Key Factors Driving Expedia’s $63 Valuation

Defying macro headwinds, Expedia (NASDAQ:EXPE) posted a stellar Q3 2012 with 17% y-o-y growth in revenues. Robust growth in room nights booked, both domestic and international, was the primary reason for the quarter revenue coming in ahead of the company’s expectation. Expedia claims not to have had any adverse effect on its brand due to the global economic slowdown. The company feels confident that with its ongoing technology projects as well as rapid innovation and fundamental changes in the hotel and air platforms, it is in a good position to leverage growth in online travel. (Read Our Earnings Article: Expedia Shows Growing Strength In Hotels & International Markets)

With good execution, innovative technology, expanding international presence and a robust hotel business, we think the company is growing strong. While there are some favorable trends driving growth for Expedia, here we list down certain drawbacks of the same.

See our complete analysis for Expedia

Increasing Shift Towards Agency Model Could Impact Revenue Margins

Last quarter, Expedia rolled out its “Expedia Travelers Preference” (ETP) program which offers consumers a choice to either pay Expedia in advance or pay the hotel at the time of their stay. The company seems to have gained a good response from its partners with close to 13,000 hotels signed up so far. Expedia claims that the majority of users are opting to pay at the time of their stay via the ETP program. Thus, the broader acceptance of this scheme is likely to drive back growth in agency model and reduce the share of merchant model revenue.

As the merchant of record, Expedia has the discretion to establish prices charged to travelers as opposed to “agency” transactions in which Expedia does not set prices but merely collects a commission on prices set by the travel product supplier. This could further put a downward pressure on hotel revenue margins, which we estimate to decline on account of rising competition among various OTAs.

The shift to agency model will have a negative impact on working capital as well, but Expedia feels that it has a strong balance sheet to support the same. During 2010-11, while the agency revenues grew at 8% y-o-y, merchant revenues registered 16% growth. Though Expedia expects the merchant model to continue having a significant impact on its business, we estimate the proportion of agency model to increase in the future.

Expanding International Business Might Reduce Revenue Per Room Night

We estimate hotel bookings to contribute over 66% to Expedia’s valuation, making it the most important division in the company’s portfolio. With revenue margins in excess of 20% it is also the most profitable compared to air tickets (3%) and car rentals & cruises (9%). Apart from certain regions in Southern Europe, Expedia is witnessing growth in all the international markets.

However, despite a 27% increase in global room nights booked, Expedia posted only a 20% y-o-y growth in hotel revenue as it registered a 6% decline in revenue per room night. We believe a greater mix towards hotels outside US would put a downward pressure on revenue per room night in the future as well. However, international markets, particularly Europe & Asia-Pacific, present a tremendous growth opportunity for Expedia and the company feels that the robust increase in volume will more than compensate for the decline in revenue per room night.

Lower Conversion Rates For The Mobile Platform

The company is witnessing an increasing proportion of its traffic moving to the mobile platform. Expedia got approx. 4% of its traffic through mobile bookings in 2011 but aims to further introduce innovative offerings in this segment to tap the rapidly expanding mobile user base. So far, the Expedia app has been downloaded 5 million times in 220 different countries. ^[1]

With an increasing number of people using mobile devices to go online, we think this is definitely a platform which offers immense growth potential and could significantly impact Expedia’s future growth prospects. However, as per Expedia, the conversion rate (percentage of people browsing Expedia’s website who actually make a booking) for mobile is much lower compared to PCs.

However, Expedia claims that expanding its mobile platform has helped it penetrate the last-minute bookings business. Around 60-70% of the mobile bookings received for Expedia are for the same day (24 hour) hotel bookings. The company feels that mobile phones are more popular for last minute bookings while tablet users tend to behave similar to PC users.

While the mobile space poses a number of challenges in terms of design and developments, we believe that it is worth the investment and would help expand Expedia’s user base in the future. The company is currently working on introducing an air experience on its iOS app and expects mobile penetration to increase in the future.

Our price estimate of $63.12 for Expedia is almost in-line with the current market price.

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1. Expedia’s Management Discusses Q3 2012 Results – Earnings Call Transcript, Seeking Alpha, October 25, 2012 [↩]