Why We Think Priceline Is Fully Valued At $590

From around $485 in January this year, Priceline’s (NASDAQ:PCLN) stock price has increased by more than 35% and is currently trading at close to $665. Despite macro headwinds, the company has registered robust growth in its revenue for the last few years and continues to be one of the leading global online travel agencies.

Priceline recently reported its Q3 2012 earnings and despite an anticipated deceleration in growth from Europe, it posted solid quarter with a 17% y-o-y and 29% q-o-q growth. Witnessing growth across all its business segments – retail hotel rooms, airline ticket and rental car reservations – the company marked 30% growth in international gross bookings and a 7% increase in domestic (US) gross bookings.

While we maintain a positive outlook for Priceline’s long-term growth prospects, we think the current growth rate is difficult to sustain in the long run and estimate this to slow in the years ahead. Our price estimate of $584 for Priceline marks our valuation at a discount of close to 10% to the current market price.

Here we list certain key trends that impact Priceline’s near-term as well as long-term growth prospects.

See our complete analysis for Priceline

Lower Than Expected Deterioration of Economic Condition in Europe

With the acquisition of Booking.com, Agoda and TravelJigsaw, Priceline has been increasing its focus on growing its business internationally. Gross bookings from international markets as a percentage of total bookings have gone up from 55% in 2007 to around 78% in 2011.

While expanding its presence in international markets is clearly an important growth driver for Priceline, its increasing share in European market makes the company more vulnerable to the debt crisis in the region. After the acquisition of Bookings.com in 2005, the company has been steadily increasing its market share in Europe. Key European markets represent around 60% of Priceline’s total booked room nights, and we estimate hotel bookings to contribute around 86% to the company’s valuation. However, despite its concentration in European countries experiencing weak economic conditions, Booking.com’s growth held up in Q3 2012.

Priceline is probably more sensitive compared to other OTAs to any adverse developments in the region due to the high contribution of hotel bookings from the European markets to its revenues. However, we feel that growth in Q3 earnings are proof that the European economy is stabilizing, which is an encouraging trend for Priceline.

Growing Hotels Business & Greater Penetration of Existing Hotels To Drive Unit Growth

Contributing over 86% to Priceline’s valuation, we estimate hotel bookings to be the most important division in Priceline’s portfolio. Not only do hotel bookings account for the majority of Priceline’s revenue, but with 23% revenue margin, it is also the most profitable division compared to airlines (3%) and car rentals & cruises (9%). We consider this business to be of strategic importance for Priceline’s future and believe the company has fared well so far to leverage growth not only in the US but in the international markets as well.

While Booking.com is concentrated in Europe, Agoda.com is focused on Asian markets. The company has been focused on aggressively expanding its presence in both of these regions. Currently, Booking.com has over 245,000 hotels and other accommodations, a 44% increase from last year. Additionally, Agoda is significantly building scale in Asia-Pacific and is also witnessing strong room night growth.

Apart from an increase in the hotel supply base, we feel the greater penetration of existing hotels is also equally important to drive momentum in unit growth.

Increasing Usage Trends In Mobile

With an increasing number of people using mobile devices to go online, we believe the mobile platform offers immense growth potential for travel services. In its recent earnings call transcript, Priceline declared that it is witnessing rapid growth of business moving to the mobile platform. To leverage the same, it is focusing on developing new applications and upgrades to the mobile web. Priceline is also working on its desktop functionality and user experience to optimize the same for browsing on tablets.

The favorable mobile trends gives Priceline the opportunity to offer new products to its customers. It recently launched Express Deals and a number of other services specifically for the mobile users. The company claims that the transactional business on its mobile services is growing rapidly and it expects continuous innovation to further fuel the growth momentum.

Downside – The conversion rate (percentage of people browsing Priceline’s website who actually make a booking) for mobile could be much lower compared to PCs. Additionally, developing the mobile platform poses a number of challenges in terms of design and developments and requires a significant amount of investment.

Pressure of Investments To Restrict Growth In Margins

The online travel services is a highly competitive niche segment with stiff competition among OTAs. In an effort to gain competitive advantage, travel companies are creating new promotions and consumer value features such as eliminating processing fees, waiving cancellation and change fees, etc. The intense price competition affects operating margins in two ways:

– it puts a downward pressure on prices, and

– it increases the company’s promotional spending to lure more customers to its websites.

The macro headwinds have led to lower revenue margins and high promotional spending, in turn further squeezing operating margins. Priceline registered a marginal decline in operating margins in Q3 2012 and expects the downward pressure to persist in Q4 as well. However, it intends to continue investing in marketing and people to build its brand and expand its international operations, in addition to investing in supply, product and service innovation.

The high expenditure puts pressure on the company’s operating leverage and we estimate Priceline’s EBITDA margin to remain more or less around the present level for the rest of our forecast period. However, we believe that high expenditure incurred will help drive future growth for the company.

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