Anticipating a significant deceleration in growth from Europe, Priceline (PCLN) maintained conservative estimates for revenue growth in Q3 2012. However, the company posted a solid quarter with $1.7 billion in revenues, which translates into 17% y-o-y and 29% q-o-q growth, and registered growth across business segments in retail hotel rooms, airline ticket and rental car reservations. This, along with higher average daily rates (ADRs) and air ticket prices, contributed to robust growth this quarter.
Benefiting from growth in hotel supply and Rentalcars.com, the company marked 30% growth in international gross bookings, while domestic gross booking grew by 7%. While the downward pressure on operating margins remains a concern, we think the Q3 earnings are proof that the European economy is stabilizing, which is an encouraging trend for Priceline given that the majority of its business is concentrated in the region.
While we remain positive on Priceline’s long-term growth prospects, we think the current growth rate is difficult to sustain in the long run and estimate that to drop in the years ahead.
Strengthening Hotel Business
At 55.2 million units, Priceline’s global hotel room nights reservations were up 36% y-o-y, only a slight deceleration from 39% growth in Q2. Contributing over 86% to Priceline’s valuation, we estimate hotel bookings to be the most important division in Priceline’s portfolio. We consider this business to be of strategic importance for Priceline’s future, and believe the company has fared well so far to leverage growth not only in the U.S., but also in international markets. Here are a few factors that drive our belief:
1. Strong footing in international markets – Key European markets currently represent around 60% of Priceline’s total booked room nights. The hotel markets in Europe and Asia are much more fragmented, with smaller, independent lodgings compared to the U.S., where the hotel market is dominated by large hotel chains. Hotel chains are more likely to offer online bookings through their own websites, while online travel agencies are more appealing to small, independent hotels outside the U.S. We believe that Priceline has benefited from this trend, and will continue to do so in the future as well.
2. Expanding supply base with Booking.com & Agoda.com – While Booking.com is concentrated in Europe, Agoda.com is focused on Asian markets. The company has been focused on aggressively expanding its presence in both these regions. At present, Booking.com has over 245,000 hotels and other accommodations, a 44% increase from last year. Additionally, Agoda is significantly building scale in Asia-Pacific, and is also witnessing strong room night growth. With Booking.com and Agoda.com in its portfolio, we believe Priceline is well-equipped to leverage growth in hotel bookings.
3. High revenue margins – Not only do hotel bookings account for the majority of Priceline’s revenue, but with 23% revenue margin, it is also the most profitable division compared to airlines (3%) and car rentals & cruises (9%). Priceline’s opaque bookings model, “Name Your Own Price”, and the newly launched “Express Deals” for hotels facilitate even higher premium pricing, leading to revenue margins in excess of 30%. Though the “Name Your Own Price” service posted a decline in gross bookings in Q3 on account of competition from other similar schemes, we expect the launch of "Express Deals" to offset any potential decline this quarter.
Continued Pressure On Operating Margins
Priceline registered a marginal decline in operating margins, and expects the downward pressure to persist in Q4 as well. Online advertising and personnel expenses impacted margins this quarter, as online advertising grew faster than gross profit due to the continued shift in business to paid channels.
Online travel services remain a competitive niche segment with stiff competition among OTAs. Macroeconomic headwinds have further intensified competition, leading to lower revenue margins and higher promotional spending, thereby squeezing operating margins. Additionally, the relatively low entry cost makes the industry vulnerable to potential threats from new players.
Priceline intends to continue investing in marketing and people to build its brand, and expand its international operations, in addition to investing in supply, product and service innovation. Thus, we estimate Priceline’s EBITDA margin to remain more or less around present levels for the rest of our forecast period.
Top issues, trends and questions that were highlighted in the Q3 2012 earnings release:
- Lower than expected deterioration of economic condition in Europe
- Growing hotels business and greater penetration of existing hotels as a driver for unit growth
- Increasing usage trends in mobile
- Near-term pressure of investments on operating margins
- A slowdown in growth in the current quarter on account of higher revenue/ gross bookings base last year
We are in the process of updating our price estimate of $564 for Priceline to incorporate the Q3 2012 earnings results.