Thursday, May 11, 2006

Expedia Looks Abroad to Boost Growth

Travel services giant Expedia (EXPE) will report earnings after the close today. Here's a quick peek at what the stock brings to the table.

Overview Expedia provides travel products and services to leisure and corporate travelers in the US and other countries. Its diversified portfolio of travel brands and businesses includes,,, and TripAdvisor. As the world's largest online travel agency, the firm generated over $15 billion worth of gross bookings last year. Expedia was spun off from parent InterActiveCorp (IACI) in August 2005.

Right now, the firm is looking to increase its international operations to at least 40% of sales. Currently, non-US bookings account for just over 20% of revenues. If Expedia succeeds here, we see the stock enjoying significant price appreciation. Expedia has already proven to us that it can make a killing through the mushrooming relationships it has with several hotels -- large or regional. When the hotel industry is in a funk, Expedia cashes in. That is because when hotels get desperate and occupancy rates plummet, they're more than glad to unload inventory on Expedia, who in turn sells it a deep discount. Isn't this a great business model? We think so. Counter-cyclical in nature, it has already given EXPE 40% market share. Going forward, we think EXPE will ramp up marketing to get more traffic to its website. This in turn will pique the interests of hotels, who'd love to get a piece of the action. Customers, suppliers, and Expedia shareholders all go home happy.

Risks Expedia faces competition from various search engines as well as a bevy of online travel agents. More importantly, some of EXPE's customers recently went M.I.A. and decided they'd go after customers without Expedia's help. If this continues on a large scale, Expedia's top line story could take a hit. On the other hand, many of the hotels who backed off were large, name-brand hotels, which make up a small part of EXPE's sales. Expedia's bread and butter are regionals, who depend on Expedia to bring in the guests. As independent hotels, these players lack the brand visibility to operate without Expedia holding their hand.

Valuation Analysts expect earnings to jump 18% in 2007. Right now, EXPE is trading at a 18 x forward multiple, so the stock looks fairly priced to us. Or does it? Expedia may not be growing a gazillion times faster than its industry, but it is run by Chairman Barry Diller. For this reason, we'd like to see EXPE go for at least 1.5 x growth. If it makes progress on its European and Asian plans over the next few quarters, we expect EXPE to trade anywhere from 24 to 27 x our $1.30 2007 EPS estimate. At that valuation, the stock would be priced at $32, our fair value estimate for the stock.

The Bottom Line We like Expedia and we find the stock to be grossly undervalued by the market at large. We believe this is due to the firm's management composition, which is beginning to resemble a revolving door. Nevertheless, given Expedia's size/scale, we think it'll continue to capture market share and improve on supplier relations while rolling out its international expansion plan. Expedia should capture more hotel room inventory as its endures higher marketing expenses. This will crimp margins, of course, but we think it is the right move for the firm: Expedia is trying to differentiate its services in what is a terribly commodified space. At today's price, we're definitely interested.

Update: We screwed up royally -- EXPE tanked 16% in AH trading after the firm missed estimates by a mile (margins compressed and net income was dog shit). After today's bloodbath, we are putting the stock under review.

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