Monday, March 13, 2006
Plenty of runway ahead
If their catchy commercials hadn’t caught your attention, maybe EXPE’s recent rise and fall did – It certainly has mine. Actually, I originally caught interest in Expedia about 5 months ago as I watched its stock price deteriorate from $24 to around $19 following its spin-off from IACI.
I initiated a long position at $20.34 after seeing no material change in the company’s operating prospects and discounting pre-existing ‘synergies’ from the IACI ownership. After all, if synergies did exist, the ‘whole’ should have been greater than the ‘sum of parts’ and IACI would have retained EXPE. From a business definition perspective, EXPE and IACI ranked poorly on both customer and cost sharing. The spin-off was the right move and it presented an attractive buying opportunity. For reasons more eloquently described by Bruce Greenwald in his book Value Investing, spin-offs often represent interesting investments:
“Spin-offs are a wonderful opportunity for investors who are not constrained by questions of corporate size. Because many of the shares are sold for reasons unrelated to the company’s prospects, there are bound to be gems tossed away by the large funds for whom a small company stock, though perhaps a jewel, is still a nuisance” (23).
After holding on from $20 to $26, and now down to $18, I’ve had to re-evaluate my position. Am I still bullish on EXPE?
Yes, and to show you my thought process I’ll walk through the basic ‘focused’ approach that I discussed in my March 12th posting.
EXPE comprises a portfolio of leading online travel agencies that include Expedia.com, Hotels.com, Hotwire.com, TripAdvisor.com, and Expedia Corporate Travel. You might be surprised to learn that of the ~$900B WW travel market (business & leisure), online store fronts account for only 10% of gross bookings. Even by conservatively estimating that online travel will reach full market penetration at 40% of total bookings (I think the end-game saturation point is much higher), there is plenty of headroom for growth in the sector and I believe that the industry's long term prospects are very attractive.
In online travel, scale matters and EXPE has a lot of it. A straight-forward way of looking at the benefits of scale is by comparing relative market shares (RMS: market leader's share / closest competitor's share, all other company's share divided by the market leader) and their associated returns (ROS, EBITDA %, etc.). EXPE commands a dominant RMS of 1.8x as compared to its closest competitors Cendant Online Travel (Cendant: Orbitz, Cheaptickets,com, Gullivers, eBookers), .6x, and Travelocity (Sabre-Holdings: Travelocity and lastminute.com), .5x. RMS goes a long way to explain why EXPE earns 28% EBITDA margins as compared with 13% and 6% for Cendant and Travelocity, respectively. A further analysis of ROIC could prove interesting; however, I’m uncertain how to treat EXPE's large Goodwill account as it makes up ~75% of assets. I think including all of Goodwill would understate EXPE's true economic return; however, comletely excluding Goodwill overstates the figure. Regardless, EXPE's strong RMS is a valuable asset and they have acquired it early.
But, is EXPE’s RMS sustainable? Is its franchise (read: competitive advantage) intact? Yes. Interestingly enough, EXPE has fueled its 27% 2003-05 CAGR in gross bookings through organic expansion while competitors have relied on acquisitions (Travelocity purchased lastminute.com and Cendant purchased its entire online platform: Orbitz, Gulliver’s, and eBookers). EXPE invaded Europe with a 77% 2003-05 CAGR in gross bookings thanks to the importation of US best practices: technology, content procurement, and sales & marketing.
In addition to a solid technology platform and strong market share, EXPE’s management team seems competent (from what I, as an independent, retail investor can discern) and possesses an impressive understanding of what drives value in online travel . I encourage you to review to their 2005 Q4 earnings call as well their March 6th Allen & Co. presentation, both available at http://investors.expediainc.com. The CEO effectively lays out how EXPE will seek out profitable growth from the core by pursuing geograhic adjacenices (e.g. continental Europe, Japan, and China), business adjacencies (e.g. Hotels.com, TripAdvisor, Hotwire, and Corporate Travel), and improving customer retention and loyalty (e.g. CRM systems and the Expedia Best Price Guarantee).
Valuation makes up the last, yet most important, piece of my investment decision. Initially, on an EV/FCF and EV/EBITDA basis, EXPE feels cheap at 8.9x and 10.7x, respectively. PCLN is the only pure-play online agency of which I’m aware, and she trades at 15.6x EV/EBITDA. Beyond comparables analysis, estimating a simplified earnings power value (EPV) produces equally interesting results. For the time being, let’s assume that EXPE achieves no ongoing growth and FCF remains stagnant at $706M (EXPE's reported FCF of $798M net of stock option expense of $92M). How much would we pay for this annuity? How about: $702M / 10%? A 10% discount rate would yield a per share value of $20.58. Again, $20.58 values EXPE’s US, European (the world’s largest travel market), and Asian growth (Expedia’s 51% stake in elong.net, China’s #2 online travel agent and the launch of Expedia.co.jp) squarely at $0. I believe EXPE's intrinsic value sits significantly higher than $21 and that $2/share (Annuity value minus current price) plus the international growth opportunity is an adequate margin of safety.
To summarize:
- Online travel represents 10% of WW travel spend and is no where near fully-saturated
- The Expedia franchise remains intact with a 1.8x RMS and 28% EBITDA margin
- Management has laid out a competent plan for profitable growth from the core
- At $18 and change, the stock is priced attractively relative to comparables analysis as well as intrinsic value estimates
I like EXPE and I’ll be adding to my position this week. Until next time, good luck, RMA.
# posted by RMA @ 23:39 
Comments:
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RMA,
I wish you have let me known your blog a little bit earlier so I can get a good price on EXPE :-). I agree with your analysis and will watch the stock closely. Thanks!
Dr. Ge
Investing With Dr. Ge"
I wish you have let me known your blog a little bit earlier so I can get a good price on EXPE :-). I agree with your analysis and will watch the stock closely. Thanks!
Dr. Ge
Investing With Dr. Ge"
Please try to keep a regular schedule. The last time you posted was back in March 13th.
Come on.
That was three weeks ago.
Come on.
That was three weeks ago.
# posted by 
: 10:01 PM
: 10:01 PM
You clearly present an interesting stock to watch.
Its future growth is yet to be proved, and its high goodwill assessment may make the stock vulnerable if the business ever experiences problems, even though short-term.
Siyu LI
Siyu's Hybrid Pick
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Its future growth is yet to be proved, and its high goodwill assessment may make the stock vulnerable if the business ever experiences problems, even though short-term.
Siyu LI
Siyu's Hybrid Pick
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