Travel series (2): Expedia (EXPE)

A  logical follow-up to lastminute.com is clearly Expedia. Why ? Well, firstly because I use it personally (for flights) and secondly because it is one of the leading “OTAs”.

The company:

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Expedia started in 1996 as a division of Microsoft and did an IPO in 1999. They have a pretty detailed company history web page.

They were taken over in 2003 by Barry Diller’s Interactive Group (IAC), combined with other IAC travel businesses like Hotels.com and then spun-off again in 2005 when also the current CEO Dara Khosrowshahi got his job. After that they acquired a couple of other brands and businesses similar to lastminute.com but on a much larger scale, such as Trivago, Orbitz, Homeaway etc.

In 2011 they spun off Tripadvisor, last year they partially IPOed Trivago, the hotel meta search site.

The business:

In comparison to lastminute.com, Expedia has much more hotel revenue. Only 9% of Expedia’s revenues are from flights, Expedia is effectively a hotel room booking company. The hotel booking business is clearly more interesting than flights. Why ? Because with most hotels, each OTA has to build up bilateral relationships. GDS play a much smaller role for hotel rooms compared to the flight industry. This clearly moves the power to the large OTAs because as a distributor you make the most money if you have many suppliers and many customers.

Interestingly they also  differentiate between the “Merchant model” where they buy hotel room contingents and resell them and an “agency model” where they just act as an agent for a fee. Slightly more than 50% of Expedia’s revenue is “merchant” revenue.

The “Merchant model” is clearly more risky on one side. If you have bought hotel rooms early last year in Turkey you would have made a big loss. On the other hand, the merchant model allows an OTA to leverage its size and gain economies of scale. Competitor Booking.com seems to be a pure agency player.

Competition:

These are some paragraphs from the annual report on competition:

We face increasing competition from other online travel agencies (“OTAs”) in many regions, such as The Priceline Group and its subsidiaries Booking.com and Agoda.com, as well as regional competitors such as Ctrip

We also face increasing competition from search engines including Google. To the extent that these leading search engines that have a significant presence in our key markets disintermediate online travel agencies or travel content providers by offering comprehensive travel planning, shopping or booking capabilities, or increasingly refer those leads directly to suppliers or other favored partners, increase the cost of traffic directed to our websites, or offer the ability to transact on their own website, there could be a material adverse impact on our business and financial performance. For example, in recent years search engines have increased their focus on acquiring or launching flight and hotel search products that provide increasingly comprehensive travel planning content and direct booking capabilities, comparable to OTAs. In addition, these search engines continue to expand their voice and artificial intelligence capabilities. To the extent these actions have a negative effect on our search traffic or the cost of acquiring such traffic, our business and financial performance could be adversely affected.

Travel metasearch websites, including Kayak.com (a subsidiary of Priceline), trivago (a majority-owned subsidiary of Expedia), TripAdvisor, and Qunar (a subsidiary of Ctrip), aggregate travel search results for a specific itinerary across supplier, travel agent and other websites.

So even in the hotel space competition is heating up. And again, in many cases competing against Google is no fun.

Finally a story from Bloomberg about Air BnB which also wants to become an OTA:

To Be a Travel Behemoth, Airbnb Is Accelerating Dealmaking
The home-sharing site is examining deals that would allow it to expand into a full-service travel company.
By Olivia Zaleski(Bloomberg) —
Airbnb Inc. is on a mission to be more than a home-sharing platform. It wants to be a flight booker, an itinerary planner and a vacation-home manager. To become a global travel behemoth, Airbnb is considering a combination of acquisitions and partnership deals to quickly grow its portfolio, according to three people with knowledge of Airbnb’s plans.The company’s targets are in luxury tourism, airfare aggregation, group payments and guest-management, said the people, who asked not to be identified because Airbnb hasn’t authorized them to speak publicly. Airbnb is also focused on doing deals in China and India, the people said.

Interestingly enough, last year Airbnb seems to have been valued at 30 bn with sales of 900 mn. Quite a lot compared to Expedia which has an enterprise value of arund 23 bn and 8 bn of revenue.

But clearly the OTA space is very competitive and consolidating. Expedia could be one of the winners but at least for me the outcome is not clear.

Expedia Pros and Cons:

+ good products (good, not great. For hotels I prefer Booking)
+ strong market position in the US
+ size advantage for a brand business (and merchant model)
+ focus on hotels. less reliant on flights (only 9% of revenues)
+ lot of room for industry consolidation (currently 6% of market)
+ are active in many areas (including meta search for hotels etc.)

– CEO has super high salary (90 mn USD in 2015)
– top line growth, operating profit stagnant
– expensive acquisitions in 2015/2016, number of shares and debt increased significantly
– reported growth numbers not adjusted for acquisitions in investor presentation
– lots of share options

Little organic growth:

If you look at the investor presentations, they only show unadjusted growth numbers which look good at first sight. One really has to dig into the annual report to find that the growth in 2016 came almost exclusively from acquisitions:

The increase in worldwide gross bookings in 2016 as compared to 2015 was primarily driven by the inorganic impact from acquisitions of 13% and growth in the Core OTA segment, including growth at Brand Expedia and Hotels.com, as well as in Egencia.

