Priceline's Pulsing Growth Inevitably Will Slow

| About: The Priceline (PCLN)

Despite uncertain global economic conditions, Priceline (NASDAQ:PCLN) reported another strong quarter with a 26% y-o-y increase in revenues ($1.3 billion). The robust growth in its international business contributed to a 36% y-o-y increase in total gross bookings ($9.2 billion). While the 43% annual growth in international bookings were driven by a strong global portfolio, the domestic gross booking growth accelerated to 9% due to rising rental car reservations and improved hotel room nights aided by Express Deals. Additionally, on account of better than expected margins, Priceline’s operating income grew by 28% annually.

An expanding international footprint, a focus on building its domestic brand, strengthening hotel inventory and investment in building its mobile platform are the key factors driving Priceline’s growth. While we maintain a positive outlook for the company’s long-term potential, we think the current growth rate is difficult to sustain in the long run and estimate this to slow over our review period.

Expanding International Business To Be An Important Growth Driver

With the acquisition of, Agoda and TravelJigsaw, Priceline has significantly expanded its international business. Gross bookings from international markets as a percentage of total bookings have gone up from 55% in 2007 to around 82% in 2012. Robust growth in international bookings, especially hotels, has been one of the most important drivers behind Priceline’s growth momentum.

As the U.S. travel market nears saturation, most OTAs are focusing on leveraging the rising demand from international markets. The fragmented European hotel market and increasing per capita income in emerging economies provide tremendous growth opportunities for travel agencies. Additionally, Internet penetration in these economies is relatively low but is expected to rise at a rapid pace.

In Q1 2013, Priceline’s worldwide hotel room nights reservation crossed $60 million, a 38% y-o-y increase. Rising demand from Europe and Asia Pacific contributed to the high growth rate, though domestic demand (U.S.) continued to increase as well. While the brand outpaced growth in Europe, is continuing to build a leadership position in the Asia-Pacific market.

On the flip side, since the key European markets represent approximately 60% of Priceline’s total booked room nights, its increasing share in the region makes the company more vulnerable to the European debt crisis. Additionally, as emerging markets account for an increasing percentage of Priceline’s business, the average daily rates (ADRs) could decline in the future, impacting its growth rate. Though the international ADRs increased by 1% in Q1 2013, we believe the same will remain under pressure as Priceline derives an increasing proportion of revenue from emerging markets.

Priceline Will Close Kayak’s Acquisition This Month

Priceline has received the requisite approvals for acquiring Kayak, a leading global meta-search company. It expects to close the transaction on May 21. The acquisition of Kayak will mark Priceline’s entry in the meta-search space. A meta-search engine is a search tool which collates results from multiple search engines, providing a broader scope for user searches. Meta-search remains an integral part of the online travel booking supply chain.

Growing at a CAGR of 47%, Kayak’s top-line witnessed robust growth between 2007-2012. The company currently receives about 80% of its revenue from the U.S. and has over 50% share of the U.S. meta-search market. [1] We believe that by attracting more traffic to Priceline’s website, Kayak’s acquisition can increase the company’s booking transactions.

Margins To Remain Under Pressure

Though Priceline’s operating margin declined by 70 basis points annually, it was better than the company’s expectation. In Q1 2013, Priceline launched its first offline advertising campaign to build the brand in the U.S. and continued to spend aggressively to build its international operations. However, with Easter falling on March 31st this year, it gained additional revenue related to the holiday season which, combined with lower than expected online advertising expenses, eased pressure off of margins.

Nevertheless, the online travel services is a highly competitive niche segment with stiff competition among OTAs. In an effort to gain a competitive advantage, travel companies have expanded their advertising budgets and are creating new promotions and consumer value features such as eliminating processing fees, waiving cancellation and change fees, etc.

Priceline expects gross margins to remain under pressure this quarter as it aggressively invests to build its global brand. Though we believe that high expenditure incurred will help drive future growth, we estimate Priceline’s EBITDA margin to remain more or less around the present level for the rest of our forecast period.

Q2 2013 Outlook

  • Gross bookings to increase by 30% to 37%.
  • Revenue to grow by 15%-22% annually.
  • Gross profit to increase by 26% to 33%
  • Adjusted EBITDA to be between $560 million to $595 million.
  • GAAP EPS of $7.87 to $8.45 per share.

We are in the process of updating our price estimate of $633 for Priceline.

Disclosure: No positions.