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.
Sunday, March 12, 2006
My approach to investing
Before getting started, I wanted to post something on how I think about investing. If I had to describe my investment style, it would most closely resemble a value-based approach before any other. However, an important caveat is that I believe an investment style evolves as the investor gains experience... hopefully for the better.
I try my best to pursue a focused approach; however, I find myself tempted by less-researched, more speculative plays. Ben Graham said that "Investment is most intelligent when it is most businesslike." I am still working towards that goal.
My interest in more speculative (less researched) work arises from the accepted truth that investing is more art than science. A more precise approach does not necessarily guarantee more accuracy. With any speculative idea, I will name it as such. More often that not, my speculative ideas are stocks that we can flat out call cheap with minimal research (e.g. Graham's net-nets and other ideas that I call 'ambulance chasers' [credit for the 'ambulance chaser' moniker unfortunately goes to a good friend of mine, WHH]).
As for the 'focused approach', I've largely based it off what Buffet was frequently described as his method: "(1) Businesses that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) priced very attractively" (1978 letter to investors). Where Warren has been light on specifics, I've filled in detail based on my professional experience as well as my own research into methods & models used by other value investors. I'll save you the lengthy description here and instead leave you with the graphic below. It is my best attempt at summarizing my approach. I will do my best to highlight how I apply it when I discuss forthcoming investment ideas.
In the meantime, I hope that you find it valuable. Good luck, RMA.
Thursday, March 09, 2006
A little about myself
I consider myself a beginning investor (~4 years) and have created this blog as much for you as for me. By writing a blog, I force myself to synthesize and codify my ideas. In the end, I think this makes for stronger and more defensible investment theses. I hope that we can share/debate/refute ideas. I believe there are many ways to make money in the market and I pursue only one of them. The strategies I pursue most closely ascribe to the school of value investing (Graham, Buffet, Lampert, Greenwald etc.); however, I do speculate and make investments in non-value plays.
As for the rest, I'm currently a management consultant and study investments in my free time. In part, I'm penning this blog to document a track record as I anticipate pursuing opportunities in money management in the near-to-medium term. My education is a mix of romance languages and your bread & butter business sciences. I have two degrees, a B.S. in Finance and Accounting and a B.A. in French and Spanish.
