Booking Holdings (BKNG) is the undisputed leader and most efficient player in the Online Travel Agency (OTA) world. It operates predominantly in Europe and generates TTM revenue of $14 billion, $3 billion more than the second largest player, Expedia (EXPE). With increasing competition, even from the likes of Google (GOOG) (GOOGL), Apple (AAPL), Alibaba (BABA), Tencent (OTCPK:TCEHY) and Facebook (FB), Booking has been more than able to defend its turf. How?
First, the company has molded a perfect business model. It possesses multiple avenues to generate sales, employing both the agency model and the merchant model. It focuses where there is high profitability, which is in accommodation. It recognizes the threat from Airbnb (AIRB) and the competitive market environment. Second, despite being the largest player, the company does not get complacent. It continues to grow. In the past few years, it has acquired OTAs in the fastest growing market in South East Asia, partnered with Ctrip to penetrate the Chinese market and invested in non-OTAs.
Finally, with all the above qualities, how much should an investor pay to own Booking? In our view, a company that has high-quality earnings, consistent growth and an asset-light business model deserves a premium valuation. We will see in the analysis section that Bookings is head and shoulders above competitors in most metrics. Therefore, at the current free cash flow valuation multiple of 18x, we find Booking cheap. An investor will do well buying at any dips.
Business model and growth
Booking's primary source of revenue comes from earning commissions, a reward earned for bringing travelers to hotels, airlines or car rentals providers. The second source is through direct selling of hotel rooms or car rentals that the company has bought in-bulk from providers.
The first source, or called Agency model, generated 73% of Booking’s total revenue last quarter and the second source, or Merchant model, made 21%.
Source: Booking 10-Q, Q3 2018
Both models have its merits. The Agency model is straightforward and simple. On the other hand, the Merchant model gives control of pricing to Booking, and it allows sharing of the risk with providers. Thus, the second model brings mutual benefits to both parties.
We show how important the focus on the Agency model has helped Booking.
First, thanks to its simplicity, the Agency model is more asset-light. Even with the relentless expansion, last year, Booking’s CAPEX remained tiny at 2.6% of sales. The percentage was almost three times lower than the industry average. The closest comparable, Expedia, recorded an average of 8% in the past three years.
Also, employing the agency model means that operationally, it requires less effort, less personnel to win new suppliers. As a result, it is usually more cost-effective and allowed Booking to record top of the class operating margin of 35.5% in the past three years on average.
Moreover, the type of products that Booking chooses to focus on also had a positive impact on its profitability. In the travel segment, accommodation yields by far the higher margin. It also benefits from the exponential growth in online bookings, and the higher growth rate in the non-US market. Unsurprisingly, Booking is well-positioned to benefit. Comparing with Expedia for example, Booking is a step ahead. For example, last year, 88% of Booking’s revenue was generated from online accommodation reservation services compared to 68% in Expedia.
Source: Expedia 10-K 2017
Next, most of Booking’s revenue derived from outside of the US, thus it was able to benefit more from higher growth opportunities. In contrast, Expedia exposure remains high in the lower growth market, with 55% of its revenue generated in the US.
Source: Booking’s 10-Q Q3-2018
Source: Expedia 10-K 2017
Therefore, the combination of the agency model, accommodation services and exposure to higher growth market contributed Booking’s top of the class operating margin.
Hungry for growth
Booking does not strike as a company that sits comfortably at the top. Management understands the competitive environment and has not been complacent. Over recent years, the company has been actively seeking more growth by acquiring a host of companies in different geographies and product segments.
In the US, it acquired OpenTable – a restaurant platform, and Kayak – a travel meta-search website. Recognizing growth in Asia, it acquired Agoda and Grab, a travel site and a car sharing platform in South East Asia. Finally, in China, it also partnered with Ctrip.com (CTRP) to get exposure in the region.
Often, acquisitions fail and synergies disappoint. However, Booking is an outlier. Despite the relentless acquisitions its margins and cash flow grew.
And the growth doesn't seem to slow down. Impressively, at a cumbersome size of $91 billion market cap, Booking still managed average revenue growth of 14.5% in the last three years. Last year, the increase was even higher, at 18%.
Source: Booking's 10-K FY 2017
In summary, Booking’s adoption of the Agency model, focus on accommodation and exposure in higher growth markets yielded in the first-class operating margin. The asset-light model also allowed Booking to achieve an incredible 37% FCF/Sales.
The figures are astonishing compared to its main competitors, included in the table below are Despegar (DESP), a top OTA in South America, Ctrip, the largest in Asia, and finally Expedia, the largest in the US.
Source: Author’s calculations, Financials from 10-Ks, 10-Qs.
With the impressive figures above, Booking deserves a higher valuation than it's currently priced, at 18x FCF. It has far superior profitability and cash flow than Expedia. Also, in the past few years, Booking grew its FCF by 20%. The figure surpasses the revenue growth of 15%. Thus, Booking’s economies of scale work magic here. It is also incredible to see that an OTA can generate 37 cents of pure cash for every dollar of sales! No surprise, Booking is also almost at a net debt position with $7B in cash and $8.7B in long-term debt.
Source: Author’s calculations
The travel market is highly competitive, dynamic and fragmented (read more here). However, we have demonstrated that Booking has masterfully navigated through the changing business models, product segments, and geography to cast the best-in-class operational blueprint. We think that if there is one company that will stand the test of time, then it would be Booking. It is the one stock to own in the OTA market.
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Disclosure: I/we 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.