In February, online travel company Expedia (Nasdaq:EXPE) announced it missed fourth quarter earnings estimates by $0.02 or 6.1%. The news sent its stock down 12.5% and it hasn't recovered those losses in the month since. Back in August 2005, Expedia became a public company for the second time when IAC/Interactive (Nasdaq:IACI) did a one-for-two reverse stock split and then issued one new share of Expedia stock for every share of IAC/Interactive. More than six years later, its stock is worth less than in the first days after the split. I'll look at some reasons why it's a good time to buy.
Despite the two cent miss in the fourth quarter, 2010 has to be considered a reasonably strong year. Revenues grew by 13% to $3.35 billion and operating income by 28% to $732 million. Both were record numbers for the company. If not for a couple of one-time expenses, it would have achieved its goal of double-digit growth in operating income before amortization (OIBA). In 2011, due to its continuing investment in technology and marketing to make the company more competitive, OIBA growth will only be in the mid single-digits. As a result, some analysts lowered their rating on its stock from "Buy" to "Hold." Benchmark Co. analyst Fred Moran moved the stock's target price from $36 down to $26. While I understand analyst concerns, let's think about the big picture for a second. If Expedia grows revenues by 10% in 2011, it'll do $3.69 billion. In 2009 and 2010, its net margins were 12.6% and 10.1% respectively. Using the lower margin from 2009, net income would be approximately $373 million, just $50 million less than in 2010. That's the absolute downside in my opinion. I suspect the real number will be around $421 million, the same as in the past year. Short-term pain for long-term gain.
If you travel, there's a good chance you've used its site. It's a great way to get a feel for a hotel's ambiance and service. Sure, it has its detractors but you can't deny its success. Expedia bought Trip Advisor in 2004 for $237 million. It makes money from advertising on its site as well as when visitors click through to third-party booking sites such as Priceline.com (Nasdaq:PCLN), Orbitz Worldwide (NYSE:OWW) and even Expedia.com. Its profits are tremendous. In 2010, TripAdvisor's third-party revenue grew 48% to $314.5 million with an operating profit before amortization of $259.6 million and a margin of 82.5%. This compares with an OIBA margin of 29% for the much larger leisure segment. It's paid for the 2004 acquisition and then some. With 27 sites in 18 countries including China, its potential is huge, despite competition from sites like Priceline's Travel Post.
Expedia faces several issues as it continues to grow its business both in the US and internationally. Hotel chains and airlines alike are eager to reduce the amount of money they pay to intermediaries like Expedia and Priceline. The Marriott's (NYSE:MAR) of the world will continue to find ways to push traffic to their own sites, cutting out the intermediary. In addition, new entrants continue to enter the marketplace including Google (Nasdaq:GOOG) and HipMunk. Increased competition will make it harder for Expedia to protect its market share. Analysts are right to wonder how much the company will have to invest to remain competitive. Lastly, between the economic fragility that still exists in many parts of the world, tensions in the Middle East as well as natural disasters in Japan and elsewhere, travel could become a forgotten pleasure. That last point hurts everyone equally. However, if travel spending remains low in the coming years, larger companies like Expedia would seem to have a natural advantage over smaller competitors. If I'm Expedia, I'm more worried about Marriott, Hyatt (NYSE:H) and the rest of the global hotel chains.
In January, valuation website Trefis initiated coverage of Expedia at well over $38.57. After its February earnings miss, Trefis adjusted the stock's value down to $29.12 to reflect lower profit margins. Even at the new price, it's still trading well below its estimated value. Better still, its P/E today is significantly lower than what it was in 2005, despite revenues and operating profits that are 58% and 84% higher. I'm not suggesting that Expedia shares should be trading at 37 times earnings but certainly higher than 15. Put another way, if Priceline is considered fairly valued at 45 times earnings, I don't see why Expedia isn't trading for a higher multiple. After all, Priceline faces similar issues.
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Expedia's stock is down 23% since October. Margin concerns are overblown and even though the next few quarters will be a bumpy ride, the result on the other side should be a higher priced stock.
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