Description

Expedia Group, Inc. (NASDAQ: EXPE)

Buy Recommendation

Summary:

Buy recommendation EXPE at $119 with 35% upside to $160 in 1 year, and continued teens value compounding over time.  The stock is trading at an attractive valuation: 9.3x 1 year forward EV/EBITDA vs. ~10.5x 5-year average, and 8.2x 2020 EBITDA, and 17x 2019 P/E and 15x 2020 P/E,  which I think is cheap for a company growing revenues at 10% CAGR, EBITDA at 10-15%, and P/E at a high teens rate. EV/EBITDA is the main valuation metrics for EXPE.   It’s is cheap on an absolute, relative, and historical basis; especially for a company that has secular tailwinds (travel and the shift to online), with much runway for growth.  The discount is due to near term execution challenges that are transitory and overly negative sentiment around competitive threat from Aribnb and Google’s push into the OTA segment.  I believe those worries are overblown. EXPE is well positioned to benefit from continued share gain from offline travel agencies and international growth, and operates in an oligopily.  EXPE owns HomeAway and also benefits from the growth of alternative accommodations.

Also, Expedia (and Booking) have reset rev growth expectations lower over the last 1.5 years and gotten past a marketing investment phase and will get past a costly cloud transition investment phase in 2 years.  Hence margins are expanding and should continue to expand for years (which is important and generally drives Internet stocks and multiples higher). The stock has also recently been pressured by European macro concerns (which I think will abate as China stimulus takes root and the trade war is resolved [Europe’s economy is more sensitive to China]).  And recent Boing 737 max has also caused a brief hiccup in travel, but will sort itself out as airlines swap in other planes.

Industry Backdrop

Online travel industry is an attractive market with strong underlying momentum and favorable near and long-term growth prospects. Phocuswright (a travel industry focused research firm) estimates total global travel bookings was ~$1.4T in 2018, up 9% from 2017. The industry group believes online bookings growth outpaced the overall market, grew by 14% and accounted for 45% of total travel.  

Globally, air accounts for 41% of total travel spend with hotels at 34%. However, hotels are far more lucrative for OTAs with commissions ranging from 10-20% of total room value vs. a single digit % or flat fee for air bookings. The two industries operate on different fee structures because:

• On the supply side, the hotel industry is far less consolidated compared to airlines, which means the large OTAs have greater leverage to negotiate commissions. Additionally, hotels rely more on intermediaries for distribution

• On the demand side, travelers utilize online channels to assess room type/quality, offered amenities, and price differential between rooms. For air bookings, travellers look for the lowest ticket price and look to utilize accumulated miles to offset as much cost as possible

• On both sides, OTAs offer a far more compelling value proposition for booking hotels through their sites compared to plane tickets. This leads to the substantially different commission structures between the two industries.

While a lot of the U.S. travel industry growth has been driven by baby boomers in recent decades, millennials will serve as a growth driver going forward. There is a clear preference among millennials for experiences versus material possessions, and travel fits that bill. This is also the first generation to grow up entirely in the internet age; as a result, there is a high degree of comfort for booking trips online. Millennials expect to have real-time information, personalized trips, and authentic/peer reviews accessible across multiple devices. This creates a huge opportunity for online travel agencies.

Outside the developed markets, China represents an enormous opportunity from (1) outbound Chinese travel, where Western companies are fairly well positioned; (2) inbound Chinese travel, where Booking Group has a leg up given its relationship with state-run travel provider Ctrip.com, and (3) domestic Chinese travel, which is largely untapped by Western companies.

However, there are a few competitive risks for the large and established OTA vendors. As a result, they are de-rated fairly significantly from their peak valuations from a few years ago. Key concerns include:

• Alternative Accommodations:

• The proliferation of alternative accommodations (individually owned homes and apartments, B&B’s, vacation properties, etc.) driven by consumer’s preference for uniqueness and better pricing.  This is both an opportunity and a threat to OTAs.

