2012: A Disruptive Year For TripAdvisor

| About: TripAdvisor Inc. (TRIP)
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TripAdvisor's (NASDAQ:TRIP) recent spinoff from Expedia (NASDAQ:EXPE) gave equity investors access to buy up the first pure-play "review platform" stock. This has helped TRIP's shares have a nice run since its split in December 2011, as there are always eager buyers to get exposure to a new and hot sub-sector. I would agree with these buyers of TRIP that the fundamental value-add of a consumer review is quite high, especially when it comes to travel destinations and accommodations.

However, looking past all this "pure-play review" hype, there are some fundamental headwinds that TRIP is going to have to face over the coming year. 2012 has the potential to be a transformational year in the internet review industry, which very well might have been the reason for EXPE's desire to spin off its TripAdvisor subsidiary in the first place. TRIP is starting to see increasing competition in its bread-and-butter hotel review space, its site traffic is heavily dependent on just 1-2 players, the quality of TRIP's reviews have come into question, and from a valuation perspective TRIP's stock seems to be priced to perfection.

  1. TRIP's main source of revenue (80%) is a cost-per-click ("CPC") model, wherein consumers visit the site to check out "quality" reviews of hotel and travel destinations (written by 3rd party individuals), and are then given the option to book said hotel (for example) through various online travel agencies ("OTA"s). The OTA then pays TRIP a pre-arranged fee for every time the consumer clicks to be re-directed to the OTA's website to check out details on the hotel rate deal. Other revenue is from display ads and some subscription-based services. For many years TRIP was able to experience substantial growth as it was the poster child for travel reviews (and the first to aggregate such reviews in a meaningful way), and in addition it was able to leverage the popular expedia.com platform and relationship. There are four main sources of competitive threats that TRIP is going to experience in the near and medium term:

  • The Expedia Transition: Prior to the TRIP spinoff, EXPE accounted for 7% of worldwide sources of entries to the TRIP sites - meaning that 7% of all site visitors went through expedia.com to access TRIP sites. Also, EXPE accounted for 33% of TRIP sales in 2011. EXPE was also (and still is) front and center as the main OTA advertised on the TRIP sites as it was able to outbid all other OTAs for better advertisement positioning. The reason for this was that since TRIP was an EXPE subsidiary, whatever cost-per-click rates EXPE was paying TRIP just flowed back to EXPE's bottom line. This was also a reason for TRIP's 50% EBITDA margins pre-spinoff. Post-split, EXPE has come out and announced that it will be spending a lot less on TRIP's CPC advertising. EXPE signed a 1-year deal with TRIP to let the investment community know that it would not simply abandon its recently spun-out subsidiary, however one would suspect that this contract is simply a marketing ploy to save face in front of investors, and a gradual relationship erosion is on the horizon. Subsequently, on TRIP's 4Q call, the company guided to margin compression (the "low 40% range" of EBITDA margins) fueled by public company costs, increased marketing spend, higher headcount, and expected loss of EXPE's high-margin revenue. EXPE is slowly moving away from the partnership phase with TRIP, and gradually more into the competitive phase. (All above details are located in the S-4 filed with SEC.)

  • The OTA Review Build-Out: In addition to spending less on TRIP's CPC service, EXPE announced on its 4Q call that it would be concentrating more on new initiatives to build out its own review database with validated reviews. In order to avoid phony reviews (which will be discussed below in this article), EXPE will revamp its review platform by ensuring that all reviewers had to have stayed at the specific hotel he or she is reviewing (and had to have booked through EXPE's sites). In addition, Orbitz Worldwide (NYSE:OWW) and Priceline (PCLN) have both mentioned that they will be focusing on building out their consumer services platform to better service the all-around customer experience. (These OTAs all own various recently established and growing sites that specialize in the discounted deals and reviews related to travel as well - hotels.com, bookings.com, mytravelguide.com, igougo.com, etc.) EXPE and OWW also guided to a cautious 2012 outlook, citing increasing competition, especially on the air bookings front. So with OTA spending focused on platform investment to better serve the customer, and with OTA airline revenue being pressured by increased competition - will this really translate into growing 3rd party marketing spend allowing TRIP to keep benefiting?

  • The Google Effect: One of the main reasons these OTAs have been seeing competitive pressures on the airline bookings side is because of Google (NASDAQ:GOOG). GOOG acquired ITA Software in 2010, and it wasn't until 2011 that GOOG began transforming the airfare search environment. Now, instead of having to log onto various OTA websites to search for different airfares, you can simply do everything via Google. In addition, as you can see in the link, the OTAs have all been pushed down in the Google search queue, resulting in an inferior exposure to the consumer. Point being, GOOG is transforming the airline search space, and has just started experimenting with the hotel space as well in 2011. GOOG's "Hotel Finder" is still in experiment mode, but it performs the same exact services as TRIP does, and more. (Not to mention, it doesn't hurt how Hotel Finder is usually at the top of the Google search cue.) Hotel Finder displays all available hotels, proprietary hotel reviews, and allows you to compare room rates across the various OTAs as well as hotel sites - all similar to TRIP's functionality. And to one-up TRIP, Hotel Finder displays links to other review sites as well (i.e., expedia.com, bookings.com, and yes even tripadvisor.com, etc.). Again, this is currently in "experiment" mode, mostly because GOOG has not rolled out the finalized platform with Zagat's review database incorporated within (which GOOG just acquired towards the end of 2011). If GOOG's disruption of the hotel review/bookings space can achieve the similar type of effect as its disruption of the airline bookings space had, this will obviously be bad news for TRIP.

