Expedia (EXPE) is one of the world's largest providers of online bookings for hotel rooms, airline tickets, rental cars, and other travel products. Expedia's main competitors are Priceline (PCLN) and Orbitz (OWW). Expedia's stock is currently trading for around $33.25 with a 52-week range of $20.69-$35.57.
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Expedia's stock has risen about 50% in the last year. Let's take a look at the financials:
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Revenue | $2,665 | $2,937 | $2,955 | $3,033 | $3,449 |
| Operating Cash Flow | $712 | $520 | $676 | $777 | $1,030 |
| Capital Expenditure | $-87 | $-160 | $-93 | $-137 | $-208 |
| Free Cash Flow | $625 | $360 | $583 | $641 | $822 |
Revenue has grown by 29% from 2007 to 2011, while free cash flow has grown 31.5% during the same time period.
Owner Earnings
Owner Earnings is a better measure for valuation purposes than free cash flow. Warren Buffett defines Owner Earnings as follows:
These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.
I'll calculate Owner Earnings by taking the 5-year average capital expenditure and subtracting that from the operating cash flow. I'll also subtract stock-based compensation from the operating cash flow since it has a dilutive effect on the company but is routinely included in the cash flow figure. I'll also add interest payments adjusted for taxes since interest is tax deductible.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Operating Cash Flow | $712 | $520 | $676 | $777 | $1,030 |
| Interest Payments | $52 | $71 | $84 | $66 | $90 |
| Stock-based Comp. | $0 | $0 | $61 | $52 | $63 |
| Avg Capital Expenditure | $-137 | $-137 | $-137 | $-137 | $-137 |
| Owner Earnings | $606 | $456 | $533 | $636 | $903 |
Owner Earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the Owner Earnings figures to determine Expedia's Cash Return on Invested Capital, or CROIC. This is the cash return generated by the company on invested capital, and is simply the Owner Earnings divided by the total invested capital. This is a better measure than ROIC because ROIC relies on earnings, which is a poor measure of profitability.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Owner Earnings | $606 | $456 | $533 | $636 | $903 |
| Invested Capital | $8,295 | $5,894 | $5,937 | $6,656 | $6,505 |
| CROIC | 7.31% | 7.74% | 8.99% | 9.56% | 13.89% |
Expedia's CROIC for 2011 was 13.89%. This means that given, say, $1 million of invested capital (retained earnings for example) the company will generate $138,900 in cash from that invested capital. 2011 was an improvement over previous years, with historical CROIC between 7% and 9%. For comparison, competitor Priceline's CROIC for 2011 was about 32%. Let's look at the balance sheet.
| Cash and Cash Equivalents | $1,337 |
|---|---|
| Investments | $289 |
| Debt | $1,249 |
| Pension Obligations | $0 |
| Minority Interest | $105 |
| Net Cash (Debt) | $272 |
| Diluted Float | 139 |
| Cash/Share | $1.95 |
Expedia has a strong balance sheet with almost $2 per share in net cash. Interest payments only take up about 10% of owner earnings, so the debt level is not a concern.
Valuation
I use a discounted cash flow analysis to determine the fair value of a company. I use a discount rate of 15%, and you can read about my view on discount rates here. I will set the initial growth rate to 7%, which is in line with the lower end of historical CROIC, and let the growth rate decay over 10 years to 3%, which will then be the perpetual growth rate. The growth schedule is shown below.
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
| % | 7% | 6.6% | 6.2% | 5.8% | 5.4% | 5% | 4.6% | 4.2% | 3.8% | 3.4% |
| Year | 11 | 12 | 13 | 14 | 15 | 16 | 17 | 18 | 19 | 20 |
| % | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% |
Using these parameters I arrive at a fair value of $66.99, which is twice the current stock price. Buy targets for various margins of safety are listed below.
| Margin of Safety | Buy Target |
|---|---|
| 10% | $60.29 |
| 15% | $56.94 |
| 20% | $53.59 |
| 25% | $50.24 |
| 50% | $33.50 |
Conclusion
Expedia is currently trading with a 50% margin of safety to my fair value estimate. I believe that the growth rates I used are conservative; analysts' estimate for earnings growth is 9.81% for the next five years for comparison. I think Expedia offers a compelling value and is dramatically undervalued.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EXPE over the next 72 hours.
