Expedia (NASDAQ:EXPE) is scheduled to release its Q4 2013 earnings results on Thursday, February 06. The leading online travel agency (OTA) earned $1.4 billion in revenues in the third quarter of 2013, registering a 17% year-on-year increase. Worldwide hotel revenue grew 11% to more than $1 billion helped by robust growth in room nights sold, while air ticket booking revenues increased 16% to about $100 million as the company sold 7% more tickets and airfares rose 3%, compared with the year-ago period. 
In the first half of 2013, high competition in the travel industry had negatively impacted Expedia by weakening the growth in direct type-in traffic, which is the most efficient traffic for customer loyalty and profitability, according to the company’s management. Expedia witnessed some improvement in direct type-in traffic in Q3 as competitive activity in the industry eased, and the company continued to invest in direct marketing channels, such as TV advertising.
We have a $65 price estimate for Expedia’s stock, in line with its market price. We will update our estimate based on the upcoming results.
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Increasing Strength In Hotel Bookings
Hotel bookings is the most important division in Expedia’s portfolio. It contributes approximately 65% to the company’s valuation as per our estimate. The division posted 20% year-over-year growth in hotel room nights sold in Q3, topping 44.1 million, on the back of rapid adoption of its Expedia Traveler Preference Program (ETP).  The ETP program allows travelers to pay for bookings upfront (merchant model), or pay after the stay is completed (agency model).
Prior to the roll out of ETP in the back half of 2012, Expedia was predominantly a merchant model based company. The agency model is now gaining preference from hoteliers via the ETP program. Hotels that have converted to ETP are witnessing market share increases since guests prefer to pay at the time of checking out of the hotel. More than 35,000 hotels have signed up for the ETP program since its launch.  We expect an increase in the number of hotels joining the program as it is rolled-out globally, driving up Expedia’s market share of worldwide hotel rooms booked.
Expedia also recently entered into a strategic marketing agreement with Travelocity that will allow it 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. According to an SEC filing by Sabre, Travelocity’s parent company, Expedia has the right to acquire Travelocity at any point of time during its eight-year contract with Sabre. For more insights on the Expedia-Travelocity deal, read our article Expedia Is Better Positioned For Growth After The Travelocity Deal.
ETP Will Put Pressure On Revenue Margins
Expedia registered a 7% year-on-year decline in revenue per room night in Q3. This was the result of a plethora of factors, the most important being the ETP program which increased agency model revenues by 40%, much higher than 4% increase in merchant model revenues.  Revenue margins under the agency model are lower as Expedia simply acts as a travel agent and earns a small commission on bookings, while under the merchant model revenue margins are higher as the transaction is completed on Expedia’s website itself. The shift from the previously dominant merchant model to the ETP model lowered overall revenue margin for Expedia. Going by our expectations, if the ETP program is embraced by hoteliers globally, Expedia’s revenue margin will continue to decline as agency model revenues rise. Consult the Hotel Bookings drivers to see how we are modelling this decline.
The increasing mix of low ADR (Average Daily Rate) room nights in Asia-Pacific via the partnership with eLong, a shift to bigger hotel chains with lower margins and competitive discounting additionally impacted Expedia’s revenue margin in the third quarter. We expect these trends to continue in the near future which will further weigh on revenue margins. However, it is not a matter of concern for investors as the company’s market share will benefit from such initiatives.Notes: