Recommendation: Long Expedia (NASDAQ:EXPE) equity
Current Stock Price: $122.65 (as of 02/10/17)
Target Stock Price: $200 (63% upside)
Timing: 1 to 4 years
Catalysts: integration of recent acquisitions, continued strong organic growth, and margin expansion.
Expedia is the largest Online Travel Agency (OTA) by bookings. Over the past 3 years, Expedia has rolled up the OTA industry through a series of strategic acquisitions which have transformed the OTA space into a duopoly with Priceline (NASDAQ:PCLN) remaining as the only competitor at scale. Over the next 4 years, we expect Expedia's earnings to more than double as the company benefits from acquisition synergies and strong organic growth. Trading at only 11.4x 2017E analyst consensus EBITDA, we believe the stock price can more than double over the next four years, in-line with earnings growth and with minimal multiple compression.
Online Travel Agencies are internet based distribution services which are differentiated in their ability to generate user traffic, offer unique travel inventory, and push through a high rate of user traffic conversion into bookings.
Expedia is the only OTA that offers a full range of travel inventory covering flights, hotels, cars, cruises, attractions, vacation rentals, and rail. Expedia is uniquely able to offer packaged deals (flight + hotel) at attractive rates.
Expedia completely overhauled its technology platform from 2010 to 2013, enabling the platform to operate more effectively and at a lower cost. Expedia now has an industry-leading traffic conversion rate. Expedia continues to spend ~$1 billion a year on technology to maintain its edge, more than any other OTA.
Expedia has made significant brand investment since its founding in 1996. Expedia and its multiple sister websites (Travelocity, Orbitz, Hotels.com, Hotwire, ect.) are some of the most recognized brands in online travel. Expedia leverages its brand position to generate over 450 million monthly unique website visits. Expedia's enormous traffic advantage enables the company to drive significant leverage in its negotiations with travel providers and operate at superior scale unit economics.
Barriers to Entry
Online Travel Agencies benefit from network effects and need scale to operate at a profit. Expedia has a dominant market position in the U.S with 7x the bookings base as compared to Priceline, the #2 player. In Europe, Expedia is the #2 player with half of the bookings base as compared to Priceline.
Travel inventory is extremely fragmented and requires the OTAs to maintain large salesforces to recruit travel providers to their platforms. The OTAs also need significant IT resources to integrate the various online reservation platforms maintained by the millions of individual travel providers.
Expedia has spent billions of dollars and over 20 years developing, testing, and optimizing its technology systems to operate effectively and generate the highest possible conversion rates. Having a high conversion rate is the key differentiator which enables an OTA to operate at lower costs so that it may spend more aggressively on user traffic acquisition and thus attract more travel provider partners. This is a virtuous cycle which is difficult to set into motion.
Expedia has made enormous brand investment to establish significant brand equity in the marketplace. In the last 12 months, Expedia has spent over $4 billion on sales and marketing, of which the majority was spent on brand advertising and direct marketing. This enormous marketing spend enables Expedia to maintain its industry-leading traffic generation, reinforcing the network effects on its platform.
Expedia operates in the massive $1.3 trillion global travel market. Overall spending on travel is growing faster than GDP in both developing and developed countries due to the growing preference to spend money on experiences vs. physical goods. Additionally, ~50% of global travel bookings occur offline. OTAs will benefit from the gradual increase in online penetration of travel bookings. Industry experts estimate that organic growth in the OTA industry will continue at a double digit pace for the next 5 to 10 years. Expedia serves almost every geographic and market segment through its vast portfolio of travel brands and will be the primary beneficiary of the significant secular growth in online travel bookings.
Management and Governance
Dara Khosrowshahi is a visionary leader who has served as the company's CEO since it was spun out of IAC Interactive in 2005. Legendary media executive and investor Barry Diller serves as the Chairman of the Board. Dara previously served as CFO of Diller's IAC Interactive. The duo was extremely early in recognizing the potential in the OTA industry and began acquiring OTA businesses in the late 1990's under the IAC Travel umbrella. Management has shown extremely capable and flexible capital allocation skill and has at various times made significant internal investments, acquisitions, divestitures, buybacks, and dividends. Over the past 10 years, Expedia has generated an annual total return of 14.0% vs. 7.1% for the S&P 500 and 8.4% for the Morningstar Leisure industry benchmark.
Other notable shareholders include John Malone, who maintains a Board seat, and notable travel industry specialists PAR Capital Management and Altimeter Capital.
Expedia has closed over $7 billion in acquisitions since 2014 (1/3 of the current Enterprise value) which has obscured the company's financial trajectory and has made the stock more difficult to study and value.
The trivago business operates at earnings break-even due to its aggressive growth plans. trivago adds almost 10% to enterprise value but does not contribute to earnings, making Expedia's stock appear more expensive. In December 2016, Expedia IPOed trivago in a small float offering which highlighted the value of the segment. Adjusting for trivago reduces the valuation multiple on the core business by ~9%.
Over the past 4 years, Expedia has reduced its commissions charged to hotel partners in order to match Priceline. This intentional reduction has created a multi-year headwind to unit economics and has resulted in overhead spending deleverage. Beginning in 2017, Expedia will no longer need to adjust its commissions lower which will lift the headwind to unit economics and enable margin expansion.