• Glass half full: alternative supply is a largely untapped resource of potentially bookable properties to online travel providers, which could offer significant incremental commissions (e.g. through Expedia’s HomeAway)

• Glass half empty: alternative accommodations could put potential downward pressure on overall room prices. This is also a market that is dominated by Airbnb, a relative upstart that is looking to encroach on more traditional room supply. Airbnb is undercutting OTAs by providing many of the same services to independent hotels at lower commissions, but usually charges travellers a booking fee

• I’m in the glass half full camp:   As we’ve seen, alternative accommodations have been a growth driver for both Expedia and Booking.com with huge TAM.  The rising tide is lifting all boats as BKNG, EXPE, and AirBNB are all growing rapidly in the alternative accommodations space.  HomeAway has been growing EBITDA rapidly (and become a meaningful contributor to growth) while the core OTA business has also kept growing at a healthy rate

• Hotel and AirBnB rentals have been able to co-exist and fit different use cases, rather than directly cannibalize.  

• Indeed, the alt accommodations space has been driving the growth for BKNG and EXPE recently and provides a long runway of growth

• Expedia has accelerated organic inventory growth in 2018 and beyond, and has made impressive progress in urban areas and parts of Europe

• EXPE is also working on cross-listing properties between its core OTA and HomeAway to improve bookings on both

• Google:

• Over 60% of leisure travellers and 70% of business travellers begin their search process on Google. As a result, Google is the primary distribution point for online travel companies and the beneficiary of a disproportionate share of marketing dollars

• Google has been slowly improving its travel services and offerings, in many instances favoring Google’s own products over organic search results. As a result, this hurts the efficacy of OTA’s organic search results, lowers OTA’s conversion rates, and drives up OTA’s price of Google ads

• Google does not have the capabilities to function as an OTA (end-to-end multi-country, multi-language customer support, on the ground salesforce to sign up hotels…etc.), and it would require substantial amount of investment to do so

• OTAs still provide a substantial amount of advertising revenue to Google (EXPE ~$3.5bn, BKNG ~$4.3bn – around 6% in total), so it’s not in Google’s best interest to negatively disrupt OTAs dramatically.  But is is in their interest to make just enough changes to make OTAs pay more for ads.

• Expedia generates 2/3rds of its Bookings from direct branded channels.  So their reliance on any other intermediary isn’t that large (around 25%)

• Expedia (like Bookings.com are also using other advertising channels

• Hotels Going Direct:

• Large hotels suppliers like Marriot and Hilton, have attempted to disintermediate OTAs and capture a larger portion of direct bookings. These suppliers are not only looking to minimize distribution costs but also developing direct consumer relationship to upsell on rooms/amenities, increase customer loyalty, and bolster their brand

• This has been the trend in the US, where hotel chains are much more consolidated. However, the vast majority of hotels around the work are mostly operated as boutiques (hence have little bargaining power or ability to go direct), so they offer much better opportunities for OTAs.

• i.e. the hotel industry overall is very fragmented,  so the few aggregators (EXPE, and BKGN) still have the bargaining power and take rates likely will stay high in what is effectively an oligopoly

Company Description

Expedia Group is the second largest OTA in terms of annual revenue, it has 1.8mm vacation rental listings (370k HomeAway listings), 312mm annual room nights, over 500 airlines, in 200 countries and territories. The company’s reporting segments consist of Core OTA, Homeaway, trivago, and Egencia.

VRBO stands for Vacation Rental By Owner

Core OTA: EXPE’s largest reporting segment which accounts for ~82% of Gross Bookings, ~78% of revenue, and ~87% of EBITDA

• The segment targets non-managed leisure travellers across every global region with websites catering to a wide array of travel needs and price points. Core OTA revenues are split between merchant and the agency models, with skew heavily favoring merchant but agency revenues growing at a faster rate. The vast majority of revenues are derived from hotels, although relative to BKNG, EXPE has a sizable air ticket business.

• Merchant Model: In this model, hotels sell rooms to OTAs in bulk at discounted or wholesale prices. The OTAs then sell them to customers at a marked-up price. This is the most commonly used model, and it benefits both parties.

