Shares of Expedia Due for Re-Rating on Margin Evolution

Expedia is one of the best online internet travel players, driven by its scale as the world’s largest online travel agent (OTA) based on gross bookings, its well-known brands and portfolio of websites, strong and accelerating hotel room night growth, high mix of organic traffic, and portability to mobile.

Thesis
The big differentiators among OTAs are scale, geographic mix, and product mix. We believe Expedia is well positioned given its large market share in the OTA space where scale is becoming increasingly important. It also has lower exposure to economically challenged European regions vs. its largest peer (PCLN), which temporarily should help sentiment. The company is coming out of a 4-year investment cycle which has allowed accelerating growth and expanding margins driven by its technology platform upgrade.

Expedia is in the midst of a major acceleration from improving conversion rates as a result of its recent website and platform upgrade. We believe its key metric, hotel room night growth, is poised for acceleration on the back of the platform overhaul. The initial stages of the global platform migration have already yielded impressive results, including a significant improvement in the core Expedia brand.

Expedia still stands to benefit from the rollout of its revamped air and package platforms over the next couple quarters. We expect the conversion rate improvement and rapid growth in hotel room night bookings to continue as part of the company’s turnaround, and see the stock to trade up from the current $61 share price to our target price of $75 in the next twelve months.

Continued solid execution, strong organic tailwinds and an aggressive expansion strategy have allowed the company to gain market share and record accelerating results despite the challenging macro environment. There are also rooms for margins improvement and a favorable mix shift in revenue towards higher-margin segments.

Valuation
At $62, Expedia is currently trading at 16.2x 2013 P/E and 8.9x 2013 EV/EBITDA. While the stock has recently hit its 52 week high, we see potential for Expedia share price to continue to rise.

At 16.2x 2013 EPS, EXPE trades at a marginal discount to PCLN. Given Expedia’s improving growth outlook, despite its larger exposure to the air ticket market and on the more mature domestic hotel versus Priceline, Expedia warrants higher premium vs. historical multiple spread between the two. We also believe that the macro conditions impacting PCLN shares are not reflection of deteriorating company’s fundamentals, and we expect investor sentiment around the company and valuation to improve from current depressed levels.

We derive our target price using a five year DCF, which assumes 10% 5-year EBITDA CAGR, long term perpetuity growth rate of 3% and a weighted average cost of capital of 11%, consistent with the risk profile of similar large-cap internet companies.  

The online travel peer group is trading at 18.4x 2013 P/E and 10x 2013 EV/EBITDA. Given Expedia’s ongoing market share gains, accelerating growth from website and platform improvement, and growing international exposure, we believe a 20x our 2013E EPS of $3.8 is reasonable. Combined with a valuation at 8.2x 2013E EV/EBITDA, we arrive at a 12-month price target of $75 per share.

Catalysts:
1. Strong and Accelerating Hotel Room Night Growth
2. Platform Upgrade Driving Conversion Improvement at Hotels.com (and Expedia.com)
3. Margin Expansion Opportunity
4. Buyback and Dividend