According to a report by Reuters, Expedia (NASDAQ:EXPE) has already set in motion the process for an initial public offering for Trivago, its popular hotel metasearch/media business. The IPO, which according to a source, could be valued at more than $1 billion, is set to take place in late 2016 or early 2017. Expedia paid 477 million euros ($531 million) in 2012 for a 62% stake in Trivago, with the rest of the company remaining in the hands of its three German founders. Expedia has insisted that this is not a spinoff since it does not plan to sell its shares during the floatation. Investors will, however, still get a chance to own part of the 38% stake by the founders since they are reportedly seeking to sell out through the IPO.
Although Expedia is unwilling to let go its majority stake, investors are naturally drawing parallels between the Trivago IPO and the TripAdvisor (NASDAQ: TRIP) spinoff in 2011. The TripAdvisor spinoff was simply sensational, with the spun-off unit sporting a market cap 40% bigger than the parent company just 20 months after the event.
Does Trivago have the potential to reward shareholders as richly as TripAdvisor?
Trivago operates quite differently from your average OTA (online travel agency), with its revenue model being remarkably similar to TripAdvisor's at the time of its spinoff. The company acts as an independent information resource for travelers where people visit to compare hotel prices. The platform aggregates hotel content from a variety of sources and then displays the results to users. Trivago compares rates from more than a million hotels on more than 250 booking sites. Once people make a decision to book a certain property, they navigate to traditional OTAs such as Priceline (NASDAQ:PCLN) and Expedia where they can do their booking. Trivago makes money through a cost-per-click model when users on its platform click on ads displayed on the platform.
Trivago's revenue model is remarkably similar to how TripAdvisor has traditionally operated, the key difference being that TripAdvisor users can now book directly from its platform using the Instant Booking feature. More than half of TripAdvisor's revenue comes from directing traffic to the two giant OTAs.
Looking at the respective business models of TripAdvisor and Trivago, we can easily surmise that the actual valuation of Trivago could be significantly higher than the $1 billion being thrown around. For starters, Trivago generated revenue of $200 million during the second quarter (~10% of Expedia revenue), after growing 48% Y/Y. The business is expected to finish the year with revenue of ~$770 million, or about 20% higher than TripAdvisor's revenue during the time of the spinoff. Trivago remains a growth machine, with its core European market growing at a 33% clip during the last quarter while the rest of the world grew 69%. At the time of the spinoff, TripAdvisor was valued at $4 billion, with Expedia investors receiving one Expedia share and one TripAdvisor share for every two Expedia shares.
Expedia says that Trivago is solidly profitable, though the company has never divulged actual profit details. One thing is clear, though: that Trivago might not be anywhere nearly as profitable as TripAdvisor was in 2011, mainly due to heavy marketing spends. The company has been expanding into international markets aggressively and spends heavily on TV advertising to create brand awareness in new markets. While Trivago still operates as an independent unit, TripAdvisor's close ties to Expedia allows it to spend relatively less money on marketing expenses.
Trivago's heavy spending on S&M activity quite naturally depresses margins quite a bit. Benchmark analyst Daniel Kurnos estimates that Trivago finished last quarter with a 25% contribution margin in its Europe market and 10% across other geographies outside Europe. Assuming half of Trivago's revenue comes from its core European market with the rest coming from other parts of the world, then the business sports a contribution margin of ~17.5%. The profit margin is bound to be lower than that. TripAdvisor had a 30% profit margin during the time of spinoff and an EBITDA margin of ~40%. A $4 billion valuation implies the company was valued at ~15.6 x EBITDA. Assuming Trivago sports an EBITDA margin of just 10% and applying a 15.6x EBITDA valuation would put Trivago's value at ~$1.2 billion.
There's a good possibility that I have underestimated Trivago's EBITDA margin, which implies that the company's valuation could turn out to be significantly higher than that.
Why Expedia is not selling
It's not very hard to see why Expedia is unwilling to sell its 62% Trivago stake - and it has a lot to do with post-spinoff remorse from TripAdvisor. By spinning off TripAdvisor, Expedia lost a high-margin and high-growth media business forcing the company to rely more heavily on a single, transactional revenue stream. Expedia has continued to rely heavily on TripAdvisor as one of its largest marketing channels, but it's more of a love-hate relationship than the purely symbiotic one it has been in the past.
And that's not a very good thing, especially now that TripAdvisor's Instant Booking competes directly with traditional OTAs like Expedia and Priceline. Using Instant Booking, people can book properties directly on the TripAdvisor platform without having to navigate to OTA websites. This definitely means loss of valuable traffic and business for the companies. Trivago can conceivably borrow a leaf from TripAdvisor and start monetizing its vast traffic by allowing people to book on its platform directly. You can be sure Expedia doesn't want to be blindsided by events this time around.
And now the big question: Does Trivago have the potential to reward shareholders a la TripAdvisor? Although TripAdvisor has lately hit a wall leading to the TRIP stock losing 25% YTD, investors who bought at the IPO are still sitting on a healthy return of 154%. Notably, the market has rewarded TripAdvisor with a richer valuation since the IPO, with the current 26.9x EBITDA TTM almost double the reading at the time of the spinoff. Trivago's revenue model is quite similar to TripAdvisor's, and the business has continued growing briskly despite global economic headwinds and persistent terror attacks. Investors will quite likely be willing to bet on the company's long-term growth prospects. Don't be surprised if the Trivago IPO enjoys a fairy tale run a la TripAdvisor.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.