• Agency Model: This is a commission-based model wherein hotels give OTAs commissions based on business bought. In this model, the hotels list their services, and the OTAs don’t have to buy anything up front. This is beneficial for hotels, as it gives them the freedom to price their rooms according to demand scenario.

• Core OTA consists of the following websites and programs:

• Expedia.com: Full-service OTA where users can book hotel, airline, cruise, and rental cars via localized sites in 33 countries with over 95mm unique monthly visitors

• Hotels.com: Non-opaque hotel booking service along with bundled hotel and airfare deals. Users can book hotels in 242 countries and territories. By itself, Hotels.com is one of the largest OTAs with over 50mm unique monthly visitors across over 90 localized websites and +$20bn in gross bookings  

• opaque inventory is the market of selling unsold travel inventory at a discounted price. The inventory is called "opaque" because the specific suppliers (i.e. hotel, airline, etc.) remain hidden until after the purchase has been completed. This is done to prevent sales of unsold inventory from cannibalizing full-price retail sales.

• The primary consumers of opaque inventories are price-conscious people whose primary aim is the cheapest travel possible and are less concerned with the specifics of their travel plans. Hotel discounts of 30-60% are typical, and bargains are stronger at a higher star hotel. While one has control over the dates and times of a travel itinerary, the downside is these purchases are absolutely non-refundable and non-changeable and, as noted above, the specific hotel or airline is not revealed until after purchase.

• Orbitz: Orbitz was acquired by Expedia in September 2015 along with Orbitz for Business, Cheaptickets, eBookers, HotelClub, and RatestoGo. Orbitz is a multi-product OTA which had its own sizable inventory but now leverages Expedia supply and technology. Orbitz essentially competes with Expedia.com for customers with the only differentiating factor being the rewards offering, which pre-dates the acquisition and has over 7mm members using “Orbucks.”

• Expedia Affiliate Network (EAN): Expedia’s primary B2B partnership which gives corporate partners and travel agents access to hotels.com supply, rates, and company technology

• Hotwire: Expedia’s opaque booking service for more price conscious travellers willing to sacrifice detailed product knowledge for a below retail rate. Hotwire provides supplier with flexibility to dump excess inventory without diluting brand and effecting retail pricing structure. The site sells hotel rooms, airline tickets, and car rentals under merchant model. Hotwire competes directly with Priceline’s “Express Deals” and “Name Your Own Price” services

• Wotif Group: Wotif primarily acts as an OTA in Australia and Asia providing access to 29K hotels and airline tickets. Acquired by Expedia in July 2014 for $657mm. Competes with Agoda.com and Ctrip

• Travelocity: Full-service OTA acquired by Expedia in January 2015 from Sabre for $280mm

• CarRentals.com: Part of Expedia since acquisition in March 2008. Pure car rental site with inventory from all of the largest U.S. and European carriers. Gained European presence after Expedia acquired Auto Escape Group in June 2014

• Expedia Local Expert: Resource for finding and scheduling local activities/events. Local Expert (LX) provides over 100 concierge desks at different hotel and retail locations around the world available for face-to-face or virtual client interactions

• Expedia CruiseShipCenters: North American seller of cruises and vacation packages, consisting of a network of independent franchises with over 240 locations and 5k employees in North America

• SilverRail: Purchased by Expedia in August 2017 for $148mm following a commercial partnership with Egencia since 2010 and with Expedia UK since 2016

• Expedia Media Solutions: Company’s digital marketing unit that connects travel and non-travel companies with targeted audiences across Expedia’s network of sites. Monetizes internal user data and creates custom marketing campaigns for clients

• Primary competitors are the supplier-direct websites and other OTAs such as Booking.com (US and Europe), Booking owned Priceline.com (US), CheapOair (North America), Ctrip (Asia), Lastminute.com Group (Europe), and various regional players/ start-ups. Airbnb and Google are emerging threats

Trivago: This is EXPE’s second largest reportable segment and operates as a travel metasearch engine

