Key Factors Behind Priceline’s $560 Fair Value

Priceline (NASDAQ:PCLN), the second largest online travel company in the world after Expedia (NSDQ:EXPE), has registered around 40% increase in its stock value so far this year. Backed by strong international gross bookings, the company entered 2012 with an impressive growth in Q1 2012 earnings despite weak macroeconomic conditions. (See: Priceline Shows Feverish Growth In Asia And Latin America) While we do believe that there are some favorable trends driving up the stock value, we are also wary of potential threats facing the company.

We have a price estimate of $561 for Priceline, a discount of over 10% to the current market price. Here, we discuss certain trends that favor Priceline’s growth as well as potential risks that might restrict this growth in future.

See our complete analysis for Priceline

Supporting Trends

1. Opportunities For Growth In Online Travel Business Outside US

With the acquisition of Booking.com, Agoda and TravelJigsaw, Priceline has been increasing its focus on developing business internationally. The relatively low internet penetration, high GDP growth rate and a growing middle class is fueling travel demand from the emerging economies, while scope for higher internet penetration and a fragmented hotel market makes Europe an attractive destination for online travel companies.

The lack of standardization in travel services outside US and a fragmented lodging industry in Europe and Asia Pacific, leaves much scope for premium pricing. Hotel booking offer travel agencies a higher revenue margin (>20%) compared to air tickets (3%), car rentals and cruises (9%). Priceline’s growing focus towards international markets is buoyed by a 5 year CAGR of 66% in international booking revenues.

Gross bookings from international markets as a percentage of total booking have gone up from 55% in 2007 to around 78% in 2011 and we expect the upward trend to continue in future.

2. Expansion In Hotel Markets in Europe and Asia To Provide An Added Opportunity

The hotel market in Europe and Asia is much more fragmented with smaller, independent lodgings compared to US, where the hotel market is dominated by large hotel chains. Hotel chains are more likely to offer online bookings through their own websites, while online travel agencies are more appealing to small, independent hotels outside US.

We believe that Priceline has benefited from this trend as it has registered a significant increase in its market share in Europe. Additionally, the high revenue margins on hotel bookings makes the growth in this division even more lucrative for travel companies. Priceline’s opaque bookings model- “Name Your Own Price” and the newly launched “Express Deals” for hotels, facilitates even higher premium pricing leading to revenue margins in excess of 30%.

As hotel bookings contribute close to 90% to the Trefis price estimate for Priceline, the trend will positively impact its business in the long run.

3. Increasing Internet Penetration To Benefit Online Travel Agencies

Given the increasing worldwide online penetration, the internet has become an integral part of the overall travel planning process as it enables travelers to refine searches, compare destinations and view real-time pricing. According to PhoCusWright’s Global Online Travel Overview (April 2011), the global online leisure and unmanaged business travel segment is expected to grow twice as fast as the total global travel market, with gross booking in the online segment expected to surpass $300 billion globally in 2012.

The relatively low internet penetration in Europe (61%) and Asia-Pacific (26%) provides an upside for online travel industry in these regions. With rising affluence in emerging economies of South Asia and an increased adoption of internet and e-commerce, the proportion of travel bookings over the internet are expected to rise in the future. With Priceline’s growing focus on International business, we feel the trend will be favorable for the company in the long run.

Threats

1. Growing Threats From Online Search Engines Jeopardize OTA Business

Large, established Internet search engines with substantial resources and expertise in developing online commerce and facilitating Internet traffic are creating and intend to further create inroads into online travel, both in the U.S. and internationally.

Google (NASDAQ:GOOG) recently entered into an agreement to acquire ITA Software, a major flight information software company, which could allow it to pursue the creation of new flight search tools that enable users to find flight information on the internet without using the services of online travel agencies (OTA) such as Priceline and Expedia.

Google’s recent ventures such as HomeAway, a vacation home rental service and travel “meta-search” site that shows searchers specific hotels and rates in addition to text advertisements, leverage its search technology to aggregate travel search results for the searcher’s specific itinerary across supplier, travel agent and other websites.

In the future, Google could compete directly with online travel service providers for customers, a decrease in which could significantly impact Priceline’s valuation.

2. Increasing Price Competition Can Erode Operating Margins

Online travel services remain a competitive niche segment with stiff competition between the likes of Expedia, Priceline, Orbitz (NSDQ:OWW) and Travelocity among others. Additionally, the low entry barrier makes the industry vulnerable to potential threats from new players.

In an effort to gain competitive advantage, travel companies are creating new promotions and consumer value features such as eliminating processing fees, waiving the cancellation and change fees etc. The intense price competition affects the operating margins in two ways – First, by putting a downward pressure on prices and second, by increasing the company’s promotional spending to lure more customers to its websites.

While in the last quarter Priceline registered a slight improvement in operating margins, we feel that the above mentioned factors will restrict the growth in margins for the rest of our review period.

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