The purpose of a spin-off is to unlock shareholder value. As separate company, the market will often assign a higher value to a business compared to when it is owned by a parent company. However, this greater value of the two separate companies is rarely created instantly and there is frequently an opportunity to buy shares of one of the companies at a good price as the market slowly re-prices the companies. In the case of this spin-off, I believe TripAdvisor shares are undervalued.
In a filing with the SEC, Expedia included pro forma financial statements showing the results of the company as if Expedia had already spun off TripAdvisor. These financial statements can help investors gain a better understanding of how much of Expedia's past results were attributable to TripAdvisors and how much are attributable to the rest of the business. I've included some of the details below, although if you are really interested, you should take a look at the SEC filing.
|6 Month Ending June 30 |
(Millions of $)
|Net Profit Margin||6.3%||28.57%|
The difference in growth rates of the two companies is where the real value lies. According to Expedia's latest quarterly filing, which was before the spin-off, the TripAdvisor segment grew revenue 33% quarter over quarter, while the other two segments of Expedia grew revenue at a combined 15.9%.
Companies with high growth typically trade at high valuations. TripAdvisor's valuation, however, isn't all that high. We know the EPS for the six months ending June 20 were roughly 63 cents based on the pro forma financial statements. The same SEC filing also included pro forma financial statements for 2010, over which TripAdvisor earned 80 cents per share.
We want to further break the 2010 results down and estimate the EPS for the second half of the year so we can calculate trailing twelve month earnings. Fortunately, the SEC filing contained the results of the TripAdvisor segment of Expedia, from which we can estimate how much of the 80 cents are from the second half. The 2010 first half net income for TravelAdvisor Holdings LLC was $77,435M and the total 2010 net income was $138,776M, indicating that second half EPS were roughly 44% of the full year's EPS.
Applying this to the 80 cents per share figure results in an estimate of 35 cents per share for the second half of 2010. Adding the 63 cents from the first half of 2011 results in earnings of 98 cents for the twelve months ending June 30, 2011. With shares of TripAdvisor currently trading at $27.22, the P/E ratio is a little over 27. At first glance, this may seem a bit on the high side, but we also know for a fact that TripAdvisor grew significantly during the third quarter, which would lower the P/E ratio as the 98 cents EPS estimate we used did not include the third quarter.
Overall, I think that Expedia's spin-off of TripAdvisor is likely to unlock shareholder value, but that this will primarily be in shares of TripAdvisor (TRIP). Shares of TripAdvisor may have high valuations, but I believe this is more than justified given the high growth rate of the company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.