Expedia (EXPE) is the leader in online travel accommodations and services. They released earnings recently and have since encountered bumpy roads in terms of stock price. EXPE was down 17% last Friday and briefly hit $20.99 in intraday trading.
So, what was in that earnings call (see transcript here) that rattled investors so? It is pretty simple, really: Expedia seems to be making some investments in their business that will increase returns later at the expense of short term earnings. This is an absolute crime in the eyes of Wall Street, as evidenced by the downgrades in price targets and analyst ratings across the board.
However, for the long term, fundamental investor, this could be a great time to get in on a value stock. Let’s take a deeper look at that earnings call and see what there is to see.
Increased costs: One of the main points of concern for analysts covering Expedia is an increase in costs that is being used to expand into lower monetization rate markets. These include APAC, China, Brazil, and more. Michael Adler, CFO of Expedia said that they are:
Continuing to grow faster and expand in international markets where our marketing efficiency today is still lower than it is in the U.S.
However, these markets are highly fragmented and the sooner a company can capitalize on imprinting a brand the better. It does Expedia no good to rest on its laurels and wait until the internet travel sector is attractive in China; the time is now to invest and act in the best interest of creating a future presence. As a result, there may be a lower margin associated with these investments initially. The alternative, however, is a future where Expedia is a late mover in some of the larger travel markets in the world.
In addition to expanding into international markets, Expedia has been making investments and acquisitions in many different parts of their business. Adler said that Expedia is:
Going to continue to make the investments in SniqueAway, Vacation Rentals, China, mobile, social, et cetera. And those things will impact OIBA margins, and we expect probably several hundred basis points of drop in 2011 to somewhere around 50% level.
Now, on the surface this looks like margins squeezing in an increasingly competitive online travel market while the CFO feebly tries to justify this by pointing to various investments the company is making. However, if you take a close look at those investments you’ll see a few key words. China. Mobile. Social. Any company not caught in the flurry of investments in these three spheres might as well close their doors and turn out the lights. This is the trifecta of growth, especially in the online sense. If EXPE were not investing in all three of these things, and doing so aggressively, I would be concerned.
Another factor was a change in fee recognition that drove cost of revenue for the quarter. Adler points out that:
[Expedia] accelerated the recognition of certain credit card fee payments, and these, along with some other adjustments, drove the deleverage in cost of revenue in the quarter. In fact, without these adjustments, cost of revenue would've grown slower than revenue for the quarter and for the full year.
So, if you take all these pieces into consideration, you might get a different picture than a industry leader that is losing its edge. Not to say there aren’t concerns in the long term profitability and competitive position of a company like Expedia, but it seems the ambulance chasers have gotten to the scene a bit early.
Investments in Technology: One of the most attractive things about EXPE is their constant investment in areas vital to long term success. Their new platform for Hotels.com is now running at full tilt, and the same steps are scheduled to be taken to further optimize Expedia. Dara Khosrowshahi, CEO of Expedia, said that Expedia has:
Significant potential ahead of us on product improvements, resulting from our technology investments. For example, we're seeing great results at Hotels.com, which completed its platform migration roughly a year ago and has executed quite effectively, driving conversion improvements and substantially higher room night growth in both the U.S. and Europe compared to just a half a year ago. January trends are even better, with Hotels.com room night growth in the 30% range, so we're very encouraged by their progress and execution.
Their new platform for Hotels.com has improved conversion and allowed them to test the foundation they will build out for Expedia’s more complex business lines. Dara noted this when he explained the steps in optimizing that platform for Hotels.com:
Once we improved the platform and completed that work, we were able to engage in significantly accelerated work on the hotel path on the various stages to innovate and bring in new feature sets which increased conversion for Hotels.com. And it's kind of a sequential methodology. You come out with a new feature, you test it. If it works, you roll it out, if it doesn't work, you pull it back. So it's really the amalgamation of, I'd say, the great work that the Hotels.com team has done on site optimization, which has gone throughout 2010 and has added up on top of itself. So when we look at Hotels.com's growth rate in 2010, the first half was not so good, but the second half got better. And in 2011, it's really off to a roaring start.
So, what happens when you take a tested plan of action and apply it in a more complex fashion? Hopefully, the same result. With the platform already running strong on Hotels.com, EXPE hopes to apply that to Expedia as well. Dara is confident the same recipe will work:
It's really that playbook that I was talking about for Expedia. The Expedia platform is more complex. It has more lines of business, so to speak. But we've seen it work for Hotels.com, and there's no reason why it can't work for Expedia as well.
This is a risk point for EXPE that may be a determining factor in their future. If they can apply their new platform to Expedia.com in a way that will increase conversion rates in the same fashion it has with their hotel line, then their numbers will reflect that success.
TripAdvisor: TripAdvisor is one of the differentiators for Expedia that has recently come under attack. With Google now giving preference to their Google Places in search, some expect TripAdvisor to basically go extinct. Let’s remember that just because Google does something doesn’t mean their competition will wither and die (Google Buzz vs Twitter ring a bell?). Also, take into consideration that the market Google Places will primarily hit is the United States market, which is less important to TripAdvisor on a volume base. Khosrowshahi noted that:
Steve Kaufer, who's the CEO of TripAdvisor…said in January, probably 25% of his traffic came from U.S. IPs. So 75% of TripAdvisor's traffic now is coming from non-U.S. IPs. Obviously, the non-U.S. business is younger, it doesn't monetize as well, but it's a pretty extraordinary number, and it tells you about the long path that TripAdvisor has, as far as growth goes.
