Shorting stocks, just like investing from the long side, is best done over the long term. From the short's perspective, we must reverse all the aspects that make a business (note, that's much different than a stock) attractive to find profitable short opportunities.
One of these aspects is a strong, relatively stable and impenetrable business model or niche. Priceline.com (NASDAQ:PCLN) immediately fails this test.
Incredibly Intense Competition
Priceline tries to separate itself from the multitude of other online travel booking sites by offering a "Name Your Own Price" hotel and airline booking service whereby customers enter the specifics of their desired trip and Priceline finds matches. Customers don't find out the airline or hotel until the deal is confirmed.
However, even Priceline now discloses in its annual reports (2011) that Expedia (NASDAQ:EXPE) and Travelocity have had a significant impact on revenue growth rates. With those companies on the rise and gaining significant market share, Priceline's total revenue growth and margins will contract.
The competition doesn't end there. Daily deal sites like Groupon (NASDAQ:GRPN) and Living Social have started to also nibble away at market share, further limiting the available supply of discount hotel bookings. Microsoft's (NASDAQ:MSFT) Bing travel, Yahoo (NASDAQ:YHOO) travel, Kayak.com, Orbitz, and, perhaps most importantly, the service "Room Key," whereby hotels sell their discounted rooms directly to customers, are all up-and-coming competitors that are flooding the market with product and limiting supply.
While Priceline discloses these services as a threat to only their U.S. business, it is apparent that the nature of the business means its much larger and important international operations will also face pressures in the coming years. The reality is that there are essentially very low barriers to entry, and thus a very low probability of returns that meaningfully exceed the normal rate of return.
Valuation is far less important than you might think when it comes to shorting stocks. After all, what really is the difference between the market valuing a company at 30 vs. 50 times earnings? How about 50 vs. 70? At some point (generally above 25 for relatively mature businesses) valuation is thrown out the window and investors focus on "the story," and hype it so that the consensus is the company will "grow" into its massively risky and premium valuation. However, it is worthwhile to check if the market is already discounting the aforementioned concerns. If so, the short opportunity becomes far less attractive.
Q1 revenue growth (according to Priceline's Q1 10-Q) was about 28%, while EPS growth was an enormous 73%. Operating cash flow was down significantly in Q1 due to prepaid expenses, but adding those back, OCF was only up 18%. With a PEG ratio of 0.90, the stock seems to be pricing a realistic current valuation, but that's assuming the lofty growth projections come to fruition. Here's where we run into a major problem.
In 2013, Priceline is supposed to earn almost $40 per share. Assuming the same annual growth as in the past, about 35%, this appears doable. However, there's no room for error. Given the concerns about limited supply of discounted rooms and airfare, and increased product, it seems unlikely that margins won't compress -- and even more unlikely that earnings are able to grow to that extent.
Regardless, the shares are priced for a best-case scenario that certainly doesn't discount legitimate (and present) competition.
After Q2 guidance that missed analyst expectations, a double top, lower lows, and upcoming seasonal weakness, the $660 region provides a decent entry point for Priceline. But that comes with one caveat: The overall market is currently at an inflection point where further easing or a legitimate EU restructuring plan will spark a rally, and an unorganized Greek exit or Spanish default could send stocks plunging.
I consider Priceline to be very similar to Netflix (NASDAQ:NFLX). Yes, the growth is and has been impressive, but the business isn't sustainable. Massive competition has already led to a huge increase in the need for advertising (almost $1 billion in 2011), and limited supply in the product that Priceline tries to sell will have a very negative impact on future earnings. Granted, Priceline doesn't quite have the valuation Netflix had, but the poor, low-barriers-to-entry business model is the same.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in PCLN over the next 72 hours.