  • Yelp: Although mostly a restaurant review service, Yelp has formed a relationship with Orbitz, wherein consumers can check out hotel reviews via Yelp and then book directly through OWW. This "Yelp factor" is minor in relation to the above 3 competitive headwinds, but news headlines about the recently successful Yelp IPO can't hurt the company from getting its name out there and more and more users to use the service. This then turns into increased business, and increased capital to use to build out its newer hotel review business.

  • The SEC forces public companies to disclose if certain customers make up large amounts of revenue. This is because high customer concentration is a risk. OTAs make up a large majority of TRIP's revenue - EXPE being the biggest at 33% of 2011 revenue, and then one other unnamed OTA makes up 11% of total sales (S-4). So 44% of total sales is derived from two OTAs. OTAs spend large amounts on TRIP's CPC services because they see TRIP's growing monthly user traffic, which is fueled by people like you and me logging on to search for various reviews. OTAs then want to re-direct all that traffic to their own websites for booking purposes, so they pay TRIP to access these users. The alarming part here is that there is one company that makes up 23% of worldwide sources of entries to TRIP sites (i.e., the company that drives all this TRIP traffic). And that company is Google. GOOG - the very company that is methodically building up a content-rich presence in the vacation review/booking space - is TRIP's biggest vehicle through which consumers access TRIP sites. And what is the 2nd most common source of entry to TRIP sites? Well, it's through Expedia.com, measured at 7% of total TRIP entries. TRIP sources one third of all its global traffic through two companies that are subtly, yet very methodically, disassociating themselves from TRIP and investing heavily in changing the internet review landscape.

  • TRIP's CEO continuously touts the company's competitive advantage as being the "quality" of the reviews on its sites. From a Porter's Five Forces standpoint, I would consider that "competitive edge" as being pretty subpar, but that's not my main issue. My main issue with his statement is if the fundamental value-add that TRIP gives to the consumer is the quality of all 3rd party reviews, then what does it mean if the quality of those very reviews are being questioned by regulatory authorities? The idea that a website with reviews has high barriers to entry and allows for a competitive edge is rather naïve to begin with, but now this very "edge" is being put in jeopardy. No wonder EXPE is proactively putting measures in place to protect its customers from phony reviews. Is this investigation a broader metaphorical "review" of TRIP itself as a service?

  • When valuing TRIP relative to other players in the broader travel space, it is difficult as there is no true comp. Thus, when I say the company's stock is "priced to perfection", I mean relative to its growth trajectory and in absolute terms w/r/t its intrinsic value.
  • PEG: The travel industry is a relatively mature market, especially in the U.S. (as admitted by most Street analysts). The OTA business model has been around for many years, encompassing a broad array of offerings over the years - airline bookings, hotel bookings, hotel reviews, discounted deals, etc. This makes sense when you look at the PEG ratios of these companies which on average are about 0.90x. TRIP, on the other hand, has a 1.5x PEG ratio with the company trading at 25x forward EPS. Reviews are not a novelty. Reviews in a mature industry are even less of a novelty. Yes, Asia and LatAm online travel spending is still expected to grow at 15% and 32%, respectively, but those two countries are still small pieces of the overall Online Travel spend pie, 16% and 3%, respectively. (Source: EXPE and TRIP investor presentations.)

    DCF: Do a little work and you can get a decent grasp of the global travel market size, and then drill down to the online travel ad spend market. Use this to build a simple top-down model of TRIP. Sparing you too much detail, assume the global online travel ad market grows at a 20-25% growth rate (comparable or faster than it has been in the past) over the next 3 years. Then assume TRIP does not run into any further competition (w/r/t all threats discussed above) and expands market share from 9% expected in 2012E (based on TRIP's outlook, which is slower revenue growth in 2012E vs. 2011) to 10% in 2014E. This equates to growth rates of 23% in 2012 and then 31% for the next two years (vs. 31% achieved in 2011). Keep EBITDA margins in the low 40% range, as guided by management. Using an 11% WACC (accurate WACC calc as of this week) and a 9x terminal EBITDA multiple, you get roughly to the current TRIP stock price at ~$31. So if the overall market grows as fast (and faster) as it ever has, and if TRIP continues its same growth pattern as it has in the past (inherently assuming no new competition), then there's your perfect $31 stock price.

    Risk #1: TRIP institutes dividend.

    Mitigant #1: Short-term lift to stock; does not help structural issues.

    Risk #2: GOOG entry into hotel reviews not as disruptive as GOOG entry into air bookings

    Mitigant #2: GOOG has enormous online presence; Has content via Zagat's and current proprietary reviews; Hotel Finder experiment site launched à GOOG just needs to fully execute.

    Risk #3: Network effect more powerful and the TRIP consumer is more loyal.

    Mitigant #3: Consumer is always in search for all available options to facilitate lowest price and best value (especially in a slow economy); loyalty is out the window if a better product is introduced.

    Disclosure: I am short TRIP.