In 2016 , revenue increased primarily driven by 19% of inorganic impact from acquisitions

The management / CEO:

The CEO is one of the top earners in Corporate America. In 2015 for instance he received a salary (including stock options) of around 90 mn USD:

Khosrowshahi’s 2015 earnings were made up of a $1 million salary, $2.8 million bonus, and $90.8 million in stock option awards. Khosrowshahi’s large pool of option award came because he entered into a long-term employment agreement with the company, stating he would stay with Expedia until Sept. 2020, according to the company’s annual filing.

This is from Bloomberg:

Another block of options, worth about $53 million, vests in two stages between now and 2020, provided that Khosrowshahi stays with the company.

A third block of options valued at $30.3 million vests only if Expedia’s stock price hits $170 a share within 12 months of September 2020. Earlier this month, the company’s stock was trading for about $107 a share. Expedia’s share values would have to climb 58 percent to hit the target price.

Maybe I don’t understand fully how this works in the US, but such a grant just for staying seems odd to me. Also a 58% increase over 5 years is not that spectacular as a hurdle.

On a positive side, as a former refugee from Iran, he is not shy to criticise Donald Trump’s “politics” in public. He also seems to own stock in the value of 400 mn USD or so.

Valuation:

At 119 USD per share, Bloomberg tells me that they have a trailing P/E of 54, an expected 2017 P/E of 22,3 and an EV/EBITDA of ~16. This means that a lot of growth is already priced in.

Without deeper modelling, I do think that this valuation is ambitious. Yes, there might be more opportunities for consolidation, but first they have to digest the recent purchase and then defend against the other players. So I don’t see a lot of opportunity here.

Liberty Expedia:

For historical reasons, the control of Expedia is bundled in a stock listed vehicle called “Liberty Expedia” which was spun off from Liberty Interactive Group.

Liberty Expedia owns 23,6 mn Expedia shares thereof 12,8 mn unlisted class B shares which have 10 voting rights per share. So overall Liberty Expedia has slightly more than 50% of voting rights in Expedia. Liberty Expedia also owns  “bodybuilding.com” and has 300 mn USD net debt. If we assume that the bodybuilding business is worth 300 mn, then the value of Liberty Expedia should be the worth of the underlying Expedia shares which would be 23,6*119= 2,8 bn USD. This compares to 2,5 bn market cap, so we have a small discount of ~10%. As I think that Expedia itself is not so cheap, a 10% discount on an expensive stock is still expensive, so for the time being also Liberty Expedia is not interesting.

Summary:

The OTA sector is very competitive. Expedia seems to have a better position than lastminute.com because it focuses on hotels and is much bigger. Nevertheless they struggle to grow organically and have levered their balance sheet significantly and acquired competitors. This might play out in the long run, however it looks that the share price is already reflecting a significant portion of this future success.

So in the absence of other potentially positive aspects like a strong company culture or an owner/CEO combination, Expedia is not an interesting investment for me. Oh, and Air BnB doesn’t look like a homerun either….

 

 

 

4 comments

  • Stockholders’ equity $ 4,132 million
    Goodwill $ 7,942 million
    Intangible assets $ 2,447 million
    ROA 1.8%
    ROE 6,27%

    If the fair market value goes below historical cost, an impairment is due to goodwill. So it says.
    Market values of this kind of assets tend to fall with rising interest rates, especially with low returns on capital.
    I wonder whether I will live to see that at some companies.

    Expedia and Travelocity were disruptive innovators once. By now, medium-sized and large companies can use some better integrated travel-and-expense apps with direct relationships with travel, hotel, and entertainment suppliers as well as through global distribution systems.
    Concur is an example. Hotels and airlines remain in the game, as well as distribution systems (Sabre).
    I don’t know what proportion of Expedia’s revenue is generated by business customers.

  • Thanks for the comment. One remark: In my opinion, one should deduct Option grants from Free Cash flow. Those option grants are part of the salary and either lead to dilution or negative cashflows because of future stock buybacks. It is a nice game played especially by tech companies but one should not fall for it.

  • Nice summary. I can agree with almost everything you write. Just a few comments.

    – Priceline makes about 70% of it’s revenue with the agency model, ~22% with the merchant model (with the rest being other revenue sources), although the agency share of booking.com itself may be higher

    – revenue, operating profit stagnant: it’s true that there are a lot of acquisitions and it is really hard to split between organic and inorganic growth. However, I believe there is organic growth.

    – Additionally, EBIT is heavily depressed by amortization of acquired intangibles which, at least in my opinion, can be added back to EBIT. Then you’d have double digit operating profit growth, but again: it’s hard to split between organic and acquired growth…

    – with these adjustments, the P/E for 2016 falls to somewhere in between 25 and 30. Not that cheap either, but much better than the 54 from Bloomberg.

    – to make this even clearer: FCF (cash from operations – capex) for 2016 is ~ mio. 815., way more than net income of mio. 282. However, this is distorted by share-based payments, which you recognized as a problem anyway. I agree that the latter is excessive, as is the CEO compensation.

    – Liberty Expedia: I guess you are correct there. After a short view into the financials, I have a hard time valuing bodybuilding.com at mio. 300. So maybe I was wrong and there is no discount at all..

    In the end I completely agree: interesting company, but at current share prices there is too much risk of overpaying.

    I look forward to the next part of this series 🙂

    Thanks,
    Tom

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