ONLINE TRAVEL - April 2016
The digital age has caught many industries napping, upending the way business has been done for decades. Travel, in particular the way it is researched and booked, is one industry that has been completely turned on its head. We believe this disruption has created powerful investment opportunities, which still have some way to run.
When the internet first started gaining momentum in the late 1990s, travel websites focused on last-minute deals, a useful dumping ground for the industry’s excess inventory. This quickly evolved and saw the emergence of a few industry leaders: Priceline and Expedia dominated the online travel agency (OTA) sector, while TripAdvisor became the go-to internet resource for all travel and hotel review research.
They disrupted the way the travel industry worked, effectively replacing travel guides and booking agents, while also causing a shake-up in the rest of the sector.
Founded in 2000, TripAdvisor offers some 320 million usergenerated reviews of hotels, restaurants, airlines and other travel-related experiences. It is the biggest travel website in the world, and for its 350 million unique monthly visitors has become the first port of call before they decide on holiday arrangements or a night out.
TripAdvisor offers localised websites in 48 markets and in 28 languages, and has successfully established a strong mobile presence, with nearly 50% of its users now accessing its content via cellphones and tablets.
The majority of its income is earned from advertising. When a user enters a query on TripAdvisor to see hotel prices (based on specific dates of travel), advertisers bid to be placed first. Each time a user clicks on a specific ad, TripAdvisor is paid on a cost-per-click basis. It also earns a sizeable amount in traditional display advertising and through business listings on the site. The company’s revenue has grown by 25% per annum over the past five years, and in 2015 amounted to almost $1.5 billion.
The strength of TripAdvisor’s business comes from the network effects of its content-rich website. TripAdvisor has managed to create an enormous and engaged internet community who posts reviews of activities, hotels and restaurants without receiving payment. This has established TripAdvisor’s content as a valuable and reliable research resource, which adds value to users’ lives. This, in turn, encourages users to become part of the TripAdvisor community and to add to the efficacy and helpfulness of that community.
TripAdvisor is positioned right at the start of a user’s travel research process, putting the company at the top of the funnel of a typical traveller’s travel purchase decision. Consequently, the site is extraordinarily well placed for travel suppliers (such as hotels) to advertise and market to potential customers. As they say, he who owns the customer, owns the power.
Currently, only a minority of TripAdvisor users visit the site with the intention of comparing and booking hotels, which represents the bulk of OTA industry profits. If TripAdvisor can get more users to also book and compare prices through its website, it has a long runway of monetising its audience.
TripAdvisor has over time made its website more user friendly to facilitate hotel bookings, first with the introduction of metasearch (which allows users to compare prices) in 2012 and then last year with the introduction of Instant Booking. This service allows faster and easier transactions in much the same way an Amazon shopper can easily make purchases on Amazon.com. Users can now look at a review of a hotel (and view ‘candid’ photos by former guests), and then proceed to book a room directly through TripAdvisor. However, most users are not aware of this functionality and still only use TripAdvisor for research, then go elsewhere to compare prices and make the booking. The company is making steady progress in keeping users on the site to do transactions and comparisons. The additional income earned in booking commissions should add a strong stream of revenue in years to come.
Despite its solid long-term prospects, TripAdvisor’s share price has come under pressure of late. This is largely as a result of the introduction of Instant Booking, which has had the twin effects of slowing revenue growth and depressing margins as the company invests in the new feature and hotel partners and travel users adjust to new changes. TripAdvisor had a similar experience with the roll-out of metasearch in 2012 and 2013. Just as revenue growth and margin expansion accelerated afterwards, we believe this will again be the case with Instant Booking. TripAdvisor is trading on a one-year forward price earnings ratio of 29 times on what we consider to be low earnings. Its operating margin for 2016 is expected to be 24.5%, whereas we consider a margin of 40% achievable. In addition, it has a long runway of superior growth and converts almost all its earnings into free cash. Accordingly, our estimation of the company’s fair value implies a strong upside to the current share price.
Priceline is the world’s biggest OTA, operating the sites of Booking.com, Kayak.com, Agoda.com, OpenTable.com and Priceline.com. The company manages bookings of flights, cruises, cars and restaurants, and in the fourth quarter of last year alone, booked 99 million hotel rooms – 27% more than a year before. Priceline’s main income is commission from hotel bookings, mainly on Booking.com.
Despite being the largest global OTA, there is still a long runway of growth available (although probably at lower levels than the explosive rates seen in the past). According to the company, Priceline is only responsible for selling 5% of the available rooms listed on the group’s websites. (Expressed another way, on a typical night for a typical hotel listed on one of their websites, Priceline bookings only represent 5% of that hotel’s available rooms.) In addition, the company will continue to add properties to sell on its websites, implying many years of good growth ahead.
While a US company, Europe is its biggest market. According to the travel research group Phocuswright, Priceline’s market share in Europe is almost a third of online bookings, while in the US it is just 16%. Priceline has been expanding its presence in a number of other international markets, including recently increasing its strategic investment in Ctrip, China’s largest online provider of travel services. The opportunity to grow its US market share, combined with strong market positions in Latin America and South-east Asia, which are currently seeing rapid growth in online usage, adds credence to our view that growth will be healthy for a good while yet.
Priceline benefits strongly from network effects and has the following key competitive advantages:
- The company has 9 000 employees around the world who are using purpose-built tools (content, photos, property descriptions) to work with 820 000 (and growing) properties in 220 countries around the world to make sure they have availability and up-to-date information about the properties they sell.
