000 in China (notice the falling China:India ratio). 

What is intriguing is that although it has 5% market penetration in India (no saturation), it is rapidly expanding into other geographies (keep this question in mind).

In FY2016, the company posted a revenue of INR 40 Cr($6MM), while in FY2017 it was INR 125Cr ($20MM). The company today claims to host 125,000 stayed nights daily, or 45MM nights a year. OYO, per it's own claim, does an average of $30 per night, so that implies a $1.35Bn GMV - at a "net take rate" of 15%, the company revenue run rate is $200MM in FY2018.

OYO claimed its occupancy was 70% last year, but assuming the company has 200K rooms, and 125K nights stayed - occupancy has likely dropped to 60%. To estimate CAC, the company had a marketing expense of ~76 Cr in 2017. For a $20MM revenue, that is ~600K nights. OYO customers do an average of 1.5 nights per stay and stay twice a year (3 nights annually per customer).

That assumes they had 200K customers that year, and let's assume 200K more were acquired for next year due to the company's growth. That puts CAC at ~INR 1,775 (or $30). In FY2017, the company spent 194 Cr on employees.

Per LinkedIn, the company has grown from 3000 in 2017, to 6000 today. That likely puts employee expenses at 400 Cr ($70MM). Notice the employee growth is 2x for a 4-5x growth in topline ("operating leverage), at scale - this will increase profitability.

The company runs at a ~50% gross margin, and we should now try to understand unit economics. (Note: Gross Margin = Revenue - Operating Expense, which as per their classification is a direct expense)

An average customer spends $30 per night, for 1.5 nights and 2 visits. Therefore an average customer spends $90 on OYO yearly. OYO makes 15% net take rate, or $13.5. At a 50% GM, that's $6.5 of margin per customer. For the $30 CAC, it would take ~4 years to recover.

Company "sources" mention CAC is far lower at INR 550($8), which would still take a year to recover. What is really intriguing is the 90% repeat rate that is repeated by the CEO (implying a 10% annual churn).

Using an Annual revenue of $13.5, at a 50% margin and 10% annual churn rate - we arrive at an LTV of $75. If this is really true, the LTV is 2x the CAC I computed ($30), and this makes OYO a fairly robust business on a customer level. The business, though is highly sensitive to repeat rate, if the repeat rate falls to 80% - the LTV is halved.

If these metrics are really true, the intriguing question of expansion despite no saturation gets answered - the business is a land grab of high LTV customers. 

OYO's biggest weakness, and biggest strength, that it is in the high volume budget segment.

The segment, unlike premium, demands scale to make a business really big. Cost and brand are big drivers, and if the quality is not scaled, it can kill the brand. If the brand can reach a high volume of customers, though, it becomes harder and harder for other brands to come in.

Customers want to look where they have more choice, hotels want to onboard where there are more customers (i.e. the definition of network effects). The reason OYO is aggressively expanding supply is so that it provides wider and wider choice to customers, who in turn help attract more hotels.

Acquire a customer and hotel today, monetize tomorrow and day after.

The bigger the moat, the higher the LTV. If the repeat rate is indeed true, there is sound logic in Son's argument that the company could be wildly profitable in the future like Facebook and Google.

Both these businesses, and McDonalds, rely on high repeat rates.

The success on OYO is pinned on having customers come again, and that may be definitive in its progress from being on a weak footing to strong foundations. It has to ensure a tight and well-served experience for customers.

OYO could very well progress from being a House of Cards to a Castle with a Moat.