It doesn't take a rocket scientist to figure out that travelers are booking an ever-increasing amount of their trips online, and much of global growth is coming out of developing markets in Asia, The Middle East and Latin America. These long-term fundamental trends provide a robust runway for Priceline (PCLN) and other online travel sites. International travel is estimated to be a $600 billion market and market share is extremely fragmented amongst a diverse array of competitors. Priceline parlayed its astute 2004 and 2007 acquisitions of booking.com and agoda.com, respectively, into becoming the leading global online travel provider. At current prices, Priceline offers a high-risk, high-reward investment opportunity due to the immense opportunity to enhance market share, weighed against the lack of a strong durable competitive advantage.
I won't be the first or the last to say that internet companies are, generally, extremely hard to value for value-oriented investors. Even if you exclude the obvious historical eccentricities such as pets.com, there are other companies such as myspace.com and yahoo.com (YHOO), which lost huge amounts of market share despite having early-mover advantages. These horror stories in my opinion are dwarfed by the long-term successes of Google (GOOG), Amazon (AMZN) and eBay (EBAY) that have continued to increase their economic moats over time. I remember considering pulling the trigger on buying Amazon stock when shares were trading around $13 when I first experienced the company's easy user experience, and I knew it was highly out of favor, but I didn't pull the trigger for a number of reasons, not the least being inexperience. Many people can tell similar experiences with an Amazon or Google at its IPO, but I've never looked at it wistfully with regret, because much of my own investment success has been due to understanding my own circle of competence. At its IPO, Google was beyond my circle of competence due to a high valuation and lack of a durable competitive advantage, but as the company grew into the most powerful advertising firm in the world and the valuation compressed, I became comfortable and invested very profitably in it. Google is an example of a company that built a moat and has kept widening it on a daily basis, while continuing to enhance its own siege-engines to attack its competition.
Priceline has been a tough cookie to crack because there are a variety of very strong and well-financed competitors that offer very similar services. The company has become the online travel leader through its effective name-your-own-price initiative, and its risky but successful acquisitions of booking.com and agoda.com in 2004 and 2007, respectively. These acquisitions focused the company's operations in Europe and Asia, which have a different travel dynamic than the United States, consisting of more boutique and standalone hotels. The vast majority of Priceline's revenues are generated internationally and on hotel bookings, which is why the different lodging dynamic overseas has weighed so heavily in the company's impressive outperformance of its peers. The larger hotel chains that saturate the United States market tend to try and drive their own website traffic, while offering rewards programs that can differentiate their offerings from some of Priceline's services such as name-your-own-price. Because European and Asian lodging markets are more fragmented, meaning lower bulk advertising budgets, a company like Priceline provides an extremely valuable service by driving traffic to its partners. Priceline spent in excess of $1.2 billion on online advertising in 2012, which directly benefits those partners. The fees that Priceline makes are generally less than the costs of using traditional travel agencies, or other referral generating entities. Latin America is fertile ground for Priceline moving forward as well due to its attractive economic and travel fundamentals, but competition is increasing in all of Priceline's key markets.
To put Priceline's phenomenal operational and financial performance in perspective, the company grew gross bookings and revenue at annual rates of 46% and 31%, respectively, between 2006 and 2011. Low capital requirements are a blessing and a curse for Priceline, because the company has generated huge returns on both equity and capital, well in excess of its cost of capital, but the low investment hurdles opens the door to a wide variety of online and traditional travel competitors. The biggest risks to Priceline in my opinion are the large and well-financed search and social websites such as Google, Microsoft (MSFT) (through Bing), and Facebook (FB). These companies are just a small fraction of companies that could severely disrupt Priceline's profitability and growth by diverting traffic away from Priceline. Google and increasingly Facebook are two of the top advertising resources across the globe, so the stickiness of Priceline's partner relationships will most likely be put to an extreme test sooner rather than later. Other competitors such as Expedia (EXPE) are partnering up with entrenched operators in key markets such as China, while various large lodging operators' have launched Room Key, which is a hotel search engine that competes directly with Priceline's. Data aggregator sites are also a huge threat, which Priceline is hoping to thwart with its November 8th, $1.8 billion acquisition of Kayak Software Corporation (KYAK).
Priceline offers in-depth financial statistics and, like many technology concerns, the company leverages a very liberal non-GAAP accounting system, which greatly improves the data. Priceline's non-GAAP numbers include the following adjustments:
Non-GAAP guidance for the 1st quarter 2013:
• excludes non-cash amortization expense of intangibles,
• excludes non-cash stock-based employee compensation expense,
• excludes non-cash interest expense and gains or losses on early debt extinguishment, if any, related to cash settled convertible debt,
• excludes the impact, if any, of significant charges or benefits associated with judgments, rulings and/or settlements related to hotel occupancy tax and other related tax proceedings,
• excludes non-cash income tax expense and reflects the impact on income taxes of certain of the non-GAAP adjustments,
• includes the additional impact of the non-GAAP adjustments described above on net income attributable to non-controlling interests, and
• includes the dilutive impact of additional shares of unvested restricted stock, restricted stock units and performance share units because non-GAAP net income has been adjusted to exclude stock-based employee compensation.
