Ctrip's Unappealing Valuation

Excerpted from Gilford Securities analyst Ashish R. Thadhani's recent report to clients on Ctrip.com International (CTRP):

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Investment Conclusion. At the outset, it is our position that the recent use of Ctrip shareholder funds to endorse a management-related entity, HMIN, represents an unacceptable infringement of U.S. corporate governance standards. Based on the sharp downturn in Chinese economic activity – offset by recent finalization of preferential tax status – we are also reducing our estimates: 2009 GAAP EPADS to $0.90 on net revenue of $243 million (+13% YoY) from $0.95 on $261 million; and 2010 GAAP EPADS to $1.05 on $297 million (+22% YoY) from $1.15 on $319 million. Near-term profitability is likely to suffer on account of airline discounting and lower occupancy rates at high-end hotels. Our model assumes an upturn in domestic business travel during 2H09. The sizable government stimulus and recent Shanghai composite index rally (+36% from an October low) could underpin improving sentiment. Given single-digit compound GAAP EPADS growth in 2008-10E, CTRP is selling at an unappealing valuation of 23x forward EPS, in our view.

Quarterly Results. Ctrip released 4Q08 results on Sunday. GAAP EPADS of $0.26 on net revenue of $58.1 million (+19% YoY in USD) beat our $0.19 estimate on $56.4 million. A catch-up tax benefit boosted results by 6.3 cents. Operating income of $17.1 million (29.5% margin) contracted 2% YoY but exceeded our $16.7 million estimate (29.6% margin). Profitability was impacted by lower average prices for air tickets (down 10-15% YoY) and hotel rooms (down 4-5% YoY) although commission rates stood firm. Cost pressures were mitigated by a hiring freeze and tight discretionary spending. Packaged-tour revenue was resilient (+47% YoY), which augurs well for newcomer Universal Travel Group (UTVG.OB). Management noted healthy volume growth (+11% YoY for hotel room reservations and +41% YoY for air-ticket sales), continued expansion of the domestic hotel network (+28% YoY to 7,700) and active customer base (+48% YoY to 6.2 million). Net cash declined to $203.5 million (or $3.00 per ADS) from $226.7 million on September 30. Ctrip has not activated the ADS buyback and management indicated that this program will replace the 30% dividend payout for 2009.

Noteworthy developments are summarized below.

December 2008. Between September 12 and December 29, Ctrip purchased the equivalent of 3.1 million ADSs or 8.7% of HMIN in the open market for $38.4 million. This translates into an average price of $12.41 per ADS and a 28% unrealized loss. On January 9, HMIN warned that December quarter revenue will come in at the low-end of its previous guidance range. Ctrip officers and directors co-founded HMIN and currently hold a 17.7% ownership interest in the company.

August 2008. The board authorized a $15 million ADS repurchase program. In 2008, results were held back by severe weather conditions (1Q), the Sichuan earthquake (2Q), disruption around the Beijing Olympics (3Q) and a slowing economy (4Q).

January 2008. To support growth in 2010 and beyond, Ctrip will invest $40-50 million through 2011 for building a second call center in Nantong (110 kilometers north of Shanghai).

August 2007. Rakuten sold its 13.3 million ADSs for $38 each to lock-in a 360% return over three years.
January 2006. Ctrip promoted COO/co-founder Min Fan to the position of CEO. James Liang, former CEO, continues to serve as Chairman.
October 2005. Ctrip announced that Ms. Jane Jie Sun will assume the position of CFO. Ms. Sun replaced former President/CFO Neil Shen, who joined VC firm Sequoia Capital but remains a board member.
July 2005. The Chinese government changed its currency policy. Over time, anticipated RMB appreciation should translate into higher dollar-denominated operating income, offset by near-term currency translation losses.
December 2004. Existing shareholders (including management) sold 7.7 million ADSs at $12.13 each.
June 2004. Ctrip attracted a $110 million investment at $8.25 per ADS from Rakuten.
December 2003. Ctrip raised net proceeds of $44.5 million from its IPO (at $4.50 per ADS).

Investment Thesis. Powered by rising GDP and disposable incomes, the Chinese travel industry is expected to sustain double-digit growth in coming years. Traditional agencies have been limited to a local/fragmented presence (due to licensing requirements) and focus primarily on tour groups. Pioneering consolidators like Ctrip offer selection plus savings to the individual traveler, and have become valuable aggregators of demand for the travel industry. Superior positioning includes the following: 85% of hotel reservation revenue is derived from bookings at three-to-five star hotels, where the commission per room is highest and room nights have grown 20%+ industry-wide in recent years. Ctrip boasts a nationwide supplier network, which assumes particular significance in a country with no hotel GDS. Market leadership has translated into a premium commission structure, i.e., 15% of the room rate or $10 per night. Ctrip has also sought to differentiate itself through service quality and innovation. Longer-term growth stands to benefit from continued expansion of hotel coverage and relaxation of travel restrictions, as well as recent implementation of an e-ticketing mandate.

CTRP is suitable for aggressive investors. In our opinion, principal risks include the following:

• Deterioration of economic conditions or a slowing of travel demand in China.
• Inability to secure adequate room availability under “guaranteed allotment” arrangements (that afford risk-free inventory and contribute three-quarters of hotel transaction volume).
• Competition could pressure future profitability by way of lower commission rates and/or higher marketing expenses.
• Disruptions affecting travel demand. This encompasses terrorist threats; geopolitical instability; catastrophic events; and spread of the H5N1 virus or a recurrence of SARS (necessitating closure of the Shanghai call center).
• Correction in the U.S. markets.

Disclosure: I, Ashish Thadhani, certify that all the views expressed in this research report accurately reflect my personal views of the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of this report.