• EXPE took a 62% stake in Trivago in 2012 for $632mm. The company is listed on NASDAQ under TRVG in December 2016. Expedia retained 65% of voting rights and 60% of economic rights. The search engine generates about a $1.2bn in revenue with about a third of that being generated intra-company

• Trivago provides localized hotel search from various providers, some of which are competitors to its parent company. The search engine had over 2bn visits in the last 12 months and has more than 1.8mm properties available for comparison

• Metasearch business model involves advertisers - in this case OTAs and hotels - paying the search engine for referrals generated to their sites on a cost-per-click (CPC) basis. Costs per click typically range from $0.75 to $2.00 on clicks through general metasearch listings but can vary depending on many factors like location and dates. Referrals made through “pop-under” ads cost $0.25-$0.50, less than general CPC rates because these are considered a lower quality user experience and have a lower booking conversion rate

• Primary competitors are TripAdvisor (TRIP), Kayak (BKNG), Qunar (Ctrip), and Google Hotel Finder/Google Flights

Egencia: Reportable segment launched in June 2008 that provides managed travel services to corporate customers in North America, Europe and the Asia Pacific regions

• Egencia charges its clients account management fees and transaction fees for booked products. In 2016, over $1T was spent on global business travel according to the World Travel & Tourism Council, a segment where Egencia is one of the largest corporate travel providers with almost $7bn in gross bookings and ~$500mm in revenue (about 6% of Expedia’s sales)

• Primary competitors are American Express Global Business Travel, Carlson Wagonlit Travel, Thomas Cook, BCD Travel, inhouse managed travel departments

HomeAway: HomeAway was purchased by Expedia for $3.9bn in December 2015  ($1b in cash, $@.9bn in stock, a 19% premium)

• The reportable segment offers entire home rentals labelled “alternative accommodations” through its brands which primarily include: HomeAway, VRBO, VacationRentals.com, and BedandBreakfast.com

• HomeAway and its affiliates link homeowners and property managers with travellers looking to stay in vacation homes. The segment has over 2mm listings across 90 countries with about 75% bookable online. The segment accounts for about 10% of Expedia’s gross bookings and 9% of its revenue. HomeAway supplies the alternative accommodation inventory for Expedia.com and Hotels.com.

• Initially, HomeAway was not involved in the transaction between property managers and travelers. Instead, the company generated revenue through annual listing fees starting at $349 per listing, essentially acting as an online classified for vacation homes. Eventually, it added a performance based fee option ranging from 10-13% per booking which was successful in attracting owners who rent out their properties less frequently than dedicated vacation home landlords. After acquiring HomeAway, Expedia decided to start monetizing the guest side of the transaction, charging a traveller fee between 4% and 10% per booking (up to $499). Under the new revenue structure, HomeAway went from an effective 3-4% commission rate to an effective 10-12% commission, closer to its alternative listing peers Airbnb (10-12%) and booking.com (15%). Other competitors include Homestay and Outdoorsy (RV rental marketplace)

• There is upside to the take rates from here,  they think it can go closer to 15% and perhaps higher as takes rates in general across Internet companies go up as they provide more services and value for customers and suppliers

In 2018, approximately 38% of EXPE’s worldwide gross bookings and 45% of worldwide revenue were through international points of sale compared to just 21% for both worldwide gross bookings and revenue in 2005. The Company has a goal of generating more than two-thirds of total revenue from outside of the U.S.