- Some 2 500 employees are working on Priceline’s sites on all platforms (desktop, mobile, iOS, Android, etc.) to ensure they have the highest and most customer-friendly conversion rates (from site user to paying customer).
- Priceline’s superior data analysis generates demand for its products. Priceline painstakingly analyses the data of millions of customers that come to their websites to ensure that they bid appropriately for the one billion key words in 42 languages that bring traffic to their sites. An OTA’s biggest expense is the acquisition of traffic (advertising to get potential customers onto their website). If they can leverage this expense better than competitors, they are at a significant advantage.
- As the largest OTA, Priceline is better able to drive bookings to a hotel than its competitors. Only 10% to 15% of the hotels on its sites are part of large chains, with the majority being smaller establishments that use Priceline as their primary marketing platform, making them an essential partner for most of their hotel suppliers. This allows them to secure superior terms relative to competitors.
As TripAdvisor is expanding into bookings, Priceline is moving into the travel review space. Its sites now have 77 million reviews that are all at most 15 months old. TripAdvisor has come under fire in recent months for the number of bogus reviews on its site, with hotels posting glowing assessments of themselves under fake customer names. In contrast, Priceline’s reviews are all from customers who have booked through the site and actually stayed in the hotels. These verified reviews – along with its growing presence in search and price comparisons, loyalty rewards, leading mobile travel booking apps and extensive inventory – will help to attract a growing audience and revenue with lower acquisition costs.
We are extremely impressed with its management, who have a clear view of what their customers need and have an exceptional ability to execute. For travellers, they focus on providing the broadest selection of properties, the best pricing and the simplest and best customer service experience. For their hotel partners, they understand that they should bring customers to their properties in the easiest and most profitable manner possible whilst supporting them with value-added services such as revenue optimisation strategies and other hotel management tools should they want them.
Also, Priceline management have shown themselves to be excellent stewards of capital. They have been returning cash to shareholders (in the form of share buybacks), which is extremely rare for a technology company. Apart from buybacks, they have an admirable history of successful acquisitions, beginning with Booking.com. More recently, its Kayak and Ctrip acquisitions are also widely accepted as successful.
In Priceline, investors get a well-managed company, offering a high return on invested capital (averaging 28.6% over the past five years), high growth (compound annual revenue growth of 24.5% over the past five years) and a prodigious converter of cash (with a free cash flow conversion rate approaching 100%) – all at the same forward multiple as the average company on the S&P 500 Index, currently 17.5 times one-year forward earnings. A bargain, in our opinion.
Risk and reward
We expect to see both companies benefiting from solid global growth in travel, especially leisure travel. (Priceline itself recently forecasted a particularly strong travel season thanks to low fuel prices.) Online travel booking will continue to take share from traditional booking channels, and online advertising will take share from traditional marketing channels such as television, magazines and trade fairs.
Travel is among the best sectors for online disruption. The barriers to entry once established are relatively high, the average ticket size of the typical transaction is large, and suppliers (hotel properties) and customers (travellers) are both largely fragmented and have relatively little power at the proverbial bargaining table. Additionally, Priceline and TripAdvisor are among the very best free cash flow generators around, and as such, a dollar of their earnings is worth far more than a dollar of earnings from just about any other business.
Due to the aforementioned network effects, the online travel market also lends itself to consolidation by the industry winners, and as such we expect Priceline and TripAdvisor to consolidate their presence in the online market, taking share from other OTAs and online marketing and traffic acquisition companies (Google, Yahoo, etc.). They could increasingly also take market share off each other as they venture into each other’s respective activities. Both will continue to benefit from their significant investments into their mobile offerings amid the shift in internet usage to mobile.
Still, there is always the threat that a new or existing entrant could disrupt the market, and with it their market positions. One possible contender often cited is Airbnb, an online platform that allows travellers to book rooms and homes with individuals across the world. Airbnb has seen spectacular growth; however, according to Priceline, it has not appeared to have had much of an impact on its business. This could change if Airbnb starts adding more hotels to its platform, but even then it is not clear whether Airbnb would charge a lower commission than Priceline. Indeed, with Airbnb entering as a substitute for hotel rooms, it may even benefit an OTA like Priceline. After all, Priceline can only sell hotel rooms that the hotel itself cannot sell. Accordingly, some level of hotel vacancies are needed for the OTAs to offer value to hotels.
Google is more of a threat. While the company has said that it does not intend to enter the OTA market, it has been making investments into travel and restaurant review sources such as Frommer’s and Zagat, purchased travel software provider ITA, and added features such as flight search and having direct links to hotels with prices in both Google search and maps. This implies they have firm ambitions in the travel industry and could be a serious threat. But listing hotels is very different to the nuts-and-bolts work of supporting reservations and ensuring that listings are updated correctly with accurate descriptions, reviews and prices in a manner that shoppers find useful. As a result, to date, Google has not really made a dent in the life of Priceline. And while Google is also well placed at the starting point of a traveller’s research, we think users will continue to prefer a specialist provider after a certain point of search (i.e. the same way that people use e-commerce sites for purchasing goods) and that Google will struggle to match TripAdvisor’s engaged community and rich content.
These risks aside, we believe Priceline and TripAdvisor offer two solid investment opportunities to take advantage of a sector that is undergoing disruption. Over the past decade, the companies have achieved a position of dominance which will be difficult to displace, and we believe they will remain the key disruptors in the travel industry, and as such will be the key beneficiaries of the shift taking place.