Analysis of Expedia's 10-K (EXPE, L)

Stifel Nicolaus analyst Scott Devitt analyzes Expedia Inc's (Nasdaq:EXPE) 10-K filing. This analysis is also of interest to owners of Liberty Media (L) stock, because at the end of 2005 Liberty Media owned 18% of Expedia's common stock and 100% of its Class B common stock:

Voting Control. As of year-end 2005, Liberty Media Corporation (NYSE:L) beneficially owned approximately 18% of Expedia's outstanding common stock and 100% of Expedia's outstanding Class B common stock, including those companies jointly owed with Barry Diller. Mr. Diller has voting control pursuant to an irrevocable proxy granted by Liberty and controlled approximately 53% of the outstanding total voting power of Expedia. Additionally, Mr. Diller and Liberty have the right to consent to certain significant corporate actions in the event that Expedia's ratio of total debt to EBITDA equals or exceeds four to one over a continuous 12-month period.

Investments in Platform Improvements. Expedia is currently investing in and building a scaleable, extensible, service-oriented technology platform to extend across all of its brands. This transition should allow the company to improve site merchandising, browse and search functionality and add significant personalization features. This transition is expected to occur in a phased approach, with worldwide points of sale migrating to the new platform by early 2008. The company is also making a significant upgrade to the data aggregation and mining capabilities across Expedia to allow enhanced personalization. The full project is scheduled for completion in 2008.

Direct Connect. By streamlining the interaction between the Expedia Web sites and hotel central reservation systems, the company can make it more cost-effective for hotels to manage reservations made through the Expedia brands. By connecting directly, hotels can upload information about available products and services and rates directly from their central reservation systems as well as automatically confirm hotel reservations made by travelers. Over 30% of Expedia's worldwide merchant hotel properties are now fully direct-connected. Management expects that this number will increase in the future.

Expanding Footprint. Expedia plans to enter the Japanese travel sector by the end of 2006. Management notes that future launches may occur under the flagship Expedia brand or its other brands, or through acquisition of third-party brands, as in the case of eLong.

Corporate Travel. Management intends to continue investing in and expanding the ECT business. ECT currently accounts for less than 5% of Expedia's worldwide gross bookings, but is anticipated to grow over the next few years.

GDS. Expedia has historically used Worldspan as its primary GDS, but also has distribution agreements with both Amadeus and Sabre. GDS partners in particular face renegotiations of their long-term contracts with airlines in 2006 that could result in decreased compensation to both the GDS companies and to Expedia (and other online travel agencies).

Airline Tickets. The U.S. airline industry has experienced increased load factors and ticket prices. These trends affect Expedia's ability to obtain inventory for its merchant air business as suppliers lower discounting of merchant air tickets. These competitive forces have caused air revenue per ticket to decline, however, Expedia's worldwide air revenue has grown year-over-year, primarily due to increases in the number of air tickets sold.

Online Penetration. As noted in the 10-K filing, according to PhoCusWright, 29% of U.S. leisure and unmanaged travel expenditures occurred online in 2005, up from 14% in 2002. Further, an estimated 14% of European travel was booked online in 2005, up from 4% in 2002.

Occupancy Taxes. Several lawsuits have been filed against online travel agencies regarding hotel occupancy tax. Expedia has established a reserve with respect to potential occupancy tax liability for prior and current periods, consistent with applicable accounting principles. Expedia believes that the claims relating to litigations relating to the hotel occupancy tax lack merit.

Revenue Margin. Revenue margin, which is defined as revenue as a percentage of gross bookings, decreased 80 basis points in 2005 compared to 2004. The decrease was primarily due to a decrease in air revenue per ticket and hotel margins. In 2005, revenue margin decreased 90 basis points for domestic operations and 21 basis points for international operations.

Credit Facility. In July 2005, Expedia entered into a $1.0 billion revolving credit facility. As of December 31, 2005, the outstanding balance on the revolving credit facility was $230.0 million, which consisted of short-term borrowings. This balance was repaid during the first quarter of 2006, and as of March 24, 2006, the was no outstanding borrowing under the revolving credit facility.

Working Capital. As of December 31, 2005, Expedia had a deficit in working capital of $848.0 million, compared to a positive amount of $1.3 billion as of December 31, 2004. The fluctuation in working capital was due to the $2.5 billion net intercompany receivable balance that was extinguished through a non-cash distribution to IAC upon the spin-off.

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