Expedia trades for 11.4x 2017E consensus EBITDA vs. Priceline at 17.1x. Priceline focuses on the high-margin European hotel market and generates a higher return on invested capital; therefore, we recognize that Priceline's valuation premium over Expedia is justified. However, given that Expedia's mix is increasingly shifting towards international hotels and high-growth meta-search, we feel that there is room for multiple expansion.
Historically, Expedia has traded with a forward multiple in the 9x to 12x EBITDA range. The current multiple is at the high end of the range, but current growth prospects are higher than they have been historically. Finally, when adjusting for the impact of trivago, the remaining business trades squarely in the middle of the historical range.
We derived our 4-year price target of $200 using a sum-of-the-parts valuation. Extrapolating the growth from each segment over the next 4 years and assigning current market multiples implies 63% upside from the current share price with no overall multiple expansion. This implies a high teens IRR. We have baked conservatism into our modeling assumptions to account for potential cyclical impacts. Our projections are materially below sell-side forecasts which gives us comfort that there is a margin of safety in our valuation.
Our valuation does not include Expedia's portfolio of minority equity stakes in other travel technology businesses which are currently carried at $520 million on the company's balance sheet. Investors have a "free option" on the upside from Expedia's investment activity. There could be significant value if Expedia has invested in the next 'Kayak' or 'trivago', which is likely considering the company's M&A track record.
Finally, investors can receive an additional 10% to 15% discount on shares of Expedia by investing in the publicly traded Liberty Expedia vehicle (NASDAQ:LEXEA). Liberty Expedia is a John Malone controlled holding company which holds shares of Expedia, debt, and ownership of BodyBuidling.com. The discount investors receive from Libery Expedia shares varies from 10% to 15%, depending on the value ascribed to BodyBuilding.com.
Key risks include the cyclicality of travel spending, the threat of competition from a new entrant, and the threat of competition from existing players.
Travel spending is inherently cyclical. In 2009, the U.S. lodging sector saw revenue decline ~20% while Expedia saw its revenue fall 6.6%. Expedia fared much better than the overall industry because of the strong structural growth tailwinds. Those tailwinds will likely continue through the next decade. The OTA model also has some counter-cyclical features. Because variable costs are ~60% and OTAs do not hold any inventory, OTAs can rapidly reduce expenses in a downturn. Furthermore, in a weak demand market, travel providers become more promotional and depend more on the OTA channel.
We do not view the threat from a new entrant (Airbnb, Google, TripAdvisor, ect.) to be a dire risk because of the significant barriers to entry and competitive advantages that OTAs enjoy. For example, Airbnb (Private:AIRB) has penetrated the alternative accommodations market with a limited salesforce and almost no advertising. In order for Airbnb to penetrate the traditional OTA market, it would need to substantially change its business model. Google (NASDAQ:GOOG) would be unlikely to transform into an OTA because it already benefits from the massive ad spend that OTAs and travel providers pay Google. To become an OTA, Google would need to make significant capital investments and cannibalize its extremely lucrative existing paid search business.
TripAdvisor (NASDAQ:TRIP) has actually attempted to compete with the OTAs and its ongoing struggles demonstrate the challenge of penetrating the market. TripAdvisor has an existing paid search business (like Google) and introduced the ability for customers to make a booking. Because TripAdvisor did not have the travel inventory, it had to partner with OTAs to fulfill the bookings requests. TripAdvisor had to reallocate space on its website from paid ads to the booking feature which cannibalized its existing business. TripAdvisor has not generated a high conversion rate from its booking option and thus has not been able to afford the variable marketing spend needed to generate traffic; this is despite the fact that TripAdvisor already had over 300 million unique monthly visitors. As a result, TripAdvisor has seen its earnings decline and its stock price cut in half since it rolled out the booking feature in 2014.
Finally, the risk of competition from Priceline has weighed on analysts due to Expedia's moves to match Priceline's lower commissions and enter the European hotel market. Priceline has responded by publicly stating that Expedia has behaved rationally by matching Priceline's low rates and expanding internationally. Priceline has not changed its business plans or pricing and Expedia has completed its transition and has stated its intention of keeping commissions at bay going forward. This strikes us as the behavior of rational industry participants.
Now that the industry has transitioned from a fragmented state into a duopoly, it is widely expected that OTA unit economics will improve as there is less competition for variable marketing spend (lower customer acquisition costs) and rising traffic conversion rates due to fewer consumer choices. Finally, there is healthy secular growth which will minimize the need for OTAs to battle for market share as a means of improving earnings.
Article by Luis V. Sanchez, Managing Partner at Anaxi Capital.
Note: a more detailed version of this write-up can be found at the Anaxi Capital website.
Disclaimer: This article expresses the opinions of the author. Neither the author nor Anaxi Capital Management, LLC is receiving compensation for this article. Anaxi Capital Management, LLC has no business relationship with any company mentioned in this article. This article should not be viewed as a solicitation or recommendation to transact in a security or financial product. Please conduct your own research before making any investment decisions.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EXPE, LEXEA over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.