Expedia’s (NASDAQ:EXPE) stock has declined by about 25% since its Q2 2013 earnings announcement on July 25. Although revenues grew by 16% y-o-y, investors were disappointed as net income declined by more than 30%. In the first half of 2013, Expedia’s EBITDA margin faced high pressure owing to heavy advertising from competitors. The company’s average daily growth (ADR) growth also remained flat due to increase in contribution from low ADR hotel bookings in Asia.
We recently lowered our price estimate for Expedia as we expect the company’s EBITDA margin and ADR to grow slower than our initial estimates. (Read: Expedia’s $62 Fair Value: Expansion Opportunities Outweigh Margin Pressures) Despite the downward revision, our price estimate of $62 for Expedia stands at a premium of over 20% to the current market price as we believe that the company’s expanding international footprint, improving scale of the advertising business and growing strength in mobile bookings and hotel bookings position the company for better growth than the past few quarters have shown.
International Expansion Is An Important Growth Driver
Expedia is the biggest U.S. online travel agency in terms of gross bookings, and the company has been focused on expanding its leadership position in international markets. The revenue contribution from international markets has nearly doubled for Expedia in the past five to six years from 24% in 2007 to around 45% at present.
The agency model for hotel bookings is experiencing greater acceptance in Europe due to a large number of small and independent hotels in the region. Such hotels prefer the agency model for bookings as it allows guests to pay at check-out. In line with this, the Expedia Traveler Preference (ETP) program, which gives guests the option to choose from the merchant or agency models of payment, is gaining popularity in Europe. Over 30,000 hotels have signed up for the new program till date. 
Rising per capita income in emerging economies also provide tremendous growth opportunities for travel agencies. Additionally, Internet penetration in these economies is relatively low and is expected to grow at a rapid pace, which leaves immense potential for growth in the online travel industry as a whole.
The acquisition of VIA Travel by Egencia, the Air-Asia Expedia joint venture, the growing popularity of hotel.com, the collaboration with Fotopedia Paris & Fotopedia Japan, and the eLong partnership to expand in China are factors that have contributed to Expedia’s growth in international hotel bookings. We believe these will continue to be the guiding factors for its future growth as well.
Increasing Strength In Hotel Bookings
Hotel bookings is the most important division in Expedia’s portfolio. It contributes approximately 62% to the company’s valuation as per our estimate. In addition to accounting for the majority of its revenue, hotel bookings offer around 20% revenue margin which also makes it the most profitable division compared to airlines (2%) and car rentals & cruises (9%).
Backed by near 20% growth in global room nights booked, Expedia registered 12% y-o-y growth in hotel revenue in Q2 2013. Although these growth rates are lower than those achieved in the past quarters, we believe the company’s market share will increase in domestic as well as international markets in the future.
Expedia recently entered into a strategic marketing agreement with Travelocity that will allow the former to sell inventory in the U.S. through the latter. In effect, Travelocity will act as an additional distribution channel for Expedia, helping it to counter rising competition from Priceline.com and Booking.com in the domestic market. For more insights on the Expedia-Travelocity deal, read our article Expedia Is Better Positioned For Growth After The Travelocity Deal.
We believe that Asian operations will drive growth in international bookings as the market is fragmented with a large a number of independent hotels. Such hotels have a greater reliance on OTAs to generate bookings compared to large hotel chains which can sell a good amount of inventory through their own websites.
Advertising Is Now A Bigger Contributor To The Overall Business
Until 2012, advertising contributed marginally to total company revenues. However, with the acquisition of Trivago the division’s revenue contribution increased close to 7% in Q2 2013. With over 600,000 hotels and 140 booking sites across 30 countries in Europe, Trivago is one of the leading meta-search engines for hotel bookings in the region. It has managed to double its revenues each year since 2008.
Expedia spent 33% more on sales and marketing in Q2 2013 compared to the same quarter last year, and Trivago accounted for 11% out of the 33%. Expedia plans to continue investing aggressively in Trivago to globally expand the business in key travel markets, including the U.S., Canada, Australia and New Zealand.  Although such investments will impact the company’s bottom line, we believe they will also drive strong growth in the advertising division. According to our analysis, Expedia’s advertising revenues will increase by over 100% y-o-y in 2013 due to the acquisition of Trivago, and grow in high-single digits to low-double digits thereafter.
Rising Mobile Penetration
Expedia claims that over 50 million apps have been downloaded across all of its brands and geographic regions. The hotels.com app is one of the top ranked apps in many countries. The company launched new apps and mobile websites in Q2 2013 across several of its brands, including Hotwire.com, which introduced an iPad app that features interactive maps and a simplified booking process that allows users to cut travel booking time by half. ((Expedia, Inc. Reports Second Quarter 2013 Results, Expedia Inc, July 2013)) Expedia is also striving to increase mobile bookings by spreading awareness about the Expedia app through its newly launched TV campaign. 
The company aims to cover 20% of its transactions via mobile devices by 2015. With a growing number of people using mobile devices to go online, we believe the mobile platform offers immense growth potential for travel services. Additionally, mobile bookings present an opportunity to generate incremental revenues as they are usually made over shorter booking windows.Notes: