Expedia: Competition Is Eating Into Its Moat

| About: Expedia, Inc. (EXPE)
This article is now exclusive for PRO subscribers.

Shares of Expedia (NASDAQ:EXPE) took a beating in Monday's trading session after analysts at Deutsche Bank took a cautious stance on the company's prospects.

I must agree with Deutsche Bank, as I have been quite cautious on Expedia for a while. I am concerned about the competitive position of the firm as competition in the online travel industry only continues to intensify.

I remain on the sideline awaiting clues about the competitive position at the third quarter earnings report, scheduled to be released in a few weeks' time.

Deutsche Bank Is Cautious

Analyst Ross Sandler downgraded Expedia from "Buy" to "Hold," giving the company a $51 price target.

Sandler believes there are three possible scenarios for the company in the short run. A "Quick Fix" allows the company to meet its full-year guidance. The "Almost Gets There" fixes the second quarter issues, but creates additional costs for onboarding the Travelcity deal and other items. The worst case scenario is the "Breakdown" case in which Expedia sees further execution and competitive issues, prompting management to guide downwards again.

While Deutsche Bank was quite optimistic about a "Quick Fix," or an "Almost Gets There Fix" outcome, it now believes the "Breakdown" scenario has become more likely. Recent management changes at Hotels.com and poor quarterly channel checks make Deutsche quite pessimistic into the next earnings report.


Expedia ended its second quarter with $2.30 billion in cash, equivalents and short-term investments. Total debt stood at $1.25 billion, for a net cash position just over a billion dollars.

Revenues for the first six months of the year came in at $2.22 billion, up 19.4% on the year before. Expedia reported a $32.7 million loss compared to a $102.0 million profit a year ago. The company took $166 million in amortization charges, legal reserves, and acquisition-related charges, mostly in the first quarter.

At this pace annual revenues could come in around $4.7 billion, as Expedia could report a modest annual profit.

Factoring losses of 7%, with shares trading around $48 per share, the market values Expedia at $6.5 billion. Excluding the net cash position, operating assets are valued around $5.5 billion.

This values operating assets of the firm at 1.2 times estimated annual revenues for 2013 and a not too meaningful profit multiple.

Expedia pays a quarterly dividend of $0.15 per share, for an annual dividend yield of 1.2%.

Some Historical Perspective

Shares of Expedia have seen solid returns over the long run as the online travel market has grown a lot. Shares rose from lows around $7 in 2009 to a peak around $68 earlier this year. Ever since, shares have given up roughly 70% of their value, trading around $48 at the moment.

Between 2009 and 2012, Expedia has grown its annual revenues by a cumulative 47% to $4.03 billion. At the same time, earnings fell from $300 million in 2009 to $280 million last year.

Investment Thesis

Investors in Expedia have had a rough year so far, while equity markets have performed well. Shares trade with year to date losses of around 21% as competition is intensifying putting pressure on Expedia's earnings, and its valuation.

I last took a look at Expedia's prospects back in April of this year, when the company reported its first quarter results. I concluded that investors were disappointed as competition is intensifying, prompting shares to fall to levels around $56 per share.

As shares have fallen even further towards $48 per share, the valuation of operating assets has also dropped to $5.5 billion, or roughly 20 times last year's earnings of $280 million.

In hindsight investors were not too happy with the expensive deal of Trivago, announced back in December of 2012. The $564 million deal added an estimated $120 million in revenues -- quite a premium compared to Expedia's valuation at just 1.2 times annual revenues.

While the market is still growing rapidly, Expedia is facing headwinds from tough competitors, including Priceline.com (PCLN), among others. While Expedia is still growing rapidly, competition is increasing, which is hurting margins. At the same time online advertising, notably on platforms like those offered by Google (NASDAQ:GOOG) is becoming more expensive, resulting in a double impact on earnings.

I have to reiterate my stance from first quarter. I do like the long-term prospects of the online travel industry. Yet I see short to medium term pressure on earnings, while the stock has sold off another 15% from the levels in April. Investors are fearful about the fact that firms like Priceline.com might outcompete Expedia by undercutting it entirely.

This downgrade will most likely put pressure on consensus estimates for third quarter earnings, scheduled to be released on the 7th of November. While the absolute valuation is somehow justifiable, it is notably the relative revenue multiples versus the likes of Priceline.com that might start to look appealing. That being said, profitability is eroding quickly as Expedia's competitive position seems to be undercut at the moment.

As above, I remain on the sidelines awaiting the third quarter earnings report to find out more clues about the valuation and competitive position of the firm.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.