The federal funds rate has hovered near 0% most of the time since the Great Recession, making the cost of borrowing money almost free for many businesses. Entire business models were built around this perceived reality. Investors analyzed stocks based on this economic basis.
Then the interest rate environment began to change in early 2021. Over the course of the next two years, interest rates increased at one of the fastest rates in history, completely turning so many economic models on their heads. Cash was effectively free before, so holding on to it was almost considered a liability. But nowadays, it's undeniably an asset because of its potential to generate no-risk interest income.
Here are five cash-rich companies benefiting from the upward trajectory of interest rates:
- Image-browsing platform Pinterest(NYSE: PINS)
- Short-term rental marketplace Airbnb(NASDAQ: ABNB)
- Cryptocurrency exchange Coinbase Global(NASDAQ: COIN)
- Travel-booking platform Booking Holdings(NASDAQ: BKNG)
- Singapore-based Sea Limited(NYSE: SE)
I'll put things in context because the benefits for some of these companies may be short-lived. And one of these companies stands out as the most likely to benefit over the long term from the trend.
Pinterest is a social media platform with 482 million global monthly active users as of the third quarter of 2023. As these users browse the platform, they're shown ads, generating revenue for the company.
Since going public, Pinterest has been debt-free. In the third quarter, the company had $2.3 billion in cash, cash equivalents, and marketable securities. This cash-rich position earned it nearly $27 million in net interest income in Q3 alone, which is an exciting development.
Airbnb is a booking platform for travelers looking for short-term accommodations -- it could be an apartment, just a room, or an entire house. This is a high-margin business for the company. Through the first three quarters of 2023, its gross margin has been almost 83%. And thanks to its high-margin operations, Airbnb has cash, cash equivalents, and short-term investments of nearly $11 billion as of the third quarter of 2023.
Airbnb earns interest income not only from its cash but also from its customers' cash. In Q3, the company had about $6 billion in customer funds -- travelers have already paid, but Airbnb doesn't release the money to the hosts until guests check in. In the meantime, this money is also making money for Airbnb.
Between its cash and its customers' cash, Airbnb earned $129 million in Q3 interest income. And it has earned $529 million year to date. In short, its financial profile would look quite different without the currently high interest rates.
3. Coinbase Global
Coinbase offers cryptocurrency trading and custodial services for retail and institutional investors. Counterintuitively, perhaps, the company has massive resources in cash, not crypto. At the end of its third quarter of 2023, it had $5.5 billion on its balance sheet, and only 7% was held in stablecoin USD Coin(CRYPTO: USDC).
Coinbase has a special relationship with USD Coin -- it co-created it. Therefore, the company is entitled to a percentage of the profits. Stablecoins hold cash reserves on behalf of users, which generates income.
Over the last year, Coinbase generated $167.9 million in interest income from its own cash. Its interest in USD Coin brought another $668.4 million. This is over $836 million for not a lot of effort. It's a lot of money, considering Coinbase's market capitalization is about $21 billion.
The problem for Coinbase here is that adoption rates for USD Coin seem to be falling off a cliff. To start 2023, the market cap of USD Coin was around $45 billion, according to CoinMarketCap. Today, it's just $24 billion and still steadily sliding. This means that there are fewer USD Coin reserves to make Coinbase money in coming quarters.
4. Booking Holdings
Over the last 10 years, travel platform Booking went from less than $2 billion in long-term debt to nearly $14 billion. Needless to say, the company has had hefty interest payments to service this growing debt load for some time now.
But something unprecedented for Booking happened in the third quarter of 2023. In Q3, the company had net interest income on a trailing-12-month basis for the first time, as seen in the chart below.
Investors should expect this trend to continue for Booking. The company does have over $13 billion of its own cash. But it's been prioritizing a shift in its business model to more resemble Airbnb.
Before, travelers used Booking's platform to find deals and then left the platform to book their travel. However, Booking is building its own payment platform now, allowing travelers to book inside its platform. The end result is that the company gets to hold onto the travelers' funds.
Now, like Airbnb, Booking is increasingly earning interest income from customer funds and not just its own.
5. Sea Limited
Sea has operations in e-commerce, video games, and financial services. The rise in interest rates has changed the company in more ways than one. When cash was basically free to borrow, it borrowed and burned through cash to stimulate growth. But once interest rates went up, Sea's management started prioritizing profitability.
In the second quarter of 2022, Sea had a net income of $331 million compared with a net loss of $931 million in the prior year period. This nearly $1.3 billion one-year swing shows just how serious the company is about profits.
Sea will report financial results for the third quarter on Nov. 15. But for Q2, the company had cash, cash equivalents, and short-term investments of $7.7 billion. It also had over $3.3 billion in convertible note debt. But these notes all have interest rates lower than 2.4%, which means it's not costing the company much.
Consequently, like Booking, Sea's net interest income has skyrocketed in recent quarters, as the chart below shows.
What does this all mean for investors?
Interest rates have materially changed the economics of many businesses, including Pinterest, Airbnb, Coinbase, Booking, and Sea. So it's important to think through how it changes investment theses.
Of these, I'd say that the benefit to Coinbase may be the shortest-lived. As I explained, a large part of the company's interest income is thanks to USD Coin, but adoption is trending in the wrong direction.
For Airbnb, Booking, and Sea, there's something else for investors to consider: Interest rates are up in order to slow down the economy and reduce inflation. And travel and video games fall under discretionary spending. Therefore, these could experience reduced demand as consumers make cuts in a slower economy.
For its part, Pinterest's users will likely continue to browse the platform regardless of economic conditions and will, therefore, keep seeing ads. Advertisers may pull back on ad spending in a slower economy, which wouldn't be great for Pinterest. But it has a way to push past this headwind.
Pinterest is opening up its ad network to third parties, which has the opportunity to boost rates. Therefore, even if advertisers pull back somewhat on their spending, Pinterest might be able to make up the difference.
In conclusion, higher interest rates have changed the economics of many businesses for the better, including Pinterest. I believe its opportunity is the least threatened of these five companies, which makes it the clear winner for me today.
That said, I believe Airbnb, Booking, and Sea are also good stocks to buy today. Investors will just want to monitor consumer demand in coming quarters just in case these businesses take a step back in a cooling economy.
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Jon Quast has positions in Airbnb and Pinterest. The Motley Fool has positions in and recommends Airbnb, Booking Holdings, Coinbase Global, Pinterest, and Sea Limited. The Motley Fool has a disclosure policy.