On May 9th, Priceline.com (PCLN) announced excellent results for the first quarter of 2013. Here is the skinny: about $9.2B in bookings for the first quarter, up 36% year over year. Non-GAAP net income came out at $297 million or $5.76 per share, up 35% versus prior year. Worldwide hotel room night reservations came out at 63.2 million for the quarter, a figure much lower than the bookings, but still up 38% year-over-year. Rental car days were up 43%. Overall revenue grew 25% y/y to $1.3B, 69% of it coming from international markets. So far, the market has reacted extremely well to the announcement. Shares are 9% up since the announcement and there are no early signals of a correction.
But can Priceline be able to continue delivering such amazing rates of growth in the long term? This is a very important question, as both the current market capitalization of $40.B and the recent improvement in upward momentum show that many investors are optimistic about it. This article explains the main challenges that Priceline.com faces in order to keep growing like there is no tomorrow.
The first thing I did when I was studying this company was to check the overall 1 month stock performance, in comparison with some of its direct rivals. Both Tripadvisor (TRIP) and Orbitz (OWW), which are much smaller in terms of market cap but are, after all, in the same business, posted strong results recently. As a matter of fact, TRIP and OWW outperformed PCLN by a tiny margin. Kayak Software (KYAK) and Expedia (EXPE) performed terribly. Turns out that Kayak will soon be acquired. The total acquisition price is $1.8 billion in cash and stock on May 21 of this year, about $40 per share. This explains why Kayak's stock price has not moved since May 8th. The poor relative performance of Expedia can also be easily explained: the stock never recovered from the last earnings call on April 26th. Shares are down after the firm lowered its organic growth view, due to pressure coming from Hotwire, which offers cheap and discount travel deals.
Kayak and Expedia are exceptions to the rule: people are traveling more often this year due to macroeconomic reasons. It is no news that there exists a strong correlation between the performance of the S&P 500 and the tourism and travel sector. This category includes online travel search engines. Therefore, although I respect the amazing growth figures the company has been able to deliver consistently so far, I believe that macroeconomics is helping a lot here. In this way, my first caveat consists of watching carefully the overall performance of the economy. Priceline may have some important competitive advantages, but without positive macro, amazing growth could stop.
It seems that I am not the only one worried about the high dependence on positive macroeconomics here. After giving a somewhat pessimistic forecast for the next quarter, Daniel J. Finnegan - CFO and CAO, mentioned:
We're pleased by the strong set of unit growth the group has delivered over the last several quarters and that is inherent in our forecast. Our guidance reflects our expectation for sequentially decelerating growth rates for very large business comparing against high transaction growth rates.
We're still concerned about economic conditions on a worldwide basis and in Europe in particular. Our forecast does not assume any material change in macroeconomic conditions in general and conditions in the consumer travel market in particular. Given the uncertainty surrounding worldwide economic conditions, particularly in Europe where much of our business is concentrated, we believe the variability around our guidance is elevated.
Therefore, if you happen to be bearish about the current European outlook, Priceline is definitely and officially not your stock. This brings us to the official forecast for the next quarter:
Now for second quarter 2013 guidance, we are forecasting total gross booking to grow by 30% to 37% and to grow on a local currency basis by approximately 27% to 34%, with U.S. gross bookings growing by 5% to 10%.
We expect international gross bookings expressed in U.S. dollars to grow by 36% to 43% and to grow on a local currency basis by approximately 33% to 40% (...)
We expect Q2 revenue to grow year-over-year by approximately 15% to 22% and gross profit dollars to grow by approximately 26% to 33%. We expect 400 to 500 bps of deleverage in non-GAAP operating income as a percentage of gross profit compared to prior year (...)
Our forecast reflects growth in personnel and other expenses as we continue to make the investments necessary to keep up with current and future growth. As I mentioned a moment ago, Q2 margins compared to prior year are expected to be slightly impacted by the shift of some Easter gross profit into Q1 and 2013 (...) Adjusted EBITDA is expected to range between $560 million and $595 million, which at the midpoint represents 17% growth versus prior year. We are targeting non-GAAP fully diluted EPS of approximately $8.87 to $9.45 per share, which at the midpoint represents 17% growth over prior year.
A 15%-22% growth rate interval reflects extreme volatility and volatility, my dear readers, is a synonym for risk. Notice that the company is considering that the macroeconomic condition in Europe will not change. Therefore, 15% is not the worst scenario.
I attach some past growth figures for the company in the picture below. You see, it seems pretty clear to me that the 25.5% increase in revenue that the company announced for 2013Q1 is a one time thing. The company saw some extremely insane rates of revenue about 2 years ago. But the recent figures show a clear decline in acceleration. 20.3% for 2012Q2, 17.4% for Q3 and 20.2% for Q4.
The acquisition of Kayak confirms that there is little room for improvement in organic growth. Artificial growth will replace organic growth as much as possible, as long as there is cash. These are, after all, the necessary investments "to keep up with current and future growth" that the CFO was talking about.
Macroeconomics is not the only risk here. The fact that even Priceline finds it challenging to keep up with current and future growth rates shows that "being big" in this business is no advantage. This is a business with few barriers to entry. I can deploy a travel search engine in less than 2 days with open source. By using cloud computing and some other tools for developers (Github for version control, Heroku for the website, Parse for the mobile, etc.), I can make a very efficient app in terms of costs. It wouldn't cost me that much to have it online, but as traffic starts coming, I would most likely be charged. That's the way that companies offering services to developers charge nowadays. The upside is that I will only be charged when I have some decent probability of closing sales online. The only challenge is how to get a decent amount of reviews. But this is not impossible to achieve with good social mechanics, gamification features, a reward system and some luck. This is why some early stars, like Adioso.com (which has a great algorithm), are growing extremely fast; while Priceline finds it hard to keep up with expectations. And acquiring similar websites for big premiums does not seem like a long term solution to me.
Price target: $600 / from N.A.
Rating: Neutral / from N.A.
Uncertainty: Very High