About the Company
Priceline is an online travel company that provides booking services for hotel rooms, airline tickets, rental cars, cruises, and other vacation packages under both the agency and merchant models. The company operates under the Priceline.com name in the United States, Booking.com and Active Hotels in Europe, and Agoda in Asia. Transaction fees for online bookings represent a substantial portion of the company's revenue. Priceline offers hotel reservations in more than 60 countries and is based in CT, United States.
Priceline is executing exceptionally well in a tough industry known for cut-throat competition and low margins. PCLN offers a commodity product in a price-competitive industry. Although scale in the online travel market can lead to network effects, we have never seen this due to the segmented industry structure. However, as PCLN continues to gain market share, we will see margins expand and a competitive advantage form. In fact, sales, margins, EPS and market share have increased strongly since 2005, driven by a focus on the agency business model and European hotel bookings; significantly outperforming competitors. We suspect this might the beginning of a natural consolidation of the travel industry. If so, we are pretty confident that Priceline.com will be one of the industry leaders.
PCLN basically operates two models:
- Merchant Model Pricing: A system in which the airlines or the hotels sell space to Priceline.com at a net price, allowing Priceline.com to set a retail price of its choosing.
- Agency Model Pricing: Priceline.com would act as an agent in the transaction, passing reservations booked by our travelers to the relevant airline, hotel, car rental company or cruise line.
Generally speaking, the merchant model pricing system has better margins but the agency model pricing system has a better return on invested capital. In terms of scalability, it is much harder to scale the merchant model. Therefore as the company grows, we are certain to see more revenue coming in through the agency model.
Regardless, PCLN has successfully applied a format which appeals to both its suppliers (hotels) and customers. Priceline uses a proprietary "Name Your Own Price" bidding system. In this system customers make non-cancellable offers for travel services, which are then compared to undisclosed prices offered by companies; if there is a matching price, then the transaction is completed and Priceline takes the difference between the prices. This structure allows retailers (airlines, hotels, car rentals), to sell excess inventory without harming their brand name and price structure, as the name of the supplier is not known to the consumer until the transaction completes. This is also known as a "demand collection system" and as an "opaque" system.
The revenues from "Name Your Own Price" bidding system are classified as "Merchant Revenues" by Priceline. Merchant Revenues are reported as the gross amount of the transaction (ie. The total hotel / air ticket price); this includes the cost of goods paid to the airline / hotel supplier. This can make revenues appear inflated.
- More concentrated focus on fragmented hotel market than competitors, creates opportunity for differentiation
- Booking.com business has deep inventory of hotels globally (120K hotels in 99 countries)
- Proven management team
- Agoda + Booking.com could capture material share of Asia Pacific travel market
- Scale-based competitive advantages could continue to drive secular growth + margin expansion. Mix-shift towards Europe will also help margin expansion
- As the economy recovers, PCLN may see even more volume growth
- Share repurchases remain an option
- Further industry consolidation is possible, and priceline.com seems to be a strategically valuable asset
- PCLN continues to execute well and capture market share
- Europe is a large market that represents a sizable opportunity
- Capital intensity is low and cash flow is strong
- Travel industry is economically sensitive, growth could be at risk if global economic recovery slows / European sovereign debt issues resurface
- Lacks sustainable competitive advantages
Threats & Risks
- Google (GOOG) threatens to disrupt the travel with its purchase of ITA
- American Airlines sets an example to the airline industry on how to manage relationships with agencies
- Industry growth will slow as the market for online travel matures
- Highly competitive industry with several franchise online travel agencies, suppliers that are increasingly focused on the online channel, and entrants trying to disrupt the legacy online travel business model
- Investor expectations are high, and the stock is expensive
- Rising gas prices, airline cut backs and consolidation, and FX fluctuations also present risk
- Year-over-year comps will soon become more challenging
- Margins may be restrained due to regular marketing and IT spending, as well as declining GDS incentives
- U.S. or global economic weakness can weigh on the stock
- Booking.com acquired Sept. 2004 (U.K. hotel online services)
- Booking.com BV acquired July 2005 (European Hotel online services)
- In 2009, acquired agoda.com in Asia.
- Online travel agents such as: Travelocity & LastMinute.com (Sabre Group), Expedia & Hotels.com (EXPE), hotel.de, Orbitz.com (OWW), ebookers.com & CheapTickets.com (Blackstone Group)
- Travel suppliers' own websites (airline, hotel and car rental companies)
- Traditional travel agents
- Large online portals [eg. Yahoo (YHOO) and AOL(AOL)] and online search companies (eg. Google)
- Online travel research companies that have search functionality (eg TripAdvisor, CheapFlights.com)
- Internet search engines, such as Google
In Q4, Global gross bookings grew 44% fueled by 65% growth outside the United States. This rate of growth will be hard to maintain in the long-run but as of now, we continue to expect robust growth in travel bookings as the global economy continues to gain traction. The valuation dilemma is for how long Priceline can sustain its high revenue growth (>30% pa.) & EBIT margins (>25%); which are both well above industry averages. Plenty of growth potential remains and recent financial results suggest that this good operating performance is entrenched and will likely to continue.
Although PCLN is investing in new geographies, it is still delivering solid Y/Y gains in operating leverage. Thus, it saw a 408 bps improvement in margins to gross profits in 4Q10. Although guidance calls for a decline in EBITDA/gross profits of ~200 bps in 1Q11, we believe significant leverage is possible as the company moves out of the seasonally slower 1Q period and, at the same time, begins to scale operations in Asia Pac and Latin America. Thus, we look for gains in 2H11 and 2012.
Priceline.com has already invested considerable amounts of capital in its international expansion, and the company is rapidly gaining market share from Expedia (hence their valuation). While we expect this global expansion to slow as the markets become more saturated, any incremental international business that is added should increase margins and this is our support for our view that long-term margins will continue to increase, especially as the industry consolidates. Economics of scale and scale itslef will empower PCLN in a largely fragmented supplier base in Europe and Asia, allowing Priceline to negotiate better premiums than they have traditionally been able to domestically.
Priceline's international growth opportunities should allow the company to become more profitable as long as it can maintain its pricing power in the tough competitive environment that will come with new entrants and a more mature market.
In our view, the franchise enjoys an emerging competitive advantage, that of scale. Given the trends of the travel industry, we believe that in time, this competitive advantage will become sustainable, which gives us confidence in the franchise.
We remain very bullish on Priceline's growth opportunity in Europe, Asia-Pacific and Latin America. For P/E, we continue to user a 21x multiple for its 2012 P/E (below its current valuation and within historical averages) given our confidence in PCLN's ability to execute.