Ctrip: Potential and Risk in China Travel Bookings

Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent update to clients on Ctrip.com International, Ltd. (CTRP):

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• Investment Conclusions. We are withdrawing our Buy rating given the stretched valuation (67x forward GAAP EPS) and various short-term headwinds: indications of slowing air travel growth; shortened May holiday; and potential for reduced discretionary travel due to major events, i.e., the recent Sichuan earthquake and Beijing Olympics in 3Q08. Based on higher share-based compensation (not tax-deductible) – offset partially by other income and lower longer-term taxation – we are adjusting our estimates: 2008 GAAP EPADS goes to $0.90 on net revenue of $244 million (52% YoY growth) from $0.95 on net revenue of $245 million; and 2009 GAAP EPADS stays at $1.25 on net revenue of $335 million (38% YoY growth and down from $338 million previously). Our estimates imply 45%/40%/27% compound revenue/EBITDA/EPS growth in calendar 2007-09.
• 1Q08 Results. GAAP EPADS of $0.20 vs. $0.12 a year ago on net revenue of $48.6 million (61% YoY growth) beat our $0.18 estimate on net revenue of $46.5 million. Results benefited from a government subsidy and forex gain totaling $2.7 million (2.8 cent EPADS impact). Ctrip posted positive variances in net revenue ($2.1 million) and other/interest income ($2.7 million) – offset partially by operating costs ($2.1 million) and taxes ($1.2 million). Operating income of $15.7 million (32.4% margin) rose 71% YoY and was in line with our $15.8 million estimate (34.0% margin) – despite share-based compensation being $1.5 million above our forecast. Due to competitive reasons, Ctrip will no longer disclose metrics on air tickets sold and room nights booked. However, management did note continued expansion of the domestic hotel network (+31% YoY to 6,400) and active customer base (+55% YoY to 4.5 million). Results reflect a gradual recovery from severe weather conditions during the Chinese New Year holiday, an otherwise robust domestic economy, augmented inventory, strong contribution from Tier-II cities and a widening gap over rivals. Net cash increased to $197.8 million from $185.1 million on December 31.
• Noteworthy developments are summarized below.
  • January 2008. To support growth in 2010 and beyond, Ctrip indicated that it will invest $40-50 million through 2011 for building a second call center in Nantong (110 kilometers north of Shanghai).
  • August 2007. Rakuten sold its 13.3 million ADSs for $38 each to lock-in a 360% return over three years.
  • January 2006. Ctrip promoted COO/co-founder Min Fan to the position of CEO. James Liang, former CEO, continues to serve as Chairman. October 2005. Ctrip announced that Ms. Jane Jie Sun will assume the position of CFO. Ms. Sun replaced former President/CFO Neil Shen, who joined VC firm Sequoia Capital but remains a board member.
  • July 2005. The Chinese government changed its currency policy. Over time, anticipated RMB appreciation should translate into higher dollar-denominated operating income, offset by near-term currency translation losses.
  • December 2004. Existing shareholders (including management) sold 7.7 million ADSs at $12.13 each. June 2004. Ctrip attracted a $110 million investment at $8.25 per ADS from Rakuten.
  • December 2003. Ctrip raised net proceeds of $44.5 million from its IPO (at $4.50 per ADS).
• Investment Thesis. Powered by rising GDP and disposable incomes, the Chinese travel industry is expected to sustain double-digit growth in coming years. Traditional agencies have been limited to a local/fragmented presence (due to licensing requirements) and focus primarily on tour groups. Pioneering consolidators like Ctrip offer selection plus savings to the individual traveler, and have become valuable aggregators of demand for the travel industry. Superior positioning includes the following: 85% of hotel reservation revenue is derived from bookings at three-to-five star hotels, where the commission per room is highest and room nights have grown 20%+ industry-wide in recent years. Ctrip boasts a nationwide supplier network, which assumes particular significance in a country with no hotel GDS. Market leadership has translated into a premium commission structure, i.e., 15% of the room rate or $10 per night. Ctrip has also sought to differentiate itself through service quality and innovation. Longer-term growth stands to benefit from continued expansion of hotel coverage and relaxation of travel restrictions, as well as implementation of an e-ticketing mandate.
• CTRP is suitable for aggressive investors. In our opinion, principal risks include the following:
  
  • Deterioration of economic conditions or a slowing of travel demand in China.
  • Inability to secure adequate room availability under “guaranteed allotment” arrangements (that afford risk-free inventory and contribute three-quarters of hotel transaction volume). Competition could pressure future profitability by way of lower commission rates and/or higher marketing expenses.
  • Disruptions affecting travel demand. This encompasses terrorist threats; geopolitical instability; catastrophic events; and spread of the H5N1 virus or a recurrence of SARS (necessitating closure of the Shanghai call center).
  • Correction in the U.S. markets.

  ANALYST CERTIFICATION: I, Ashish Thadhani, certify that all the views expressed in this research report accurately reflect my personal views of the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of this report.