Source- Priceline 4th quarter 2012 earnings release
On February 26th, Priceline reported 4th quarter and full year earnings results that were very strong. 4th quarter gross travel bookings for the Priceline Group of sites, which refers to the total dollar value, generally inclusive of all taxes and fees, of all travel services purchased by its customers, were up 32.9% YoY to $6.6 billion. On a local currency basis, the total dollar value was up 35% YoY. Gross profit for the 4th quarter was up 29.7%, YoY, to $940MM. International operations contributed gross profit in the quarter of $836MM, which were up 37.3% from the 4th quarter in 2011. Operating income in the 4th quarter was $374MM, which was up 23.2% YoY. GAAP net income applicable to common shareholders for the 4th quarter were $289MM, or $5.63 per share. This was up from a 4th quarter profit of $226MM or $4.41 per diluted share in 2011. Non-GAAP gross profit for the 4th quarter was $956MM, a 31.9% increase from 2011. Non-GAAP net income was up 25.9% YoY to $349MM, or $6.77 per diluted share. Adjusted EBITDA was up 23.7% to $426MM in the quarter.
For fiscal-year 2012, Priceline had gross travel bookings of $28.5 billion, which was up 31.4% from 2011. This equated to 37% growth on a local currency basis. The company's gross profit was $4.1 billion, up 32.6% from 2011. Priceline's international operations contributed fiscal-year gross profit of $3.6 billion, which was up 38.8%. 2012 operating income was up 30.8% to $1.83 billion. GAAP net income for the year was $1.42 billion, or $27.66 per diluted share. This was up from $1.06 billion or $20.63 per diluted share in 2011. Non-GAAP EBITDA for the year was up 30.6% to $1.97 billion, while non-GAAP net income was $1.61 billion or $31.28 per diluted share.
Priceline provided the following guidance for the 1st quarter of 2013:
Year-over-year increase in total gross travel bookings of approximately 30% - 37% (an increase of approximately 29% - 36% on a local currency basis).
• Year-over-year increase in international gross travel bookings of approximately 36% - 43% (an increase of approximately 35% - 42% on a local currency basis).
• Year-over-year increase in domestic gross travel bookings of approximately 5% - 10%.
• Year-over-year increase in revenue of approximately 17% - 24%.
• Year-over-year increase in gross profit of approximately 30% - 37%.
• Adjusted EBITDA of approximately $316 million to $346 million.
• Non-GAAP net income per diluted share of $4.90 to $5.30.
Source- Priceline 4th quarter 2012 earnings release
At a recent price of $678.49 and with 51.241MM shares outstanding, Priceline has a market capitalization of roughly $34.77 billion. The company has cash and investments of $5.189835 billion, and long-term debt and liabilities of $.950940 billion. This equates to a net cash position of $82.73 per share, therefore the enterprise value of the company is approximately $30.5 billion, or $595.76 per diluted share. Net of cash the stock trades at about 21.5 times trailing twelve month earnings, which really isn't that bad when you factor in the company's robust growth rates, and huge market opportunities. Priceline generated over $1.5 billion in free cash flow so the adjusted free cash flow yield is just over 5% net of cash. I'd expect free cash flow to grow significantly over the next year or two due to the company's strong market position in growth markets, so the yield actually looks quite compelling.
While all of these metrics look like a growth-at-a-reasonable-price (G.A.R.P.) no-brainer, I unfortunately have to pass on it as an investment for many of the same reasons I missed out on some of Google's best stock performance years. Stocks are discounting mechanisms many years into the future; therefore a low P/E ratio relative to past growth rates does not necessarily indicate an attractive investment. There is another large cap technology concern that has an extremely attractive P/E ratio, and phenomenal past growth rates that is often discussed as being incredibly cheap, but the sustainability of earnings power and margins is incredibly important to a stock price. I would argue that the opportunity in Priceline could potentially be greater than that of a stock like Apple (AAPL) because of the much smaller market capitalization and huge growth opportunities, but Priceline has far less of a durable competitive advantage. I believe Google has a wider moat than either of these concerns. It makes complete sense why venture capitalists will pay rich multiples on technology businesses, but will balance that with very low portfolio concentrations. Some excellent value investors such as Ron Baron use a slightly different, but somewhat similar approach and are wildly successful. My own investment nature is to invest in stocks where there is a huge margin of safety caused by durable competitive advantages, an extremely low bargain price, and if I can get both of these characteristics, then I am willing to run a much more concentrated portfolio. Priceline has made many people rich and I might very well miss out but maintaining a disciplined and consistent approach, and focusing exclusively in my circle of competence is the only way that I believe I can outperform over the long term so I will stick to my knitting. Regardless of my own investment preferences, the future of Priceline, and the travel industry in general, should be quite fun to watch with all of these heavyweights competing in the same field.
Additional disclosure: We have taken profits on Google.