Investment Thesis

• Simplistically, Expedia basically operates in an oligopoly, and in a secular growing market that is gaining share (from offline) with much TAM and room for growth

• Growing revs at around 10%  CAGR, EBITDA low teens CAGR, and EPS in the high teens CAGR trading at a cheap valuation on a historical, relative, and absolute basis (9.3x EV/EBITDA, and 17x P/E 1 year out)

• That’s a great combination of attributes

• Large and growing global travel market that is still underpenetrated which will drive sustainable double-digit top-line growth for EXPE

• Phocuswright estimates that only 50% of hotels and vacation rentals are listed online. Of the listed hotels, vast majority of room nights are not yet sold through OTAs, they are sold through the wholesale channel (travel agencies, tour operators) 6-9 months in advance for steep discounts of 30-40%  

• Expedia has 1mm lodging properties on their site and thinks there are 6-7mm in total when you include alternative accommodations

• Corporate  travel online penetration is around 90%,  so there’s room for leisure travel to get up towards that # long term

• The overall travel opportunity remains significant at $1.7T in 2019

• Market share is defined as nights booked as a % of total inventory (i.e. take all hotels and vacation rentals on the OTA platforms, take the number of rooms they have and multiply by 365)

• Assuming full occupancy, EXPE only has ~6% market share, BNKG has ~9% market share

• Assuming 70% occupancy rate, EXPE’s market share is still under 10%. This does not include offline hotels

• Phocuswright projects that the market share of OTAs will double by 2020

• Also, there are many adjacent areas like car, activities, cruise, etc. They still have much opportunity internationally (LatAm, Asia) where they are nascent,  as well as luxury hotels:

• Margin expansion potential will drive mid-teens EBITDA growth for EXPE

• EXPE’s EBITDA margin is less than half of BKNG’s margins (18% vs. 40%). Part of that is due to structural differences

• As EXPE evolves its revenue mix (increased emphasis on hotels vs. air and an increased emphasis on Europe vs. North America) and works to improve its direct bookings, I believe there is significant upside to EXPE margins from a more efficient deployment of resources, investments, and marketing spend

• EXPE has higher mix of airline bookings, which carry lower revenue margins than the more profitable hotel bookings

• The benefit of this is EXPE can put together an entire trip (air, hotel, car rental) and could be an attractive option for consumers looking for one-stop shop with more competitive pricing. Expedia is the only global OTA with a full range of travel products, which differentiates it vs. peers

• EXPE is currently over-indexed to the US, where hotel chains are significantly more consolidated, command more of the profits, and leave less margin for the OTA

• EXPE is making a big push to grow internationally, where the hotel industry is much more fragmented and thus have better margin potential

• EXPE has invested a lot of resources in technology upgrades that should help reaccelerate revenue and improve efficiency and profitability

• The Company has been migrating its infrastructure to the cloud (a multi year and expensive effort)

• This will allow for significantly faster code deployment, better optimization driven by AI, personized search results  

• Once complete, it will significantly reduce capital intensity and improve cash flow generation

• Unlike the other internet giants, the OTAs don’t have the same regulatory noise or pressure

Catalysts / Upside

• As Expedia ramps up properties and room supply, there will be several cascading benefits: 1) greater accommodation inventory leading to 2) improved selection and shopping experience leading to 3) higher conversion rate which leads to 4) greater marketing efficiency and ultimately higher operating margins.   In addition, benefits from the cloud migration could drive better customer experience and faster product rollouts.

• Revenue: room to grow / improve

• EXPE now has 1mm properties, where BKNG was two years ago, but only 50% of room nights  

• There is significant room for room night growing by improving effectiveness of reaching customers. So far, Company is happy with the increased level of penetration for new properties added

• Incremental gross booking and FCF dollars from HomeAway as Expedia continues to integrate HomeAway inventory on its core platforms and take down friction

• Optionality for faster product innovation following full transition to cloud

• Margins: rising

• Changes in marketing spend (better mix and less reliance on search – which is effective but expensive) should drive more efficient spend and better margins

• Allocating more to brand marketing and reducing costlier digital advertising

• They spent 2018 increasing ad spend and testing out other channels.  That YoY increased ad spend pressure will abate in 2019 and beyond as they’re done with that investment and will get leverage on sales and marketing going forward

• Marketing spend leverage driven by rising conversion on improved shopping experience

• Cloud transition expenses will abate in 2021

• In 2018 incremental cloud expenses $141 million (compared to $1.97bn in EBITDA) and go to ~$250 million in 2019 (compared to $2.27bn of EBITDA).  Excluding cloud expenses, adjusted EBITDA growth would be approximately 400 basis points higher.

