The travel agency industry is a quality investment route as it has proven to be recession resistant. During a recession consumers are even more desperate to find the bargains on travel so a travel agent is the perfect place to search for all accommodations for their trip. After performing a Discounted Cash Flow valuation model, comparable company analysis, and a deep dive into what sectors of the business generate the greatest margins I believe that Expedia (EXPE) is undervalued and can generate even greater returns by selling their Egencia segment.
One of the largest growing competitors to travel agencies today is AirBnB as people are preferring to stay at residences as opposed to hotels. In 2015 Expedia acquired HomeAway as an adaptation to this trend and it has paid off significantly. HomeAway is a rapidly growing alternative accommodations company and it has helped Expedia diversify their system of services as they can now provide the local residence vacations that many travelers are looking for. As you can see from the excerpt of Expedia’s FY2018 10K below, the majority of revenue is still driven by the “Merchant” business model but the HomeAway business model has experienced the most rapid revenue growth with a 32% bump in 2017 and an increase of 29% in 2018. The merchant business model provides hotel bookings for customers and it is no surprise that this sector has experienced slower growth. I believe that HomeAway will become a more and more important source of revenue for Expedia over the next 2-3 years.
Expedia is broken up into four main sectors: Core Online Travel Agency, Trivago, HomeAway, and Egencia. The Core Online Travel Agency is the largest segment and it provides a variety of travel and advertising services through a portfolio of brands. Trivago represents the media and advertising expertise of Expedia. HomeAway is the second largest segment of Expedia and it provides alternative accommodations. Egencia provides the exact same services as the Core Online Travel Agency except it is more focused on the corporate traveler. I believe that Expedia can increase value moving forward by conducting a spin-off of their Egencia segment. Egencia is facing many competitors in the corporate travel agency space such as Trip Actions, Travel Perk, and Travel Store. This segment of Expedia has also produced the smallest revenue margins over the years hovering around just 7.5% while Core OTA and HomeAway are at around 10.5%. The sale of Egencia could decrease the costs of Expedia and increase their efficiency in generating revenue. It would also decrease the cost of Selling and Marketing which has been the greatest expense for Expedia in the last three years. Creating a relationship with an investment bank who can find a buyer for the Egencia segment would rid Expedia of their lowest revenue generator on margin and provide the company with cash that can be spent towards marketing their more valuable sectors such as the Core OTA and HomeAway.
DISCOUNTED CASH FLOW
Expedia currently trades at $120 but I believe that with the company’s strong ability to generate cash it should be trading higher. I have attached an image of my Discounted Cash Flow model below and I believe that I made some conservative assumptions to come to my valuation. I used the same WACC (Weighted Average Cost of Capital) across all five years in my forecast and I believe that the low cost of debt caused by today’s incredibly low risk-free rate (2.13% on 10-Year Treasury Bill) leads to an unreasonably low discount rate. The current state of the economy that features an inversion in the yield curve makes the longer-term debt cheaper. I do not expect the cost of debt to be this low for Expedia moving forward and I believe that this led to a higher than realistic valuation of the company. However, I believe I mitigated for this optimistic WACC by using a Free Cash Flow growth rate of 6% for the next five years as opposed to the analyst expected growth rate of 9%. This led to a more conservative valuation that I believe helped mitigate for the unusually low discount rate. I used this growth rate of 6% for the next five years.
I believe that in approximately five years’ time Expedia’s run of steady growth will slow as companies such as AirBnB grow to a size in which it significantly damages Expedia’s hotel booking segment. At this point in time I decreased the growth rate down to 1% (which I believe is once again a conservative assumption). As a result I realize a valuation of $300 per share which I believe is high given the low input of cost of debt into the WACC but I believe it is very telling as to this stock being severely undervalued. Although I do not believe this stock is worth $300 I feel that when we compare this valuation with the multiple analysis I will dive into below this company is one of the best value plays in its industry.
Expedia also appeared to be very attractive when lined up with its comparable companies. I performed a brief comparable company analysis of a few of its relevant multiples in comparison to Booking Holdings (BKNG), TripAdvisor (TRIP), and Ctrip.com International (CTRP). Expedia has a smaller Enterprise Value (EV) than Ctrip.com yet boasts greater EBITDA. Expedia also has the lowest Price/FCF of the four companies at 13.35 as well as the lowest EV/EBITDA at 10.07. These lower than industry average multiples further prove that the company is undervalued from a Free Cash Flow perspective and generates earnings more efficiently than its competitors.
Although I believe that my DCF overstates the per share value of Expedia given the low WACC caused by the current state of risk-free rates it is still very telling as to just how undervalued Expedia is. I took a conservative approach to the current and future growth rate which decreased my valuation and helped balance out the low discount rate. My main reason for the low growth rates moving forward was the threat of AirBnB leading to a different preference in traveling but I believe that if Expedia can put more investment into marketing their HomeAway segment they can compete with the alternative accommodation companies. I believe that the best way to do this is by spinning off the inefficient Egencia segment and using the cash gained to better market the higher revenue generating departments at Expedia. When compared with its peers in already recession resistant industry, Expedia is a great value and I believe that its current market price of $120 is well below the value that its future cash flows suggest.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EXPE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.