I remember my first and only investment in Priceline.com (PCLN). I opened a traditional IRA in the Spring of 1999, when I was still in college, and invested my entire IRA in the Priceline stock only to sell at a big loss and close out my IRA by the end of the next year. Back then, I did not have a CFA charter or a lot of patience. I just thought it was a great idea to offer discount airline tickets and hotel stays in exchange for keeping the flight times and hotel exact location private until after your bid is accepted. Also, by reading numerous articles about and interviews with Priceline founder, Jay Walker, I thought it would certainly be a good investment. I bought the shares without doing any independent research on the company. My timing was off by about 10 years. Investing $1,000 in Priceline on March 31, 2009, through March 31, 2011, would have returned about $8,400 or a 840% appreciation.
Looking forward, I think Priceline still has a reasonable valuation and offers a good investment opportunity. The company is growing revenue and profits at a nice clip and its margins are one of the best of any leisure company. Following the 2008-2009 economic slowdown, I think travel will rebound. In addition, a number of developed economies, including most of Europe, Japan, and the United States, are experiencing retirement of a large portion of their populations, which should benefit the leisure industry. Finally, the world is becoming one place faster than ever and Priceline, with its global reach, is well positioned to benefit from increased demand in travel.
Priceline has close to 50 million shares outstanding and a market capitalization of $36 billion. The company has $2.6 billion in cash and short-term investments on its balance sheet and no debt. On March 6, 2012, Priceline announced the offering of a convertible debt in the amount of $1 billion (including over-allotment) to qualified institutional investors. The converts pay 1% interest and will convert in 2018 at a rate of 1.0586 shares per $1,000 in principal or a conversion price per share of $945. The company expects to use the proceeds to repurchase stock and for acquisitions. It already repurchased $166 million of its shares in March of this year. I expect the company to acquire one or more online travel companies with some of the proceeds.
Priceline derives 88% of its operating profit from overseas. It has one of the best operating margins in the industry at 32%. For comparison, its major competitors, Expedia (EXPE) and Orbitz (OWW), had operating margins of about 14% and 6%, respectively, in 2011. In terms of net income, Priceline earned $1.06 billion on revenue of $4.4 billion. Expedia and Orbitz had revenue of $3.5 billion and $767 million and net income of $472 million and a net loss of $37 million, respectively. It is clear that Priceline is well managed and offers a better investment opportunity based on profitability. Also, I think the reason for this difference between the Priceline and Expedia margins is due to the fact that 75% of Expedia's revenue is merchant revenue compared with 45% for Priceline. Merchant revenue is more labour intensive than agency revenue and carries lower profit margins. As a result, Priceline is able to generate higher revenue with fewer employees - about 5,000 employees compared with 9,400 employees for Expedia.
For 2012, I estimate Priceline to grow revenue by 25% to $5.5 billion and have a net income margin of 30% (up from 24% in 2011) or $1,650 million in net income. Assuming the company has 50 million shares outstanding and a price-to-earnings ratio of 25, which is consistent with the price-to-earnings ratio of a growth company, I arrive at a price per share of $825. This is a 12% rise for less than a year. I think this could be achieved as my assumptions are conservative. For example, 2011 revenue grew by over 40% while net income margin improved by about 7% compared with 2010.
There are headwinds that Priceline may have to face such as an increase in oil prices and online competition. However, I think that no matter how expensive, people will still travel. Instead of canceling entire trips, the first thing consumers do is look for deals and this is what Priceline offers. In terms of competition, I think that Priceline has the ability to compete well, which is not an easy task in an industry that is already saturated. I see more threats by niche travel Web sites such as homeaway.com and guestmob.com than from full travel service company such as Expedia or Orbitz. However, Priceline has the resources to make strategic acquisitions and this is where its strong balance sheet will come into play.
Priceline has a good international presence in Europe and Asia. I expect travel demand worldwide to increase due to aging and retirement of the population in the developed markets and also to the rising living standard in developing economies. For example, outbound travel in Russia is already exceeding the low levels during the 2008-2009 financial crisis with online sales demonstrating the largest growth. On the home front, Priceline is reducing its reliance on "name your own price" and shifting its focus to fixed-prices. This is evident in the killing of the "negotiator" in an ad by Priceline earlier this year. In any event, the U.S. online travel market place is mature and also Priceline derives "only" 12% of its operating profit from the U.S. so the risk here is minimal.
Overall, I think that Priceline is a good investment in the leisure industry. While the company may face difficulties due to inflation, a prolonged economic slump, and competition, I believe it is well positioned to deal with them. Its current stock price, while selling at hundreds of dollars per share may be formidable for a small investor. However, in my opinion it still has the potential for significant appreciation in the next 12 months. Most importantly, the company is a solid long-term investment with an exposure to growing international markets.