However, TripAdvisor is no doubt more profitable in the US, so how long will this lower monetization rate last for international? There was no clear guidance on this, but they were confident the monetization would converge with US rates in the future, as the CEO stated:
The fastest-growing part of TripAdvisor, international, will monetize at a lower rate, but as that monetization approaches the monetization of the U.S., which, over the long term, it should, we expect to see really great things.
TripAdvisor is also still making moves to stay relevant. Take their recent acquisition of EveryTrail, which Dara explains:
We've just, last week, announced the acquisition of EveryTrail. EveryTrail will be a part of TripAdvisor and has developed a GPS-enabled publishing platform to create outdoor tours and city guides for mobile devices. The technology will complement TripAdvisor's millions of traveler reviews and opinions, and enrich the quality of information consumers can access from their smartphones. TripAdvisor itself had a great year, with annual third-party revenue growth of 48% and growth in its international business in excess of 100%.
Although growth rates slowed for TripAdvisor in the latter part of 2010, the trend should be offset long term by the international footprint it is already making. Also, take into consideration the power of social, which TripAdvisor is practically made for. They recently put themselves on Facebook and are now trying to tap into those five hundred million potential users.
Mobiata: The Mobile Approach: Mobile is another area that Expedia is investing in. Although not a huge source of traffic yet, their forward looking strategists realize the importance of a mobile presence. The acquisition of Mobiata will help Expedia in this realm. Dara explains:
Mobile bookings are growing very fast across our brands, and extremely short booking window on these transactions, a very high percentage of which are same-day bookings, suggests to us that they're likely incremental. We acquired Mobiata, a proven success story in Q4, to accelerate our efforts in mobile. Mobiata is best known for its flight status application, FlightTrack, a top iPhone app for the last two years.
The popular iPhone app team is now being used across EXPE to add a different mindset to the way they approach mobile. Some of those benefits may manifest in 2011, as Dara explains:
It's a small team that thinks mobile but thinks differently, and already the kind of work that they're doing with the Expedia team is incredibly encouraging as far as radically improving the quality of our mobile product. So within in 2011, we expect to see those benefits. People are coming to the mobile side, and we think that to the extent that we can increase conversion to any place close to the overall stock conversion, this can be a channel that's growing even faster.
How big of a piece of the pie will mobile be in the near future? A material one, as Mr. Khosrowshahi states:
I think it can get to 10-plus percent of our traffic within the next 12 to 18 months easily.
I wouldn’t say easily, but certainly within reason. The acquisition of Mobiata could be a big differentiator in the mobile sphere.
International Investment: Expansion into the international realm is something that Expedia has seemed to lag on in comparison to their rival Priceline; PCLN has been eroding their market lead in international growth. However, they appear committed to making up that ground, and will embark on an aggressive expansion in 2011. Dara states:
What you will see with Expedia in 2011 is a significant acceleration in the points of sale that we actually launch. We launch in Singapore and expect us to launch in anywhere between five to seven, or eight new countries, depending on our technology launch schedule in 2011.
This schedule will represent costs that will be negative to margin over the short term, but potentially offer lucrative payouts for the patient investor. In addition to these seven countries, China represents a bulls-eye in terms of travel in many different ways. Dara addressed a question about this in the call, saying:
DaoDao and Kuxun. DaoDao is essentially TripAdvisor for China, already has the greatest number of reviews in the Chinese markets and growing very quickly. Kuxun is the number two metasearch player there. And we're investing in excess of $10 million in losses a year there, but the Chinese market is worth it. It's a giant market. These sites are top 10 sites, and we think this near-term investment is going to pay off long-term in a big way. And we think it puts us in a unique position. We don't think there's any other kind of global OTA out there, travel company out there that's building this kind of a position in China.
This position in China will be huge. In addition, their subsidiary eLong Inc. (LONG) is making a push to be one of the top online providers of travel in the mainland.
American Airlines Riff: Much is being made of the riff between online sites and American Airlines. AA was recently allowed to cut contractual ties with Orbitz by a judge in Illinois. Shortly after doing so, American was distinguished from other airlines on Expedia by having an extra click required to see a price for a ticket. Expedia made a statement about this action:
American Airlines has shown it only intends to do business with travel agencies through a new model that is anti-consumer and anti-choice. We believe American Airlines' proposed direct connect model will result in higher costs and reduced transparency for consumers, making it difficult to compare AA ticket prices and options with offerings by other airlines.
This is certainly not a best case scenario for Expedia, as their dealings with airlines are reliant on terms being mutually beneficial. However, the fact that they are not the only site being impacted by this move makes me more comfortable with the situation. Dara also addressed this issue in the earnings call. He said that Expedia had to:
Work with American on terms that works for us and are fair to our customers, so to speak. So while, certainly, American not being on the site will have some short-term impact on our financial results, we still have a great air product… [It is] certainly not a position that we want to be in from a long-term basis, but this is -- it's a bump in the road, and we hope that we can come to terms with American that satisfy both sides.
I am expecting this to be a minor setback for a company that otherwise has a great product. American stands to hurt from this situation, as the internet becomes more and more important in the online travel sphere. As a result, I expect this to end amicably, although the time line is not so clear.
Conclusions: While some are hammering Expedia for their lack of profitability or apparently competitive dullness, I will contrarily congratulate them on being more forward looking than a quarterly earnings release. Their investments in the mobile, social and international spheres make me optimistic about there being an upside to this stock. Market forces notwithstanding, Expedia is making the right moves.