• As these incremental cloud expenses abate, there is a sizeable lift to EBITDA and margins

• A good share of their compute will be in the cloud as of the end of 2019, but there will be more to move in 2020.  

• Into 2021, they’ll annualize the step-up in 2020 and be a lot closer to that just normalized rate and tech expenses will growing inline with the business.

• Continued compounding

• With continued low teens EBITDA growth and high teens EPS growth CAGR,  while the multiple is on the low end of its historical range. I think the stock can compound value in the high teens with continued earnings growth while holding the multiple steady

• Liberty Expedia transaction stock for stock transaction proposed on 2/4/2019,  still being negotiated. Maybe very slightly accretive (by 0-1%)

• Expedia has offered to acquire Liberty Expedia in a stock for stock transaction, under which LEXEA/B holders would receive EXPE shares in a tax-free transaction.

• Expedia has offered market price (a 5.7% discount to NAV), while Liberty has countered with a 1.4% premium to NAV.

• Liberty Expedia is basically a holdco for Expedia shares.  It has 23.9mm shares of EXPE

• They own 16.2% of the equity and have 53% voting interest

• i.e. 11.1mm common shares (one vote per share) and 12.8mm Class B shares (ten votes per share)

• Also owns Bodybuilder.com (unclear value, did $243mm of LTM rev, but declining 20% YoY and burning a tiny bit of cash)

• $3223mm net debt

• This doesn’t change the net share count or capital structure,  but it would clean up the convoluted ownership structure, which is a small positive.  If they can get it at a discount to NAV, it would be very slightly accretive as well (by 0-1%)

• Conservatism / beats:  likely can continue

• New management has lately established a track record of beating

• The CEO (Mark Okerstrom) was appointed in 8/2017.  Not too surprisingly, on the subsequent 2 quarters after being appointed, the stock was down 15.5-16% on each earnings print as he rebased expectations.

• Over the last 4 earnings since, they beat comfortably and the stock has risen

• He joined EXPE in 2006 and became CFO in 2011.  In 2014 he became EVP of Operations and CFO. Prior to that he worked at Bain, UBS, and a law firm

• Management’s 2019 EBITDA growth guidance of +10-15% includes conservatism around the macro picture.  Since I think the macro will improve, that’s part of my bullishness vs. consensus

• At the end of 2017 and through 2018, growth expectations in the OTA space were re-based lower, and expenses higher as they embarked on more brand marketing spend and cloud transition spend.  Now that expectations have been reset and they’re getting over those investments, they can get back to beating and raising

• New HQ costs

• EXPE is spending $250mm of their new HQ in 2018, $475mm in 2019, and $75mm in 2020.  FCF will look better as that capex comes down

• AirBnB IPO

• That could highlight the SOTP value at Expedia, in particular the value of HomeAway (which has been a great acquisition for EXPE)

• From a macro perspective, I’m bullish the global consumer and travel

• The US/China trade deal is likely to get done, and Chinese stimulus is starting flow through

• In turn, that will boost European GDP (Europe is highly tied to China)

• And all the above will boost the US economy as well

• Hence Expedia and global travel will be helped as well

• The dollar will probably weaken as well, which is good since 45% of their revs are outside the US.  There would be an accounting translation benefit

• Share buyback

• The company is also supporting their shares through buybacks.  They’ve shrunk share count by 2-3% YoY over the last year

• 737 max plane issues get fixed and/or airlines swap out planes

Risks:

• Competition

• Ad pricing pressure from Google

• Google could push organic search results further down and increase cost of doing business for OTAs as described above

• As mentioned above,  Google is very unlikely to replace OTAs since they’d have to hire a lot of bodies and spend much money to do all the customer service, call centers, hotel relationship, etc.  And besides, then they’d have to compete entrenched and dominant competition, and it would cannibalize their own search revenue

• In the last 1-2 years, the OTAs have realized that aggressively competing for keywords against each other is not a good idea and have tried to shift their budget elsewhere to higher ROI channels like TV.  That’s a good sign and partly helps reflect the oligopolistic industry structure

• Online and offline travel service providers

• AirBnB is obviously disruptive from an alternative basis and concerns they may get into Hotel (e.g. with a recent small acquisition of HotelTonight) and maybe start bidding more for keywords

• AirBnB faces a steep battle to get into Hotels since the site is obviously focused on non-hotel bookings, it would take a long time to scale

• HotelTonight is around a low single % the size of Booking and Expedia in terms of revs, rooms, bookings, etc.  It’ll take a long time for them to make a dent

• Hotels generally view AirBNB as a direct threat, so it’s less likely that they’ll want to partner with the enemy when they have BKGN and EXPE already   

• Cyclical travel disruptions such as economic uncertainty, terror attacks, currency movements, bad weather, etc.

• Although of course not apples to apples since the OTA industry was much smaller and faster growing in 2008-2009, EXPE grew revs by 10% in 2008 and +1% in 2009, and EPS +1% and +10% respectively.

• F/X

• EXPE generates 45% of revenue outside of the U.S.

• BKNG’s most recent quarter called out weak macro trends in Europe. It could negatively impact EXPE’s Q2 guide

• Europe accounts for ~22% for EXPE, a similar hit would result in one point headwind to global room night growth

• However, their 2019 EBITDA growth guidance of +10-15% YoY accounts for macro weakness.  Although they admit that macro changes are hard to handicap. They note that their cost are highly variable and so they have plenty of wiggle room within that range

Valuation:

Valuation is compelling, for a company with a large TAM growing rev ~10% and EPS mid-to high teens % trading at 9.3x 1 year forward EBITDA and 17x 1 year forward EPS  (and 8.2x 2 year forward EV/EBITDA and 15x 2 year forward P/E)

• Valuation is on the low end of its historical range over the last 5 years

• EXPE mostly trades on EV/EBITDA

Upside price target

• As rev growth stabilizes (and perhaps inflects upwards from more inventory added to the site and the macro), and as margins improve (from leveraging marketing and cloud spending), the multiple should also inflect higher

• At 10x EV/EBITDA and fast forwarding 1 year (also I think the high end of their 2019 guidance is pretty achievable, which should continue), I get to a $160 stock.  Along with the 1% dividend, that’s 35% upside

Forward 2 year EV/EBITDA multiples

EXPE forward 4 quarter EV/EBITDA ratio over the last 5 years using consensus

EXPE forward 4 quarter P/E ratio over the last 5 years using consensus

Comparison of EXPE and BKNG

Technicals

EXPE price chart since 2014

• Expectations were heavily reset at the end of 2017 and through 2018 as they changed their marketing strategy and invested in more brand advertising and cloud computing.  Plus growth rates slowed

Technicals wise, the stock is in a bull pennant pattern, which is usually a positive sign and resolves this current wedge higher.  An upside breakout from this pennant roughly targets upside to $180

EXPE Price chart since 2005 – long term compounder type of chart.  Consolidating for 4 years, and eventually should regain the trend up

Catalyst

• As Expedia ramps up properties and room supply, there will be several cascading benefits: 1) greater accommodation inventory leading to 2) improved selection and shopping experience leading to 3) higher conversion rate which leads to 4) greater marketing efficiency and ultimately higher operating margins.   In addition, benefits from the cloud migration could drive better customer experience and faster product rollouts.

• Revenue: room to grow / improve

• EXPE now has 1mm properties, where BKNG was two years ago, but only 50% of room nights  

• There is significant room for room night growing by improving effectiveness of reaching customers. So far, Company is happy with the increased level of penetration for new properties added

• Incremental gross booking and FCF dollars from HomeAway as Expedia continues to integrate HomeAway inventory on its core platforms and take down friction

• Optionality for faster product innovation following full transition to cloud

• Margins: rising

• Changes in marketing spend (better mix and less reliance on search – which is effective but expensive) should drive more efficient spend and better margins

• Allocating more to brand marketing and reducing costlier digital advertising

• They spent 2018 increasing ad spend and testing out other channels.  That YoY increased ad spend pressure will abate in 2019 and beyond as they’re done with that investment and will get leverage on sales and marketing going forward

• Marketing spend leverage driven by rising conversion on improved shopping experience

• Cloud transition expenses will abate in 2021

• In 2018 incremental cloud expenses $141 million (compared to $1.97bn in EBITDA) and go to ~$250 million in 2019 (compared to $2.27bn of EBITDA).  Excluding cloud expenses, adjusted EBITDA growth would be approximately 400 basis points higher.

• As these incremental cloud expenses abate, there is a sizeable lift to EBITDA and margins

• A good share of their compute will be in the cloud as of the end of 2019, but there will be more to move in 2020.  

• Into 2021, they’ll annualize the step-up in 2020 and be a lot closer to that just normalized rate and tech expenses will growing inline with the business.

• Continued compounding

• With continued low teens EBITDA growth and high teens EPS growth CAGR,  while the multiple is on the low end of its historical range. I think the stock can compound value in the high teens with continued earnings growth while holding the multiple steady

• Liberty Expedia transaction stock for stock transaction proposed on 2/4/2019,  still being negotiated. Maybe very slightly accretive (by 0-1%)

• Expedia has offered to acquire Liberty Expedia in a stock for stock transaction, under which LEXEA/B holders would receive EXPE shares in a tax-free transaction.

• Expedia has offered market price (a 5.7% discount to NAV), while Liberty has countered with a 1.4% premium to NAV.

• Liberty Expedia is basically a holdco for Expedia shares.  It has 23.9mm shares of EXPE

• They own 16.2% of the equity and have 53% voting interest

• i.e. 11.1mm common shares (one vote per share) and 12.8mm Class B shares (ten votes per share)

• Also owns Bodybuilder.com (unclear value, did $243mm of LTM rev, but declining 20% YoY and burning a tiny bit of cash)

• $3223mm net debt

• This doesn’t change the net share count or capital structure,  but it would clean up the convoluted ownership structure, which is a small positive.  If they can get it at a discount to NAV, it would be very slightly accretive as well (by 0-1%)

• Conservatism / beats:  likely can continue

• New management has lately established a track record of beating

• The CEO (Mark Okerstrom) was appointed in 8/2017.  Not too surprisingly, on the subsequent 2 quarters after being appointed, the stock was down 15.5-16% on each earnings print as he rebased expectations.

• Over the last 4 earnings since, they beat comfortably and the stock has risen

• He joined EXPE in 2006 and became CFO in 2011.  In 2014 he became EVP of Operations and CFO. Prior to that he worked at Bain, UBS, and a law firm

• Management’s 2019 EBITDA growth guidance of +10-15% includes conservatism around the macro picture.  Since I think the macro will improve, that’s part of my bullishness vs. consensus

• At the end of 2017 and through 2018, growth expectations in the OTA space were re-based lower, and expenses higher as they embarked on more brand marketing spend and cloud transition spend.  Now that expectations have been reset and they’re getting over those investments, they can get back to beating and raising

• New HQ costs

• EXPE is spending $250mm of their new HQ in 2018, $475mm in 2019, and $75mm in 2020.  FCF will look better as that capex comes down

• AirBnB IPO

• That could highlight the SOTP value at Expedia, in particular the value of HomeAway (which has been a great acquisition for EXPE)

• From a macro perspective, I’m bullish the global consumer and travel

• The US/China trade deal is likely to get done, and Chinese stimulus is starting flow through

• In turn, that will boost European GDP (Europe is highly tied to China)

• And all the above will boost the US economy as well

• Hence Expedia and global travel will be helped as well

• The dollar will probably weaken as well, which is good since 45% of their revs are outside the US.  There would be an accounting translation benefit

• Share buyback

• The company is also supporting their shares through buybacks.  They’ve shrunk share count by 2-3% YoY over the last year

• 737 max plane issues get fixed and/or airlines swap out planes